FSF recommendations on potential financial system risks relating to hedge funds

19 May 2007




The Financial Stability Forum issued a report recommending action by financial authorities, counterparties, investors and hedge fund managers to strengthen protection against potential systemic risks relating to hedge funds and other highly leveraged institutions.

This paper responds to a request from the G7 Finance Ministers and Governors at their February 2007 meeting in Essen to update its 2000 report. It focuses on financial stability issues relating to hedge funds. It does not address investor protection issues associated with institutional or retail investments in hedge funds.

The report states that activity by hedge funds has expanded rapidly. Also, a small number of core intermediaries have come to play an increasingly important role in some key areas of wholesale financial markets. The relationships between these core intermediaries and hedge funds, through prime broking and counterparty relationships, have thus become more central to the robustness of the financial system.

The FSF makes five recommendations to support and where relevant build upon ongoing supervisory and private sector work:

  • Supervisors should act so that core intermediaries continue to strengthen their counterparty risk management practices.
  • Supervisors should work with core intermediaries to further improve their robustness to the potential erosion of market liquidity.
  • Supervisors should explore and evaluate the extent to which developing more systematic and consistent data on core intermediaries’ consolidated counterparty exposures to hedge funds would be an effective complement to existing supervisory efforts.
  • Counterparties and investors should act to strengthen the effectiveness of market discipline, including by obtaining accurate and timely portfolio valuations and risk information.
  • The global hedge fund industry should review and enhance existing sound practice benchmarks for hedge fund managers in the light of expectations for improved practices set out by the official and private sectors.

    The FSF underscores the importance of ongoing cooperation among financial authorities in taking forward these recommendations and in spreading good practices. It also notes the importance of authorities’ market surveillance activities and of their continuing dialogue with a range of market participants and actors to keep abreast of innovation and to assess the adequacy of practices and policy approaches in addressing risks to financial stability.

    The 2000 Report was published in the wake of the Asian financial crisis and the turbulence in global markets that accompanied the collapse of Long-Term Capital Management (LTCM) in 1998.

    Press release
    Full report (update of the FSF’s 2000 report)
    FSF recommendations and concerns (2002)
    Progress report (2001)
    Working group report (2000)

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