Making hedge funds more transparent

Summary

15 May 2007 - Hedge funds are an important part of a modern and dynamic financial market-place. They make a key contribution to the efficient allocation of capital and risk and are responsible for an increasing share of financial market liquidity. A growing number of institutional investors such as insurance companies and pension funds use them as investment vehicles.

Hedge funds do not only enhance market efficiency, however. There can also be risks associated with their activities. The systemic risks which may arise from hedge funds, with their potential threat to international financial stability, represent the main challenge for international policymakers.

A prerequisite for ensuring sustained financial stability is adequate transparency about the level and allocation of financial risk. The rising proportion of business volume generated by market participants that are subject to no, or only limited, regulation is making this transparency increasingly difficult to achieve, however. Calls for hedge funds to be more transparent are therefore justified and are supported by Germany’s private banks.

Proposals which would use banks as a source of information about hedge funds have met with a broadly positive response. In some countries, data is already gathered in this way. An international working group reporting to the Financial Stability Forum, for instance, should evaluate the suitability of this data for providing information about systemic risks and examine possible methods of harmonisation.

Should the data be deemed a suitable tool for improving financial stability, only those prime brokers which have direct dealings with hedge funds should be involved. Ultimately, however, market discipline will only be enhanced if, in a subsequent step, national regulators exchange the information thus gained and make their findings available in consolidated form to market participants. This task could be handled by the Bank for International Settlements (BIS), for example.

Since a solution of this kind requires highly complex political co-ordination, preference should be given in the short term to various types of qualitative self-regulation. A threepillar model is proposed comprising a code of conduct, a rating system and regular dialogue both among regulators and between regulators and hedge funds.

Position paper [PDF - 85 KB]