Hedge funds have been operating for roughly three decades. Traditionally, they catered to high net worth individuals, and were thus generally excluded from the financial services regulatory framework.
However, the industry has evolved away from its origins, and now global, multi-strategy hedge funds cater to a variety of institutional investors -- including pension funds.
A committee convened by the President's Working Group on Financial Markets recognises that approximately 8,000 hedge funds currently manage about 2 trillion dollars. Such a large pool of lightly regulated capital poses significant systemic risks:
· The growth of hedge funds and their centrality to global financial markets fuelled calls for greater regulation of these entities, even before the onset of the sub-prime crisis.
To date, the United Kingdom has been much more proactive than the United States in implementing a hedge fund regulatory agenda.
· Within the United States, the industry was able to avoid a modest measure that would have required hedge funds to register with the SEC; a successful federal lawsuit blocked implementation of the rule. However, the sub-prime crisis and credit crunch have led to stepped-up calls for regulation of these entities, amidst a more general push toward greater regulation of global financial markets and financial services
Two countervailing trends prevail in the gathering debate over industry regulation:
1. Clear regulatory impetus. Consensus is building that greater regulation of financial services is necessary, yet the form and details are still being debated. Paulson in March unveiled a comprehensive plan to overhaul the regulatory framework for financial services. This plan was intended to spur discussion, and was not expected to be adopted wholesale.
2. Market saviours? The hedge fund industry as a whole just suffered through its worst-ever first quarter. Yet some leading hedge funds have been wildly successful in currently volatile markets, and others, especially 'vulture funds', are playing a market stabilising role. The industry will marshal these facts as powerful weapons in the fight against legislative intervention. Hedge funds have demonstrated considerable lobbying influence, most recently in beating back proposals to tax their principals more effectively. They are likely to remain effective in making their case on Capital Hill.