Hedge Funds Face Call to Detail Risks, Draft Report Shows

Date: Friday, April 20, 2007
Author: Rainer Buergin, Bloomberg

April 20 (Bloomberg) -- Hedge funds will be urged to disclose more information about their strategies and the risks they involve, according to a report commissioned by central bankers and finance ministers from the Group of Seven leading industrial nations, a draft obtained by Bloomberg News shows.

``For market discipline to work effectively, investors and counterparties need accurate and relevant information,'' says the report by the Financial Stability Forum, which includes central bankers, treasurers and supervisors. ``Hedge fund managers should provide information with sufficient detail and frequency'' and inform investors and lenders ``of strategies and the amount of risk being taken.''

The report strengthens German Finance Minister Peer Steinbrueck's hand in talks with his counterparts from the U.S. and the U.K., who have resisted the German-led push for tougher oversight of the $1.5 trillion industry. Hedge funds are mostly private, unregulated pools of capital where managers can buy or sell any assets, participating substantially in the profits.

The private sector should also ``enhance, where appropriate, existing sound practice benchmarks for hedge fund managers, especially in areas such as risk management, valuations and disclosure to investors and counterparties,'' the FSF said.

The report was commissioned at the G-7 meeting in the German city of Essen on Feb. 10. It will be discussed at next meeting in Potsdam, outside Berlin, on May 18-19.

`Policeman'

Bundesbank President Axel Weber's proposal on April 15 to develop sound practices into a code of conduct for hedge funds was dismissed by Robert Steel, the U.S. Treasury's top finance official, who said it ``sounds like a policeman and that's not what I'm into.''

U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke have advocated a ``light regulatory touch,'' noting that hedge funds have deepened liquidity in financial markets, spurred innovation and helped diffuse risks. Investors in them are sophisticated and the banks that lend to them have an interest in ensuring that excessive risks aren't taken, U.S. officials say.

``There has been some erosion in counterparty discipline recently, reflecting strength of competition for hedge fund business,'' said the FSF. ``These complement other signs of complacency about risks in markets,'' such as the erosion of covenants in credit contracts, possible under-pricing of credit, market and liquidity risks.

The FSF ``supports broad and effective implementation'' of disclosure proposals by the U.S. President's Working Group on Financial Markets and the draft principles for the valuation of hedge fund portfolios published by the International Organization of Securities Commissions.

Amaranth

Hedge funds' practice of awarding managers a share of the profit creates an incentive to make leveraged bets with borrowed funds, a tactic that can stoke returns and magnify loses. The funds are back in the spotlight after Amaranth Advisors LLC, based in Greenwich, Connecticut, lost a record $6.6 billion in September from bets on natural gas.

Prime brokers including Goldman Sachs Group Inc. and Bear Stearns Cos. earn fees from loans to hedge funds. International regulators are now gathering information on how margins are set for those loans.

To contact the reporter on this story: Rainer Buergin in Berlin at rbuergin1@bloomberg.net .