Hedge Funds, Private Equity Could Be 'Systemically Important'

Feb 22 2011 | 11:25am ET

A draft report from a powerful new federal regulator indicates that the alternative investments industry could find itself facing tougher regulations than previously feared.

According to the report, being prepared by the Financial Stability Oversight Council, hedge funds and private equity firms could pose a systemic risk to the financial system. The draft says that massive hedge redemptions could "cause activity in some markets to freeze" and expressed concern that the "highly leveraged nature of" private equity firms' "portfolio companies and their use of bridge loans" could also pose risks.

The draft report, obtained by Bloomberg News, offers a glimpse into how the FSOC and Federal Reserve will decide which non-bank firms are systemically important and which are not. Those that get the dreaded label will find themselves under the thumb of the two regulators, which are empowered to force firms to raise capital, boost liquidity and sell assets.

The FSOC report also details the sort of information it might make alternative investment firms provide to better monitor them, including their value-on-risk ratio, some of which they have not been previously required to provide.

The hedge fund industry has bitterly opposed the notion that any hedge fund poses a systemic risk to the economy.

The FSOC is set to begin determining the systemic importance of firms by the middle of the year.


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