Last week the US Treasury Department formally dropped its proposals for anti-money laundering regulations governing the hedge fund industry. This was partly because of the difficulties in enforcing such a system on an unregulated industry with no oversight body in place to do so, but also because Treasury experts say that hedge funds are an unlikely choice of vehicle for money laundering or terrorist financing because of their risk profile and relative lack of liquidity.

However, the situation could quickly change once new president Barack Obama is installed, according to Senator Carl Levin, who describes the decision as 'inexplicable, ill-timed and unwise'. He says: 'The absence of anti-money laundering controls on hedge funds is another regulatory gap that the Congress will have to tackle after the election.'

Early last year Obama joined fellow senators Levin and Norm Coleman in introducing legislation that would have required hedge funds to establish anti-money laundering programmes under the supervision of the Treasury Department and also sought to curb abuse of offshore tax havens and tax shelters.

The proposed Stop Tax Haven Abuse Act, a strengthened version of a tax reform bill introduced by Levin, Coleman, and Obama in the previous Congress, also failed to make it into law. But with Obama in the White House and the Democrats with a strengthened grip on Congress, third time might well prove unlucky for hedge funds and other members of the offshore financial services industry.

'Hedge funds are unregulated financial companies that can handle millions of dollars in offshore money without any legal obligation to check who is behind the funds or report suspicious activities,' Levin says, incorrectly, since funds domiciled in jurisdictions such as the Cayman Islands or British Virgin Islands are required to run due diligence checks on their investors that are often more stringent than the requirements in the US.

'But instead of plugging the hedge fund regulatory gap by issuing a final rule, the administration went the opposite way, withdrew its anti-money laundering proposal, and offered nothing in its place.'

Not everyone in the Democratic Party believes this. Barney Frank, chairman of the House of Representatives' financial services committee, notes that many financial institutions have been overburdened by anti-money laundering regulations and excessive reporting requirements. But hedge fund managers can expect the new president at the very least to revisit the Treasury decision.