International-level code regulating operations of hedge funds required

by Finanzplatz München Initiative

Munich, May 15, 2007 – Munich Financial Center Initiative (fpmi) views the ever-growing influence of hedge funds upon the financial and business communities as posing a danger to the international financial markets’ stability. For this reason, an international-level code regulating the operations of these funds needs to be enacted, believes fpmi.

With this in mind, fpmi expressly welcomes the German government’s push for laws which will provide authorities with methods of effectively controlling hedge funds’ operations and of imparting accountability to them.

This push does not enjoy the support of such important nations as the USA and the UK. Both of them are, in fact, blocking such moves. The EU, in a further development, has decided to refrain from requiring the hedge funds to develop, at the very least, a code of conduct. This lack of support is incomprehensible for a variety of cogent reasons, finds fpmi. Among them is the disparity in treatment accorded to traditional capital investment corporations on the one hand and hedge funds on the other. This disparity takes the form of the former kind of companies’ being subject to strict and world-spanning supervision and control – and hedge funds’ being exempted from both. This lack is highly puzzling when considering the facts that the hedge funds constitute a huge and powerful body of financing, one which is being used for an ever-greater number of purposes, and one which is opening itself up more and more to the general public.

The members of fpmi have the following to say about hedge funds:

Allianz: Required for all funds are a level playing field and more accountability

Hedge funds constitute an important component of capital markets. Their ability to exploit inefficiencies and arbitrage-derived opportunities serves to enhance the stability of the world’s financial markets by reducing volatility. By doing all this, the funds foster the efficient spreading of risks among a variety of kinds of players.

As current developments amply detail, the hedge funds have achieved a size (some $1.4 trillion worldwide) and an accompanyingly large influence making them a serious and growing danger to world financial markets. This danger arises especially from the large percentage of credit-financed transactions in the funds’ portfolios, and from their copycat strategies of investment. The current situation is highly reminiscent of that of 1999, in which the collapse of the LTCM hedge fund plunged the global financial system into a serious crisis.

To avoid a repeat performance, measures capable of getting and keeping the risks innate to the system under control have to be formulated. It is hard to find a compelling reason why traditional capital investment companies are subjected to strict supervision and controls when pursuing their investment strategies, and why hedge funds, even though their range of customers keeps on growing in breadth, are exempted from them. The effective protection of investor interests and fair trade mandate the setting up of a level playing field, upon which each kind of funds plays by the same rules. Allianz also views the imparting of a greater degree of accountability as being another precondition for the achieving of stability in financial markets. This accountability could be achieved by undertaking such measures as the detailed recording of all standard-type transactions entered into by hedge funds. These measures could take the form of a near real-time (one to two days’ time lag) reporting of short selling and stock loaning transactions. Allianz also welcomes the proposals issuing from the G-8 meeting. These would oblige the hedge funds to secure ratings and to accord to a code of conduct.

A large number of hedge funds are based in the USA or in so-called “offshore” centers. This fact mandates the reaching of a transatlantic agreement on measures to be undertaken. The odds on securing the USA’s approval for such an agreement have never been greater. With this in mind, Allianz expressly urges Germany’s government to push this subject at the G-8 meetings, and to make it part of the Presidency of the EU Commission’s agenda.

Association of Bavaria's banks: secure the stability of international financial markets

Hedge funds have become one of the international financial system’s main sources of liquidity. They form one of the core components of a modern and dynamic financial market. The funds also serve as a main engine of efficient allocations of capital and risks.

This increasing of overall market efficiency is accompanied by a rise in the risks to which the world’s financial system is exposed. These risks arise from the hedge funds’ lacks of accountability and of adequately-strong risk controls. The banks view the main challenge arising from hedge funds as being the securing of the stability of international financial markets.

While holding the presidency of G7/G8, Germany’s government has been pushing for measures improving the accountability of the hedge funds. Meeting in Essen, Germany, the G7 finance ministers passed a resolution calling for a clarification of this issue. This resolution represents an important, albeit initial, reward for Germany’s efforts. The next step is to precisely define which kind of accountability has to be achieved in order to secure the stability of the world’s financial system. Those approaches assessing the quality of the methods used by the hedge funds to manage risks, to valuate the derivatives employed and to evaluate controlling operations are highly promising. These ratings can be complemented by the promulgation of a code of conduct.

Hedge funds have been authorized for operation in Germany since 2004. Germany’s legal codes stipulate that the supervision of such funds is the responsibility of Bundesanstalt für Finanzdienstleistungsaufsicht (“BaFin” – Federal Supervisory Authority for Financial Services). BaFin focuses on supervising the qualification of the funds’ managers and the operations of the risk management systems. The implication of this is that few restrictions are placed on the pursuance of the funds’ strategies. Viewed from an international perspective, Germany’s regulation of its hedge funds has not demonstrated its viability. As of the end of 2006, a mere 40 hedge funds had subjected themselves to the provisions of Germany’s legal codes by registering themselves with BaFin. These funds had a total volume of some €1.7 billion. The draft bill submitted by senior civil servants in Germany’s ministry of finance for the reforming of the Investment Law still doesn’t contain the adjustments required to enhance international-level viability, although such measures had been promised.

Deutsche Bundesbank: Stable financial and monetary systems are absolute essentials

The brief entrusted to us demands that we ensure the stability of Germany’s economy. A precondition for doing such is the achieving of stability of in the national and international-level financial and monetary systems, as these, in turn, are directly and reciprocally related to stable prices. Two of the Bundesbank’s important responsibilities are the monitoring and further development of the international-level monetary and financing systems. Over the past few months, the Bundesbank issued wide-ranging position papers on hedge fund and their problems. One of these commentaries was made by Dr. h.c. Edgar Meister, member of the Bundesbank’s executive board, on December 14, 2006. His subject was “Making hedge funds accountable” (in German). Also delving into the subject is an article starting on page 21 (it forms part of the subchapter on financial market risks) of the Report on Financial Stability (PDF, 2,8 MB) published in November 2006 (in German).

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