Germany Pushes Hedge-Fund Code, Challenges U.S. Plan (Update1)

Date: Saturday, April 21, 2007
Author: Rainer Buergin and Simon Kennedy, Bloomberg

April 21 (Bloomberg) -- German Finance Minister Peer Steinbrueck said the U.S. policy of providing guidelines to hedge funds is ``not enough'' as he sought European support for them to be subjected to a code of conduct.

Germany and the U.S. are at odds over how to toughen oversight of the $1.5 trillion hedge-fund industry with Steinbrueck pushing a formal code and U.S. Treasury Secretary Henry Paulson supporting a set of principles that informs investors and leaves them to monitor risk.

``We need to see what kinds of benchmarks are developed to ensure these practices are implemented,'' Steinbrueck told reporters after a meeting of finance ministers and central bankers from the 27-nation European Union in Berlin today.

The EU is planning to form a joint proposal when its finance ministers next meet in Brussels on May 8 before those from the Group of Eight governments convene in Potsdam, Germany, a week later. Luxembourg Prime and Finance Minister Jean-Claude Juncker said there was a ``good chance'' the German initiative would be endorsed.

German officials view the surge in the size and complexity of hedge funds as a risk to financial markets and have used their presidency of the EU and G-8 to place the topic on the agenda of both. Funds have more than tripled since a bailout of Long Term Capital Management LP in 1998, and are back in the spotlight after Amaranth Advisors LLC lost a record $6.6 billion in September.

`Favorable Context'

``We need to realize we have a very favorable context in the world economy, but we need to be sure in a less favorable context these new players in the market work properly,'' Bundesbank President Axel Weber said in Berlin.

The lightly regulated pools of capital allow managers to participate substantially in investment returns. That creates an incentive to make leveraged bets with borrowed funds, a tactic that can stoke returns and magnify loses.

Finance ministers also discussed a report saying private equity funds' activities pose a risk to market stability, noting a ``need for great vigilance in enforcing existing provisions on market abuse in order to sustain market integrity and confidence in private equity business.''

Steinbrueck said his proposed code would be ``successful'' if the 15 or so hedge funds that dominate the industry could be persuaded to sign it. ``It should be market-driven, but the industry itself should have a deep interest to support us in stabilizing financial markets and in protecting the investors,'' Steinbrueck said in an interview today. ``A self-regulating system would be important.''

German Approach

The German approach won backing from the Financial Stability Forum, which the G-8 has charged with studying the issue before the Potsdam talks. A draft of its report obtained by Bloomberg News urged funds to disclose more information about their strategies and the risks they involve.

The European Commission in a separate report to the ministers today was more equivocal. While it agreed that transparency was ``important'' and that some investors needed to be protected, it also praised funds for improving the liquidity and efficiency of financial markets and questioned whether regulators would be able to use more information on them.

``Hedge funds are very useful institutions but there are reasons for concern,'' EU Commissioner Joaquin Almunia said.

The U.S. has opposed a code of conduct with Robert Steel, the U.S. Treasury's top finance official, saying in an April 15 interview that it ``sounds like a policeman and that's not what I'm into.''

Informal Guidelines

Paulson's preference for laying out informal guidelines was cemented in February after he reviewed the government's approach to monitoring hedge funds. A study by the Treasury and other U.S. regulators concluded that the responsibility of maintaining discipline falls on fund managers, investors, creditors, trading partners and market regulators.

``I think the report is very helpful, I appreciate the conclusions very much, perhaps one can improve these recommendations in some points,'' Steinbrueck said in the interview. ``We're talking about a voluntary solution. Nobody's talking about an official or regulatory solution.''

To contact the reporters on this story: Simon Kennedy in Berlin at skennedy4@bloomberg.net ; Rainer Buergin in Berlin at rbuergin1@bloomberg.net .