Hedge funds, banks need risk standards: Fed official |
Date: Thursday, April 19, 2007
Author: Reuters
NEW YORK, April 18 (Reuters) - A senior U.S. Federal Reserve official said
on Wednesday that hedge funds, their lenders, and investors have
"considerable work" to do to adopt consistent standards for managing
risk in that class of assets.
The ballooning $1.4 trillion industry still
has little in the way of standards for credit terms, risk measurement and
transparency, according to Jim Embersit, deputy associate director for the
Market and Liquidity Risks Section for the Fed's Division of Banking
Supervision.
Embersit's comments, during a panel discussion about hedge funds at
Growing legions of pension funds are piling into hedge funds, representing
growing retail investment in an asset class previously largely confined to
wealthy individuals, foundations and endowments.
"This is an area that is crying out for leadership in the investor
community," said Embersit. He said investors should demand consistent
standards for risk management and internal controls to allow them to assess
their exposure to various investment strategies.
"Investors should seek assurances that
hedge funds are complying with risk management practices," said Embersit.
He also said "more work needs to be done in dealer banks" that lend
money to hedge funds for their strategies.
With hedge funds now numbering more than
8,000, banks may be loosening their lending and due diligence standards as they
grapple with a flood of new clients in their prime brokerage divisions, he
warned.
Embersit's comments come on the heels of a
report by the U.S. President's Working Group on Financial Markets, which
concluded that current regulations appear sufficient to allay systemic threats
and protect hedge fund investors.
However, the panel, headed by the U.S. Treasury Department, urged hedge fund
managers to take measures to keep investors in the loop so they can better
assess their risks.
Of particular concern are the risks in
so-called crowded trades, where multiple funds may exit the same asset at the
same time and lead to buy-sell imbalances, panelists said.
Gary Krivo, managing director and co-head of
the asset management and hedge fund group for JPMorgan Chase & Co., said
many widely used hedge fund trades can have multiple counterparties through
investment banks' prime brokerage divisions. Hence, the extent of the aggregate
leverage and risk in such trades may not be immediately quantifiable.
"If there are eight to 10
counterparties, do we know the risks?" asked Krivo. "We may not have
the whole picture."
He said JPMorgan, however, has systems in place to
ensure that it does know the extent of counterparty risk for unusual and highly
leveraged trades.
Some panelists said there is no way to
quantify systemic risk, since the total amount of leverage is unknown with the
ballooning creation and use of financial derivatives, much of it in use to
amplify hedge fund trades.
"The real problem is that we don't know
the amount of leverage in the system," said Stephen Brown, a