Hedge funds are not “shadow banks”, says AIMA

Hedge fund managers do not operate in the shadows, report states

Amid calls to ramp up regulation of the so-called "shadow banking" sector, the Alternative Investment Management Association argues that hedge funds shouldn't be considered shadow banks.

Back in November 2010, the G20 called on the Financial Stability Board to develop recommendations to strengthen the oversight and regulation of the "shadow banking" system. In the wake of the financial crisis as policymakers have tightened regulation in the traditional banking sector, by raising capital and liquidity requirements among other things, but there's some concern that the risks once posed by the banks will instead migrate into the shadow banking sector, where there is less regulation, oversight and transparency.

Since the G20 called for more regulation in the shadow banking sector, there has been some debate about what constitutes a "shadow bank"; which has generally been thought to include entities such as money market funds, securitization vehicles, along with things such as securities lending and repo activities. AIMA argues that hedge funds, and particularly credit hedge funds, should not fall into that category.

In a new paper, the global hedge fund trade association argues that credit hedge funds are part of the asset management community that exist to serve pension funds, endowments, unions, family offices and other investors; they are not ‘shadow banks'. It maintains that hedge fund managers do not operate in the shadows. "They are or will shortly be subject to strict regulation in all major jurisdictions around the world," it says.

"The level of regulation and oversight of the hedge fund industry should ensure that if there were to be a build up of systemic risk in the hedge fund sector, competent authorities should have all the available data and tools to contemplate appropriate intervention," it adds.

Second, it stresses that hedge funds are not banks, and that there are well-established differences between hedge fund managers and banks. It notes that credit hedge funds do not take deposits, do not offer daily liquidity nor otherwise hold themselves out as guaranteeing the return of the invested principal.

Also, hedge funds manage their liquidity profiles by agreeing on investor redemption terms which correspond to the liquidity profile of the underlying investments. "They therefore do not engage in significant maturity transformation," it notes.

And, "Crucially, hedge funds do not benefit from implicit or explicit taxpayer guarantees," it says.

"Credit hedge funds – and hedge funds in general - do not operate in the shadows. Managers are extensively regulated, are subject to reporting requirements and do not engage in any significant sense in credit, liquidity or maturity transformation, so their activity is not ‘bank-like'. Credit hedge funds do not belong in the same category as banks, let alone ‘shadow banks'," said Andrew Baker, AIMA CEO.