Wednesday, October 17, 2007

Regulators Can't Have Their Cake and Eat It

There has been a lot of press recently reporting the call from regulators and politicians for hedge funds to have greater disclosure. It has been flavour of the month recently because of the 'threat' (as some see it) of the lightly regulated nature of these investment vehicles.

The real question is; Can hedge funds survive if they have to disclose their inner most workings?

I think not. At least not in their current manifestation.

Mutual funds investing the pension money for little old ladies and the masses should be accountable and heavily regulated considering the social impact of a failure of a large fund. Pensioners will still need their pensions despite such a failure, and this won't go away, so the tax payer would eventually pick up a portion of the bill. In this instance regulation is very good indeed.

The problem I have with the regulators on the hedge fund point is that you can't have your cake and eat it. You cannot, on the one hand, restrict who can invest in the funds and stop funds advertising and on then on the other ask the funds to give their inner most trading secrets to regulators via disclosure rules.

The issue, in my opinion, is not that regulators are worried about rich people losing money, it is the fact that pension funds do invest in some hedge funds and they are becoming more institutional vehicles. For accepting pension fund money, certain companies only have themselves to blame for the interest that regulators are showing. Another issue is that the big funds do have an affect on the markets, we all know that, but if a 'club' of rich people got together and started investing their money as hedge funds do would they be required to disclose? Look at it this way, where does it end?

The markets are held up as the crux of the 'free' economy. Regulators, however, are seeking to uncover the trading methods of people who are successful at playing that market and thus restrict their ability to do business.

Does Microsoft have to give there source code? Does Coca Cola have to give up their secret ingredient, do journalists have to give up their sources for stories and do politicians declare everything they should?

The argument that hedge funds are a 'threat' to the stability of the markets is, frankly, a little old school. Look at what we have just witnessed in August, the potential was for BIG trouble and yet the speculative funds were buyers of troubled debt, troubled companies and troubled banks, that, my friend, is an efficient market in operation..

I have been involved with small companies previously and there used to be huge criticism of brokerage companies that operate in that sector, it is risky yes, but it also provides speculative liquidity to the marketplace. If there were not companies and clients willing to invest in that area of the market, there would be no AIM or Plus markets for example. On a scale a thousand times larger, hedge funds provide this speculative liquidity to the markets.

If you over regulate these players and take that speculative liquidity from the markets who will be left to catch the Dow or the Footsie in the next market 'correction'? Mutual Funds? Pension funds? Central Banks? Politicians?

Somehow, I don't think so......


Jack Payne said...

With nearly 50% of the hedge funds off shore, in the Caribbean, and highly supected of money laundering because of their secretive nature, they have a real PR battle to fight.

Amaranth dropping a whopping $6 billion in 2005, is apparently not enough for most investors.
A surprising number still have faith in them.

Winterman Asset Management SA said...

Thanks for your comment Jack. I agree, there is a huge amount of PR required to keep these vehicle running without interferance... is disclosure hey key, however?