Fears over lending to hedge funds sparks probe by US and UK

Date: Wednesday, January 17, 2007
Author: Jeremy Grant in Washington and Ben White in New York, FT.com

Concern that booming lending to hedge funds may have led to a relaxation in credit standards has prompted US and European regulators to start the first joint investigation into whether banks and brokers are managing such risks appropriately.

The move is a sign that regulators are stepping up transatlantic co-ordination.

It comes after a call by German chancellor Angela Merkel for closer US-European Union co-ordination on financial regulation.

Officials from the Securities and Exchange Commission, the UK's Financial Services Authority, the New York Federal Reserve and other European regulators met last month to discuss credit issues, said an FSA spokesman.

They want to know if the collateral required of hedge funds from their lenders is enough to cover losses, and whether margins are set at appropriate levels to help avoid systemic risk in the event of trading losses. The development comes as central banks and regulators on both sides of the Atlantic have privately questioned whether relying on banks to look after their exposures to hedge funds is enough to avoid a repeat of the 1998 near-collapse of Long Term Capital Management given the explosive growth of hedge fund lending.

Annette Nazareth, an SEC commissioner, said regulators had met investment banks – understood to be Goldman Sachs, Morgan Stanley, Lehman Brothers, JPMorgan Chase, Citigroup, UBS, Credit Suisse and Deutsche Bank – to determine how each of them decides the amount of collateral they demand when lending cash or securities to hedge funds.

"This is the first time that we have come together for a particular topic; the decision was to look into margin practices," she told the Financial Times.

At issue is relationships between hedge funds and banks, as well as their Wall Street prime brokers.