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Hedge funds pose little risk to financial markets concludes FSA


Date: Wednesday, February 24, 2010
Author: Hedge Funds Review

Hedge funds do not pose a high level of risk to financial markets, concluded a report by the UK’s Financial Services Authority (FSA).

The regulator found hedge funds present a low level of credit counterparty exposure and leverage. Managers surveyed any individual fund posed a significant systemic risk to the financial system at the time, this position could change.

 

The survey looked at 50 of the largest FSA registered investment managers with over $300 billion of assets under management (AUM), around one-fifth of the global industry.

The snapshot position in October 2009 showed the overall leverage footprint of the hedge funds surveyed was relatively small. The FSA looked at leverage in terms of a hedge fund’s total gross ‘footprint’ across asset classes compared with the equity they raised from investors. The sample surveyed had a footprint that was 328% net equity with fixed-income arbitrage funds recording a footprint of over 800%.

The FSA said fixed income arbitrage and credit long/short funds, the two most highly leveraged strategies, together accounted for less than 10% of the total AUM surveyed.

The FSA also found there were "few asset classes where our samples' aggregate footprint was greater than 3% of any total market size".

Derivative exposure was also small compared with the Bank of International Settlements' estimates of market size.

The exception was convertible bond funds accounting for approximately 10% of the global market. The FSA said this was unsurprising given the popularity of the strategy.

Average cash borrowing of funds was also low at 202% of net equity. Once again fixed income arbitrage funds borrowed most — almost 1,000% of equity, mostly through sale and repurchase agreements.

The survey revealed the assets of responding hedge funds could be liquidated before their liabilities became due. Only 8% of surveyed AUM was subject to side pockets.

The FSA data showed the maximum potential credit exposure any one bank had to any one hedge fund surveyed was less than $500 million. In terms of aggregate exposure, the largest fund accounted for just over $1 billion of credit exposure to a number of banks.

"While these are large numbers, they are manageable in the context of the overall credit risks and capital requirements of the surveyed banks," concluded the FSA report.

The survey showed the number of open positions held by funds varies widely. Of the surveyed funds, three had less than 50 open positions and nine between 5,000 and 50,000, with the remaining respondents spread between those figures.

Approximately 70% of surveyed funds cleared at least a proportion of derivative trades centrally, while 16% exclusively used a central counterparty.

The FSA said results were "mostly in line with our expectations". It added: "While our analysis revealed no clear evidence to suggest that from the banks and hedge fund managers surveyed any individual fund posed a significant systemic risk to the financial system at the time, this position could change and future surveys will be an important tool in identifying emerging risks."

The two surveys, hedge funds as counterparties and the general hedge fund survey, were carried out in October 2009. The semi-annual hedge funds as counterparties survey asked large banks about the size, channel and nature of the larger credit counterparty risks that individual banks have to hedge funds, both individually and all together.

The hedge fund survey asked 50 managers about the assets and funds they managed. Respondents represented a number of strategy types with multi-strategy, global macro, managed futures and equity long/short accounting for 83% of the total. A majority (85%) of surveyed assets were domiciled in traditional offshore centres.