Thursday, 30 March 2017
Last updated 5 hours ago
Dec 21 2010 | 12:24pm ET
In the wake of the 2008 financial crisis, the call for better regulation of world financial markets rang out and regulators responded. In the U.S., the response took the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act. In Europe, the answer was the Directive on Alternative Investment Fund Managers. Both pieces of legislation required some serious wrangling to pass, but have now become law.
To find out how alternative investment managers feel about the new regulations, FINalternatives' Mary Campbell spoke with the chairman of the Alternative Investment Managers Association, Todd Groome, whose organization counts over 1,200 corporate members in more than 40 countries.
How does AIMA feel about the new regulations to be imposed on alternative investment vehicles in the US?
Legislation has been adopted and we are roughly halfway through the rule-writing and definitional process. The legislation, specifically in the United States, is in general properly calibrated to improve financial stability, as set out by the G20 in November 2008. And so, while hedge funds were not a cause of the crisis (in many respects, they were among the victims of the crisis), the registration and the reporting process, which AIMA came out very early in support of (February of 2009), seems to be proportional and calibrated to the financial stability objective.
Do you agree that derivatives need to be regulated and if so, how best should they be regulated?
Philosophically, I try not to use the term regulation in such a broad sense. A better term may be “supervision.” Policy to improve financial stability is more effective in an environment of supervision, oversight, and transparency in part because it means people are talking to each other. I’m skeptical that if we just write new rules that the regulation process can become a check-the-box exercise that fails to achieve its purpose.
Early in the regulatory process, AIMA supported improved supervision, oversight, and transparency. We supported the registration of hedge fund managers and the periodic reporting by managers of—and this is important language—systemically relevant information. It is not because hedge funds are systemically important institutions or create added stability risks—they do not—but rather because hedge funds are the best early-warning system that the marketplace has to gauge financial stability as active hedge funds are constantly looking forward and assessing the pros and cons of fundamental economic and market developments.
Take, for example, the mortgage crisis in 2007. Hedge funds were talking about it in 2006, well in advance of 2007-2008. Hedge funds have also been speaking about the fiscal positions of governments around the world, particularly in developed markets, for many years. Our industry may be the best early warning system, and this notion is understood by many policy makers.
More specifically on derivatives, I think the central clearing system—something which Secretary Geithner was in favor of when he was still the president of the New York Fed—is possibly the most important regulatory development to improve financial stability. The central clearing of OTC derivatives is intended to reduce counterparty risk exposure. However, direct counterparty exposures are not the issue; it’s the web of inter-connected exposures which creates systemic risk. Direct counterparty risk management is generally regarded as conducted to a high standard and an effective level. What is less certain is how a counterparty’s exposure with a third party may impact other risk conditions or exposure, what people call second or third round effects. And that uncertainty, when market liquidity dries up, can create stability problems. The central clearing system should go a long way to prevent such outcomes.
When you say “systematically important information,” what do you mean, specifically?
I would reference the FSA semi-annual reports for hedge funds. These reports evaluate concentrations in markets, liquidity conditions, and the use of leverage by hedge funds. The FSA is trying to develop a “footprint” that incorporates concentration levels, liquidity conditions, the use of leverage, and what they call the types of instruments being used in the market. Next, the FSA measures the importance of hedge funds in a particular market, and their general conclusion has been that hedge funds are not significant players in important markets.
In their July survey, for example, the FSA wrote that the hedge fund footprint was growing in convertibles. Upon closer inspection they concluded the convertibles market was probably not systemically important, because the amount of capital and funding raised in that market was not significant, and importantly, issuers of convertibles do not rely on the convertibles market for their core funding or core capital raising needs.
Some fund managers I’ve spoken to have expressed concerns that the new reporting regulations could require them to give away their ‘secret sauce,’ the key to their investment strategy. Do you think this is an issue?
Well, it is a good point and a concern. I would put it this way: I do not believe the intention of the SEC or CFTC is to get into ‘secret sauce’ kind of material. But, depending on what is published and the format, it is a valid concern. In this regard, we have expressed reservations about Freedom of Information Act protections, including Title IV of Dodd-Frank. And there is a concern with the possible whittling away of Freedom of Information Act protections. We have talked to the SEC about this, including Ms. Shapiro and other Commissioners, and I believe they share our concerns regarding the Freedom of Information Act protections, including specifically the protection of periodic regulatory reports filed by hedge fund managers with the SEC.