No hedge fund firm today should be designated a “systemically important financial institution” by regulatory authorities, according to the Alternative Investment Management Association (AIMA), the global hedge fund association.
As the Financial Stability Oversight Council considers and is expected to clarify soon the criteria by which it will determine which non-bank financial companies may be deemed systemically important, and thus subject to increased regulatory scrutiny, including additional oversight by the Federal Reserve, AIMA re-iterated its strong belief that no hedge fund manager based or operating in the US or elsewhere currently poses a risk to financial stability.
“We believe that no single hedge fund firm today is sufficiently large, leveraged, complex or interconnected that its failure or financial stress would cause a market disruption sufficient to destabilise the financial system,” says AIMA Chairman Todd Groome (pictured).
“We note that the UK’s Financial Services Authority has stated that, based on their risk reporting framework, none of the large hedge funds they have examined currently poses ‘a significant systemic risk to the financial system’. We also note that the FSA’s hedge fund survey has found that major hedge funds ‘did not pose a potentially destabilising credit counterparty risk’, and that the levels of leverage employed were ‘relatively low’, which ‘suggests a contained level of risk’.”
AIMA also cited the fact that during 2008 more than 1,400 individual hedge funds closed or were liquidated in an orderly manner. “It has been acknowledged by many regulators and policymakers that those closures had virtually no impact on hedge fund firms’ counterparties or the stability of the financial system at large,” says Groome. “This difficult period provided a very up-to-date and significant stress test concerning hedge fund risk to markets."
AIMA also pointed to the fact that the hedge fund industry is comparatively small, dispersed and quite heterogeneous compared to other much larger sectors of the financial services industry. The global hedge fund industry comprises approximately 10,000 hedge funds, managing a combined USD2 trillion in assets, whereas some individual financial institutions’ balance sheets are much larger than the entire global hedge fund industry.
“Hedge funds collectively represent a relatively small group of extremely heterogeneous and often very small businesses, and even their collective positions and exposures are not such that individual failures pose a risk to financial stability,” says Groome. AIMA also stressed that hedge fund firms employ significantly lower levels of leverage than banks and some other financial institutions.
Groome says: “The 2008 experience shows that hedge funds are ‘safe to fail’, even if they are not fail-safe. Moreover, hedge fund activities do not typically contribute to pro-cyclical market dynamics; they tend to be contrarian or to look for market inefficiencies and, through their investment activities tend to make markets more efficient. As such, hedge funds enhance diversity of market behaviour, and thus contribute positively to financial stability.”
While stressing that no single hedge fund firm should be deemed systemically important, AIMA reiterated its strong support for the registration of hedge fund managers. “By having managers register with and report to the Securities and Exchange Commission and other national authorities, including FSOC, more data will be available to allow better monitoring and assessment of markets. As such, hedge funds can contribute to a more effective systemic risk monitoring system,” adds Groome.
