Hedge funds: what are the main issues?

The health and dynamism of modern financial markets strongly depend on the existence of innovative and risk taking investors and institutions. Hedge funds play an important role in fostering market efficiency and stability. The theoretical value added brought by hedge funds may, however, not fully materialize in practice, looking at their performances, but hedge funds investors should be able to make informed judgments. The specific role and market impact of hedge funds may increase the potential for market manipulation and market abuse. However, hedge funds are not fundamentally different, in this regard, from other investors: strong and efficient implementation of existing rules and procedures should be adequate and sufficient to preserve market integrity. It is an open question whether stronger “governance” requirements should be introduced for those hedge funds indirectly collecting retail investors’ money, either through professional codes of conducts, market mechanisms reinforced by a “rating” process or more compulsory and binding regulations. One of the issues that could be considered is whether and how to eventually encourage hedge funds to apply the set of best practices for asset valuation proposed by the International Organization of Securities Commissions. Hedge funds’ activities may have implications for systemic risk, both through potential losses to their bank creditors and through adverse market dynamics that might in turn affect banks. Potential mitigating actions should take into account these two aspects. First, appropriate intervention by the supervisors on the prime brokers to make sure that they ask and get broad information from hedge funds and that they put in place a comprehensive risk management of all hedge funds related exposures is essential. Second, there might be scope for policy makers to encourage appropriate organization of infrastructure in order to improve the information available on the markets in which hedge funds operate. Finally, authorities may explore how to devise processes giving them, on a case by case basis, access to relevant information about hedge fund exposures and positions.