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London Turns Against Hedge Funds in Hunt for Culprit

Date: Thursday, September 25, 2008
Author: Caroline Binham and Elisa Martinuzzi, Bloomberg

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London is turning against the $450 billion hedge-fund industry that helped make the city a contender for the title of world financial capital.

As Lehman Brothers Holdings Inc. filed for bankruptcy and HBOS Plc was pushed into a government-brokered takeover, U.K. regulators and lawmakers found a culprit: the estimated 980 hedge funds that reside in Britain, mostly in London. Harbinger Capital Partners Fund chief Philip Falcone was singled out by the Daily Mirror. The tabloid used a front-page story on Sept. 18 to brand him a ``greedy pig'' for short selling, or making bets that Edinburgh-based HBOS would lose market value.

Britain's Financial Services Authority moved first among the world's regulators to ban short selling, after bank stocks plunged and New York-based Lehman, the fourth-biggest U.S. securities firm, collapsed. As funds adjust to the loss of their principal hedging strategy, they are also struggling to extract assets from Lehman and now face a political backlash. Lawmakers, including Ed Balls, Prime Minister Gordon Brown's main cabinet ally, are pushing for tougher oversight.

``People are upset at the swift change of sentiment,'' said Jacob Schmidt, chief executive officer of London-based hedge fund adviser Schmidt Research Partners. ``It threatens London as a marketplace. The demonization of hedge funds isn't healthy and more and more will think of going elsewhere.''

`Asset Strippers'

Some in the financial industry say stricter oversight is inevitable, as authorities try to protect banks from speculators. HBOS, the U.K.'s largest mortgage lender, fell 33 percent in three days last week, before it agreed to be bought by Lloyds TSB Group Plc in a deal encouraged by the government.

``There were certainly excesses,'' said Max Gottschalk, senior managing director at London's Gottex Funds Sarl, referring to the financial markets. ``Regulators will want to ensure it doesn't happen again.'' Gottex oversees $15.6 billion in funds of hedge funds. ``Over time, the industry will be more regulated. Events of last week have changed the financial landscape forever.''

Archbishop of York John Sentamu, the Church of England's second-ranking cleric, said HBOS short-sellers were ``bank robbers'' and ``asset strippers.'' He made the remarks in a speech to London bankers yesterday, according to his Web site. In an article to be published in the Spectator magazine, Archbishop of Canterbury Rowan Williams, the U.K.'s top cleric in the church, invokes Karl Marx in attacking ``unbridled capitalism,'' according to the BBC.

`Never Intended to Hurt'

Harbinger, run from New York by the 46-year-old Falcone, manages about $26 billion.

``Falcone hasn't spoken negatively about HBOS, and Harbinger has never intended to hurt the bank, its shareholders, or its employees,'' spokesman Charles V. Zehren said. ``Like all hedge funds, Harbinger has taken long positions and short positions in all manner of companies as part of our investing strategies. The failure of HBOS was based on its inability to manage itself properly.''

RAB Capital Plc and GLG Partners Inc. are among hedge funds with money tied up in Lehman, one of the securities firms that helped create the subprime-mortgage crisis.

Before credit markets seized up, London was a better place for alternative-investment firms, said Darren Fox, a lawyer who advises hedge funds at London-based law firm Simmons & Simmons.

Advocates `Routed'

Tax exemptions for foreign residents, the so-called non- doms, and the FSA's flexible oversight helped attract asset managers and prime brokerages, Fox said. The FSA enforces a commitment to a set of 11 principles, including treating customers fairly, rather than adherence to particular rules.

``The perception was that the U.S. was a rules-based system that was unwieldy and expensive, and that was a reason for firms moving to London,'' said Andrew Clare, a finance professor at London's Cass Business School.

By the end of last year, there were 984 hedge funds in the U.K., whose assets represented 80 percent of the European hedge fund industry, according to data compiled by London-based EuroHedge. Hedge fund assets in Europe rose more than 10-fold since 2000, when the industry oversaw about $46 billion.

Cabinet minister Balls said 18 months ago that ``risk'' was a part of a dynamic economy. During this week's conference of the ruling Labour Party, he said advocates of light-touch regulation had been ``routed.''

`Stop the Selling'

Brown, who supports the FSA ban, said it's right to stop short selling ``when a group of people have exploited a situation in the market.''

``The problem at the moment is that you have an unpopular government,'' said Ian Morley, the chairman of Corazon Capital, a London-based hedge fund. ``They're in desperate need of a scapegoat.''

Brown, who succeeded Tony Blair in June 2007, leads a party which trails the opposition Conservative Party by 20 points in opinion polls. Michael Fallon, a Conservative lawmaker and deputy chairman of the Treasury Select Committee in parliament, said the Labour Party and FSA overreacted.

``Short sellers imply willing buyers,'' Fallon said. ``I do think it's been overdone.''

In short selling, investors borrow stock and sell it expecting the price to fall so they may buy the shares back cheaper, return them to the owners, and keep the difference.

`Media Bogeymen'

FSA spokeswoman Kirsty Clay said the regulator has ``stressed that in normal market conditions, short-selling is a legitimate technique, and the ban is temporary.'' The ban runs through January, and Brown said this week the government may introduce new rules to curb the strategy when the limit ends.

``We hope there isn't a knee-jerk reaction for long-term regulation,'' said Andrew Lodge, managing director of Nedgroup Investment Advisers, a fund of hedge funds manager based in the Isle of Man.

Before the ban on short selling in 34 financial companies, the FSA introduced emergency rules twice in the past three months, also targeting hedge funds' investment strategies.

``Hedge funds have been reintroduced as the media bogeyman, and that is possibly to deflect attention from other shortcomings, like the failure of regulators to properly supervise the banks,'' said Simmons & Simmons's Fox.

To contact the reporters on this story: Caroline Binham in London at cbinham@bloomberg.net; Elisa Martinuzzi in Milan at emartinuzzi@bloomberg.net