The Hindu Business Line : Forum proposes steps to address systemic risks in hedge funds biz

New Delhi May 21 In a bid to bolster protection against potential systemic risks relating to hedge funds and other highly leveraged institutions (HLIs), the Financial Stability Forum (FSF) has unveiled a slew of steps to support and build upon ongoing supervisory and private sector work.

The FSF, headquartered at the Basle-based Bank for International Settlements (BIS), brings under its umbrella national authorities responsible for financial stability in significant global financial centres, international financial institutions, sector-specific global groupings of regulators and supervisors and committees of central bank experts.

In its report recommending action by financial authorities, counter-parties, investors and hedge fund mangers, released in Switzerland, it said activity by hedge funds has expanded rapidly since the FSF's report in 2000 on HLIs. Even while risk management techniques and capacity have been improving since the Long-Term Capital Management crisis, the report concedes that products and markets have become more complex, posing heightened risk measurement, valuation and operational challenges for all market participants.

"There recently have been some signs of erosion of counter party standards that reflect the strength of competition for hedge fund business and which complement other signs of complacency about risk taking in financial markets," the report said, adding that "this heightens the importance of strengthening market discipline".

Infrastructure

While welcoming recent and ongoing public policy and private initiatives to effect infrastructure improvements, the report said effective market discipline demands that counterparties and investors obtain relevant information from hedge funds and act upon this information.

The report said supervisors should act so that core intermediaries continue to underpin their counterparty risk management practices, besides working with core intermediaries to further improve their robustness to the potential erosion of market liquidity.

The FSF underscores the importance of ongoing cooperation among financial authorities in taking forward these suggestions and in spreading good practices.

It also notes the importance of authorities' market surveillance activities and of their continuing dialogue with a range of market participants and actors to keep abreast of innovation, and to assess the adequacy of practices and policy approaches in addressing risks to financial stability.

Today's report of FSF follows a request by the G-7 Finance Ministers and Central Bank Governors at their meeting in Essen in February for the FSF to update its 2000 report on highly leveraged institutions, indicating a reassessment of the financial stability issues and systemic risks posed by hedge funds.

However, it does not address the investor protection issues associated with institutional or retail investments in hedge funds.

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Forum proposes steps to address systemic risks in hedge funds biz