Treasury Sees Systemic Risk in Large Hedge Funds

Treasury today added a new wrinkle to the Obama Administration's proposed financial regulatory overhaul: All hedge funds and investment advisors with more than $30 million under management will have to register with the SEC. Despite the fact that no hedge funds had to be bailed out in the financial meltdown, Assistant Treasury Secretary Michael Barr said in an address that hedge funds need to be regulated because their deleveraging contributed to the financial crisis and regulators need to be able to identify potential systemic risk from the world of hedge funds.

By Robert Stowe England

July 15, 2009

Michael Barr, assistant secretary for financial institutions, today revealed a new item on the Administration's refinancial regulatory reform agenda: the regulation of hedge funds.

Hedge funds and investment advisors above the $30 million threshold will have to register with the Securities and Exchange Commission and be required to disclose to regulators and investors "more information about the characteristics of their advised hedge funds -- including asset size, borrowings, [and] off-balance sheet exposure," among other things, Barr said in a speech at the Exchequer Club of Washington, D.C.

The full text of Barr's speech, which was dedicated to explaining the rationale behind Treasury proposed regulatory overhaul, is at this link:

"Registration and disclosure will help to protect investors from fraud or abuse, and [also help] to protect the financial system from unacceptable systemic risks building up outside prudentially supervised institutions," the treasury said.

The proposed regulation of hedge funds is part of a broader overhaul aimed at filling the regulatory holes that federal regulators contend contributed to the financial meltdown last year.

"This crisis . . . clearly demonstrated that risks to the system can emerge from all corners of the financial markets and from any of our financial institutions," Barr said.

"Our approach is to bring these institutions and markets into a comprehensive system, where risks are disclosed and can be monitored by regulators as necessary," he added.

The very largest hedge funds will face even more regulation, according to Barr, who did not reveal what level of assets would place a hedge fund in this category.

"Hedge funds that are found to be so large, leveraged, or interconnected that they pose a threat to financial stability will be regulated as Tier 1 [Financial Holding Companies], with the regulator having the authority and responsibility to regulate these firms not just to protect their individual safety and soundness but to protect the entire financial system," Barr explained.

These very large hedge funds would be under the regulatory oversight of both the Federal Reserve and the proposed Financial Services Oversight Council contained in the broader overhaul measure.

Barr identified three segments of the financial markets that have been targeted for new regulation: over-the-counter derivatives markets, the securitization markets, and hedge funds.

Barr briefly explained why hedge funds need to be regulated.

"Hedge funds do not appear to have been at the center of the current crisis," he acknowledged, "but deleveraging by hedge funds contributed to the strain on financial markets."

The lack of transparency in hedge funds "contributed to market uncertainity and instability," the assistant secretary said.

"These firms continue to present unknown risks, and that lack of transparency is no longer tenable," Barr explained.

"We need a system that lets regulators see risks as they emerge across the financial system," Barr said.

In summing up the Administration's reform proposal, Barr observed, "Markets require clear rules of the road, consumers rely on the truth and fair dealing of financial institutions, and regulation must be consistent, comprehensive and accountable."

"The President's plan lays a new foundation for financial regulation that will once again help to make our markets vital and strong."

Copyright © 2009 by Robert Stowe England


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