Big falls in hedge fund borrowing

Hedge funds cut their borrowing to almost nothing in the wake of the collapse of Lehman Brothers, according to research by the City watchdog.

Data compiled by the Financial Services Authority show that leverage fell to just 1.15 times hedge fund net assets in October, down from almost twice a year earlier.

The survey, the only authoritative data on the opaque industry, also found that hedge funds had their highest level of "dry powder", or ability to borrow, since the research started in 2005.

However, prime brokers, the bankers who service hedge funds, say borrowing has fallen even further since the survey was carried out, and many hedge funds now have more assets than debt, or less than one times leverage.

"People are still holding quite a lot of cash," said Daniel Caplan, co-head of European prime brokerage at Deutsche Bank. "They are certainly not using the leverage that's available to them."

The FSA carries out its survey of hedge fund exposure twice a year, and found leverage - measured as the proportion of total long positions to net assets, ignoring short positions - dropped from 1.44 times in April to 1.15 times in October.

Its results arrive as hedge funds are coming under intense pressure to increase disclosure of the risks they are running.

Charlie McCreevy, the European Commission's international markets commissioner, said last week that tighter regulation was "inevitable" and said new European rules would be proposed shortly.

In the US, a bill supported by Democrats and Republicans has been introduced to force funds to register with the Securities and Exchange Commission.

The Group of 20 biggest economies will discuss tighter rules on hedge funds in plans to change financial regulation when they meet in London in April.

Meanwhile, the FSA discovered that hedge funds had cut borrowing far faster than they were required to by the lenders, even as lenders tightened terms by increasing the level of borrowing requirements.

The FSA survey covered $595bn of hedge fund assets held at 13 banks, just under half the global industry.