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AIMA’s research paper highlights crucial differences between the key functions of a traditional bank and those of credit hedge funds and other non-bank financial institutions.
Credit hedge funds do not take deposits, do not offer daily liquidity nor otherwise hold themselves out as guaranteeing the return of the invested principal. They manage their liquidity profiles by agreeing investor redemption terms which correspond to the liquidity profile of the underlying investments. They therefore do not engage in significant maturity transformation. Crucially, hedge funds do not benefit from implicit or explicit taxpayer guarantees.
Andrew Baker, AIMA CEO, said: “Credit hedge funds – and hedge funds in general - do not operate in the shadows. Managers are extensively regulated, are subject to reporting requirements, and do not engage in any significant sense in credit, liquidity or maturity transformation, so their activity is not ‘bank-like’. Credit hedge funds do not belong in the same category as banks, let alone ‘shadow banks’.”
The G20 mandated the Financial Stability Board (FSB) to develop recommendations to strengthen the oversight and regulation of the ‘shadow banking’ system in November 2010, but there has been considerable debate about what constitutes a ‘shadow bank’. Recent G20 language referred to 'money markets funds, securitisation, securities lending and repo activities, and other shadow banking entities'.
Credit and credit-related hedge funds comprise up to one-third of the global hedge fund industry and use a very diverse range of investment strategies, ranging from fundamental credit analysis and arbitrage to the trading of complex derivatives.