Hedge funds contemplate safer climate in US

Date: Tuesday, October 28, 2008
Author: Miles Costello, The Times

A new front is opening up in the battle between London and New York to be the world's dominant financial centre.

Hedge funds, and the thorny question of where they decide to do business over the coming months, could mark a turning point in the delicate balance of power between the two market capitals.

Despite widespread fears that hundreds of funds are poised to collapse, any shake-out in the industry will still leave hundreds of healthy firms with billions to invest.

Experts say that some of the industry's biggest funds are considering whether to move billions of dollars worth of assets across the Atlantic to the United States in the wake of the collapse of Lehman Brothers, the Wall Street investment bank.

Hedge fund managers are also more likely to want to trade with counterparties in the US, according to specialists. This gradual shift of power across the Atlantic could lead some high-profile funds to relocate entirely to America.

The collapse of Lehman Brothers is central to hedge fund thinking. In Europe, PricewaterhouseCoopers was forced to freeze billions of dollars of hedge fund money at Lehman in mid-September when it was brought in as administrator of large parts of the bank across the continent.

In the US, however, where Lehman filed for Chapter 11 bankruptcy protection from its creditors, a more effective regulatory regime meant hedge fund customers of Lehman were quickly able to recoup their capital. Smaller firms with $1 billion (£647 million) of funds under management or less were able to continue to trade as a result of what is known as the Securities Investor Protection Corporation (SIPC).

Andrew Shrimpton, of Kinetic Partners, the hedge fund consultancy, said: “The Lehman collapse revealed that the US regime offers more protection to funds than the UK via the SIPC.”

The corporation ensured that about 630,000 Lehman customers had full access to their accounts in double-quick time, Mr Shrimpton explained. All investment securities that were registered, or about to be registered, in a specific name could be reclaimed by their owner including individual demands for cash of up to $100,000. This would have ensured the survival of hundreds, if not thousands, of small funds. He added: “Do we need a UK SIPC to keep the UK competitive?”

According to the Managed Funds Association (MFA), the Washington hedge fund lobby group, between $40 billion and $70 billion of hedge fund capital was frozen by PwC in the UK at the time of the Lehman administration. The money would have stretched across about 1,300 prime brokerage accounts operated by the bank.

Prime brokers provide numerous services to hedge funds, and Lehman would have had hedge fund assets as well as collateral held for trading counterparties. Some estimates suggest up to $200 billion is trapped inside the failed bank.

The MFA also estimated that funds of hedge funds were affected, in some cases they were forced to suspend whole portfolios because of the exposure of a single fund.

Richard Baker, MFA's president and chief executive, wrote a public letter to Mervyn King, Governor of the Bank of England, calling for the UK's lender of last resort to intervene.

“Several firms with significant exposure to Lehman Brothers International Europe are on the brink of failure and the extent of future failures will hang in large part on how the LBIE administration is handled going forward,” he wrote. The MFA said that the problem raised big questions about the future of prime brokers based in the UK.

For other hedge fund experts, the shift of power to the US is less clear. One consultant said: “If you a European fund manager and you are managing money in London, you are not going to uproot just because your chances of being protected in a bankruptcy are marginally higher.”

Taco Sieburgh, director of research at Liability Solutions, added: “The driver of where a hedge fund decides to set up for business is much more to do with talent, infrastructure support and access to capital than how bankruptcy laws might work in a case of calamity. The issue may only be applicable to very few of the largest hedge funds in the industry, those that operate in multiple jurisdictions and deal with counterparties or hold assets in more than one place.”

New York on top

New York continues to dominate the global market for hedge fund investors despite the rapid rise of London as an investment centre during the past five years.

US hedge funds managed just under $2 trillion (£1,293 billion) of assets on behalf of wealthy individuals, pension funds and other institutional investors as at the end of June, according to HedgeFundIntelligence, the research firm and publisher.

This compared with European funds, about 80percent of which are based in London, managing more than $570 million, HFI said.

The number of funds with more than $1 billion of assets stood at 149 for New York and 77 for London. New York funds manage just over $1 trillion, compared with $363 billion at their London counterparts, according to the most recent figures.

HFI's data covers the period before the collapse of Lehman Brothers in September and the subsequent meltdown in world markets.

It is estimated that all figures will have fallen by at least 10 per cent since the end of June.