Hedge funds face tighter EU controls

Published on the Malta Today ¸ issue 27th October 2010

Last year it was a cold shower for the boffins in Brussels faced with the sudden demise of the Greek economy. This lack of preparedness has taken the EU bureaucrats by surprise and a special task force of finance ministers was swiftly set-up to analyse what went wrong. The financial distress of one so called bad apple has impinged on the stability of the euro. This instability has permeated through the 15 members of the euro club threatening contagion unless swift remedial action is taken to stem the risk of default in sovereign debt. The penny has dropped and now in the wake of the recession politicians want stronger institutions and more effective rules-based decision making. This article discusses the proposed legislation to better regulate financial markets.

In stark awareness the Greek crisis showed that a more robust framework for crisis management is needed. It is particularly relevant for the euro area where the economies¸ and the financial sectors in particular¸ which are closely intertwined and where crisis management facilities were missing. But closing the barn after the horse has bolted is often what critics say of new sanctions broadening economic surveillance to encompass macro imbalances and competitiveness. A rallying call is being made for a robust framework for crisis management in the light of defaulting member states a task force has been formed to study proposals for tighter controls. Still it is never too late to put our house in order seeing how the deep recession affected most countries and as a result has exacerbated their deficit problems. Now the task force is smarting under the pain of critics who claim that better oversight should have been in place before the sudden and unexpected collapse of credit in certain economies such as the Greek. Irish¸ Italian and Baltic States. Yes greed by certain bankers has been the popular war cry by critics who blame them for the credit crunch. But so far there is no proof that hedge funds did contribute to the financial crisis yet they together with banks have been selected for closure scrutiny amid claims of exaggerated bonus paid to managers. Hedge funds¸ thus conveniently blamed by some for exacerbating the scale of the crisis¸ are invariably branded by critics as essentially unregulated and opaque investment vehicles. These carry investments which engage in riskier bets than more tightly regulated banks¸ and achieve higher returns due to their scale of leverage¸ short-selling and appetite for risk.

Their superlative returns are the envy of many and to some extent this has led to a move to clip their wings. A common perception lingered that hedge funds were exacerbating the crisis in global financial markets by betting on indexes which saw the downfall of companies¸ and even countries. Now the time for reckoning has arrived and under the new regime¸ there will be a ‘passport’ system for hedge fund managers from outside the EU¸ giving them access to investors from all 27 member states so long as they are registered in one country. The reform empowers¸ the new European watchdog to demand information about how the funds invest and borrow money. It could also intervene by restricting trading¸ including a ban on short-selling. Short selling has been heavily criticised as a potential risky tool which may have landed some managers to cut corners and force them to exceed leverage limits.

It goes without saying that such tightening of the rules is much disliked by the industry as they gradually impose tighter bonus schemes on hedge fund managers¸ requiring them to stagger earnings over