How to Regulate Hedge Funds?

money.jpgThis week's edition of The Economist asks this very question in both a leader and a longer article (walled for non-subscribers) and argues that hedge funds by and large should be left alone.

'Nimbleness and creativity are qualities rarely ascribed either to America's financial regulators or to Congress. Perhaps that is one reason why both groups are fumbling over how to deal with hedge funds, which typically exhibit both in abundance. These lightly regulated pools of private capital employ an array of complex trades, frequently shifting strategies and, in theory, generating above-average returns. They are growing fast: there are now more than 8,000 hedge funds, managing over $1 trillion in capital.

Such dynamism seemed remote indeed on June 23rd, when a federal appeals-court panel in Washington, DC, ruled that the Securities and Exchange Commission (SEC) had clumsily passed an “arbitrary” rule in an effort to bring hedge funds under its scrutiny (see article). A few days later Congress held (yet more) hearings on hedge funds amid renewed calls for oversight of the industry. The court's decision on the SEC is as welcome as Congress's attentions are to be regretted.

The argument for more regulation is twofold. First, nowadays it is not only a few aficionados of the investment world who are exposed to them but a growing number of people—either directly, if they are rich enough, or through their pension funds. Second, some hedge funds are so large that a big one's failure could threaten the financial system.


'Whatever happens, some hedge funds are bound to go bust. That's healthy, and does not argue for more regulation. Hedge funds are one of the most dynamic forces in finance. They should generally be left alone.' '

In general it seems as if institutional policy makers on both sides of the pond are worried about hedge funds and their risky business. See here and here.  

(From the FT)

'Hedge funds have created a "major risk" to global financial stability for which there are no obvious remedies, the European Central Bank warned on Thursday in one of the bluntest official statements yet on the rapidly growing sector.

In a clear hint of rising official nervousness about the multi-billion-dollar industry, the ECB ranked an "idiosyncratic collapse of a key hedge fund or a cluster of smaller funds" in the same category as a possible bird flu pandemic as the types of shocks that could trigger fresh disruption in financial markets.'