G7 calls for disclore standards
of Hedge Funds
A communique issued by the Group of Seven (G7) industrialised nations on 30 October 1998 called on the Basle Committee on Banking Supervision to examine the transparency and disclore standards of financial players, with particular reference to hedge funds.
The Basle Committee sets the main guidelines on risk-weighting of loans, guarantees and other financial assets, and requires financial institutions to have adequate capital cushion of 8% of the value of the risk-weighted financial assets. The Basle Capital Accord is 10 years old, and many countries have entered into this accord.
Hedge funds are treated in the same way as corporate borrowers. However, there are presently no clear guidelines for risk-weightings of specialised financial products used by the hedge funds. Hence the need for a clear re-definition of the Basle guidelines.
Hedge funds have come under scrunity in recent months following the near-collapse of Long-Term Capital Management (LTCM) and financial problems at Ellington Capital Management. The financial problems were attributed to the highly-leveraged miscalulated speculative bets taken by hedge funds in the US and global financial markets. The Federal Reserve (Feds) have sponsored a US$3.75 billion bail-out of LTCM, and reduced treasury interest rates twice to bring back confidence in the financial markets and avert a global credit crunch.
High leverage is not the norm amongst hedge funds in general. Tass Management, a hedge fund consultant which reviews some 1500 hedge funds, has indicated that average hedge funds borrowings are about 60% of their capital base, unlike LTCM which leveraged some 250 times its capital.
The problem is that the larger hedge funds have developed a variety of financial products (some proprietary) using short-selling and arbitrage strategies, directional plays and market-neutral techniques, and these derivatives themselves are collatarised to leverage the borrowings -- thereby fudging the Basle guidelines.
Another problem the Basle Committee needs to tackle is the definition of hedge funds. There already exists a plethora of funds and financial products, and the Basle Committee has to resolve the issues of risk-weightings in increasingly volative capital and financial markets.
Changed rules will have limited force if the hedge funds cannot be regulated. Hedge funds are often registered in tax-haven countries beyond the reach of regulators. The Basle Committee would therefore need to consider how it can regulate these funds indirectly through the guidelines governing lending financial institutions. Though this may not avert another financial crisis, at the least it may mitigate the extent of financial losses from a fall-out of hedge funds from miscalculated speculative decables in the future.
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