Progress report
An assessment of hedge fund YTD performance in the face of renewed fears for a potential eurozone crash Read More
08/06/2011
Comment: Andrew Baker
We have been hearing a lot recently about the so-called ‘shadow banking’ sector. The IMF at its recent meeting in Washington called for enhanced oversight of “shadow banking activities”, while the G20 has instructed the Financial Stability Board to develop regulatory recommendations by the autumn.
The term ‘shadow banking’, first coined in 2007, is usually meant to refer to a wide variety of non-bank financial institutions including money market funds, structured investment vehicles and insurance companies. The implication is that such organisations are engaging in bank-like activities out of the sight of regulators, creating dangerous and unmonitored risks to the system.
But not everyone agrees on the exact definition, raising the risk of mission creep as the scope of the new regulations is expanded to cover an ever-widening array of institutions and sectors. Take hedge funds, which are sometimes included as being part of the ‘shadow banking system’. Depending on who you talk to, this mysterious system includes either the entire hedge fund industry or only credit hedge funds (those which employ a credit strategy).
There are significant regional variations too, so that someone speaking about ‘shadow banking’ in the US is not necessarily talking about the same thing as someone in Europe or Asia.
Is it even fair to include hedge funds? They are part of the asset management industry – not the banking industry. They do not take deposits, do not undertake maturity transformation nor benefit from implicit or explicit taxpayer guarantees.
The broader point made by critics of ‘shadow banking’ – that hedge fund managers are part of a vast, unregulated sector that threatens the stability of global financial markets – is wrong too. Hedge funds do not inhabit the regulatory equivalent of the shadows. All the major jurisdictions where they operate – whether in North America, Europe or Asia-Pacific – regulate the industry rigorously. What is more, this already significant level of regulation is being increased, not lessened, by legislation introduced since the financial crisis.
It is of course no accident that the re-emergence of the ‘shadow banking’ term has coincided with the efforts of the US Financial Stability Oversight Council (FSOC), among others, to identify systemically important financial institutions that will be the subject of additional supervision. FSOC defines ‘systemic importance’ in terms of the potential to threaten the financial stability of the US. But there is no evidence to suggest that a single hedge fund is sufficiently large, leveraged, complex or interconnected enough for its failure to cause such severe disruption.
Do not just take our word for it. The UK Financial Services Authority conducts twice-yearly surveys of the 50 largest UK-based hedge fund managers, including some of the behemoths of the global industry, and has yet to find an individual hedge fund that poses a systemic risk. Similar surveys are being rolled out in other financial centres. We welcome these initiatives, not least because they are helping to demystify hedge fund activity.
Of course it is possible that individual hedge funds could act together to create systemic impacts. But the hedge fund industry’s heterogeneous and proudly contrarian nature makes such unified action highly unlikely.
The truth is that systemic risk continues to reside in ‘too big to fail’ institutions. Hedge funds, for their part, are not unregulated, shadowy or even bank-like. They are, as independent academics have noted, rigorously regulated, transparent to their supervisors, not systemic, and, as Lord Reid noted at HFMWeek’s European Awards last week, “small enough to fail”.
Andrew Baker is the chief executive officer of Aima, the Alternative Investment Management Association
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60 seconds with... Kenneth Turchin
CAN YOU DESCRIBE YOUR CURRENT ROLE?
I have worked in public accounting and hedge funds and in the past eight years have been selling middle- and back-office services to the alternate investment industry. My role is to build relationships with clients, teach them about SS&C’s products and services, and ensure seamless transactions every time the firm launches a new fund.
IF YOU WERE DOWN TO YOUR LAST £1,000, HOW WOULD YOU INVEST IT?
I would buy THREE shares in Apple and hope for a repeat 383% return in the next five years.
WHAT WOULD YOU DO IF YOU WERE IN PRESIDENT OBAMA’S SHOES?
That’s one pair of size 12 shoes I do not want to be in!
WHO WOULD PLAY YOU IF THEY MADE A MOVIE ABOUT YOUR FIRM?
Kevin Bacon. He is a versatile actor and the centre of the entertainment universe. I am in sales. Everyone in the industry would be linked to me in six steps or less. My client list would be ridiculous.
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