S&P revises hedge fund rating method, eyes growth

Date: Tuesday, September 12, 2006
Author: Reuters.com

NEW YORK, Sept 12 (Reuters) - Standard & Poor's on Tuesday released enhanced criteria for rating hedge funds, a market segment expected to grow as investors and regulators press for greater transparency.

The updated criteria include more quantitative analysis and more focus on operational risk, including such issues as trade processing and risk management, said Tanya Azarchs, a financial institutions credit analyst at S&P.

S&P, a unit of the McGraw-Hill Cos. <MHP.N>, is the latest credit ratings agency to attempt to make inroads into the lightly regulated hedge fund industry, which has grown to include more than 8,000 funds and $1 trillion in assets.

Moody's Investors Service, a unit of Moody's Corp. <MCO.N>, last week completed its first public rating on the operations risk of a hedge fund, managed by Sorin Capital Management LLC.

Fitch Ratings, a unit of Fimalac SA <LBCP.PA> has also said it is exploring the possibility of expanding its ratings in the hedge fund industry in response to market demand.

"The due diligence process to assess the riskiness of a hedge fund investment is extremely in-depth and extremely time-consuming," said Azarchs. "So there is an efficiency to having a credible intermediary perform that, and it can be used by all."

S&P said it has rated a handful of hedge funds since 2000, but expects to see more demand for ratings from investors and hedge funds themselves.

"They think it's a good selling point and there's no downside to a certain type of transparency," Azarchs said. "What they must guard for everybody's sake are their exact strategies and exact position."

Some regulated investors, such as insurance companies and utilities, have also requested ratings because their internal guidelines require them, Azarchs said.

S&P has set up a separate group of about eight analysts, risk management specialists and accounting specialists to work on hedge fund ratings, and the agency plans to add more as the business grows, she said, adding that ratings may be made public if the hedge fund desires.

The ratings will not comment on the quality or performance of the fund's investment portfolio but on the likelihood that the fund will default on its debt or counterparty obligations like derivative contracts, S&P said in a statement.

Ratings will emphasize a fund's ability to liquidate its portfolio at any time after satisfying all of its creditors, S&P said.

"An important source of liquidity is the ability to sell assets to meet payment obligations without having 'fire sales' in periods of market fragility," the ratings agency said.

Ratings will also look at a fund's managers, background, legal status, organizational structure, risk strategies and investment strategies, S&P said. (Additional reporting by Richard Barley in London)