The Obedience Rules for Hedge Funds

Date: Thursday, September 27, 2007
Author: Deborah Solomon, Wall Street Journal Online

Managers, Investors To Separately Draft 'Best Practices'.

WASHINGTON -- The nation's financial overseers are asking hedge-fund managers and investors to develop voluntary guidelines to help improve disclosure and mitigate the systemic risk associated with the lightly regulated private pools of capital.

The President's Working Group on Financial Markets -- which earlier this year said current regulations were sufficient to prevent hedge funds from threatening the financial system's stability -- is creating two advisory groups to develop "best practices" for investors who place their money in hedge funds and the managers who run the investment vehicles.

One group, comprising hedge-fund managers, will develop guidelines for such things as valuation and what information should be disclosed to investors. A second group, comprised of investors, will develop guidelines for the type of "due diligence" those investing in hedge funds should undertake, as well as the kind of information investors should receive. Their recommendations are expected by the end of the year.

The move comes amid a growing push by some top foreign officials to improve global oversight and transparency of financial markets, including hedge funds and complex financial products. Pressure has been building for the U.S. to beef up oversight following the recent financial turmoil, which began with problems in the U.S. subprime-lending market and has spread overseas, affecting financial institutions in Germany, England and elsewhere.

Earlier this month, German Chancellor Angela Merkel called for more transparency in the financial markets and French President Nicolas Sarkozy has urged industrialized nations to do a better job of policing their markets.

That was followed by a statement several days ago by European Union finance ministers and central-bank governors, who said they would work with the U.S. "to further improve transparency of complex financial instruments, of institutions and vehicles as well as how to improve valuation processes, risk management and liquidity stress testing."

U.S. Treasury officials, who lead the president's working group, continue to insist that new regulations aren't necessary and that "challenges" presented by hedge funds can be managed through market discipline, limiting access to wealthy investors and continuing to scrutinize regulated entities that do business with hedge funds, such as mutual funds and banks.

Robert Steel, undersecretary of the Treasury, yesterday said the development of voluntary guidelines will help "enhance" market discipline and strengthen the financial system.

The investor group will be headed by Russell Read, chief investment officer for the California Public Employees' Retirement System, the nation's largest employee pension fund. Mr. Read said his goal is to create best practices that will "convert into accepted practices by major industry groups" and eventually become "common practice." That will include "a lot of enhanced disclosure" among hedge-fund managers, investors, the parties that do business with hedge funds and the creditors who lend them money, he said.

Eric Mindich, who will be chairman of the hedge-fund group and who runs Eton Park Capital Management, said his group, too, will focus on improving transparency. But he added that the "tension is always how do you create information that is meaningful, timely and ends up serving a purpose."

While the advisory groups will focus first on hedge funds, Mr. Steel said they could eventually expand their scope to other private pools of capital, such as private equity and venture capital. "Over time we'll see where this develops and expands," he said.

Write to Deborah Solomon at deborah.solomon@wsj.com