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U.S. Says Hedge Fund Regulation Is `Working Well' (Update2)

Date: Thursday, February 22, 2007
Author: David Scheer and Jenny Strasburg, Bloomberg

 Feb. 22 (Bloomberg) -- A U.S. presidential panel said the current system of hedge-fund regulation is ``working well'' and market discipline remains the best way to protect investors and guard against risks to the financial system.

The panel, led by Treasury Secretary Henry Paulson and including his counterparts at the U.S. Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission, said in guidelines released today that the responsibility of maintaining discipline in the $1.4 trillion industry falls on hedge-fund managers, investors, creditors, trading partners and market regulators.

``Those who would believe that the role of regulators is to guard against any losses or somehow prevent losses or a hedge fund from having problems, they have a different philosophy about regulation than I do,'' Treasury Secretary Henry Paulson, who led the panel, said in an interview today.

The panel's report, which Paulson called the ``unified perspective'' of U.S. regulators, follows the failure last September of Amaranth Advisors LLC, a hedge fund that lost $6.6 billion on natural gas trades. In June, a federal appeals court knocked down an SEC rule requiring hedge funds to submit to inspections.

``Investor protection concerns can be addressed most effectively through a combination of market discipline and regulatory policies that limit direct investment in such pools to more sophisticated investors,'' said the guidelines issued by the President's Working Group on Financial Markets.

At Odds with Europe

The panel's stance is at odds with the position adopted by some European governments which, led by Germany, have advocated tougher regulation, such as a voluntary code of conduct or registration of trading positions.

It is up to pension managers who invest some of the retirement pay of less-sophisticated individuals in hedge funds to be diligent, the panel said. Some members of Congress have expressed concern that more workers' pension fund money is moving into the risky funds.

The report ``places the risk of investing in hedge funds with the investors who are best able to understand and accept those risks,'' Jay Baris, an attorney at Kramer Levin Naftalis & Frankel in New York who represents hedge fund advisers, said in an interview. `` It's consistent with the approach regulators have taken in the past.'

Hedge funds are private pools of capital that let managers participate substantially in gains on the money invested. The panel said the funds ``bring significant benefits'' to the financial markets.

Paulson said in the interview ``there is no doubt they give rise to certain challenges,'' including the use of derivatives traded outside stock exchanges.

Derivatives are financial instruments whose value is based, or derived from, an underlying stock, bond, loan, currency or commodity. They account for $370 trillion in over-the-counter trading 10 times more than in 1998.