In a
May 16, 2012 letter to the European Commission, the Managed Fund Association (MFA), an association of hedge funds and managed future firms, shot back at the FSB's
April 2011 greenpaper/background note on shadow banking. In its response, MFA argues that it was a mistake to include hedge funds as part of the shadow banking system as the FSB has defined it. Neither their funding characteristics nor relative size should warrant regulation of hedge funds to a greater degree than other investment sectors.
In MFA's view, hedge funds generally do not share many of the characteristics the FSB has identified as "shadow banking." For example, hedge funds do not engage in maturity transformation, and are well regulated and subject to significant reporting and oversight requirements under both US and EU regulatory reform initiatives. Also, hedge funds' activities are not reliant on unsecured, short term financing.
Unlike many other financial market participants, hedge funds generally do not rely on unsecured, short term financing to support their investing activities. Instead, hedge funds typically rely on secured borrowings, which are designed to more closely match the term or expected liquidity of the asset and the financing which funds it. Without the benefit of a government safety net, the industry has evolved carefully crafted practices to manage liquidity risk.
For these reasons, MFA believes that hedge funds are fundamentally different than entities like money market funds, which are subject to runs and can pose much wider systemic risks.
They also feel that it is inappropriate for the FSA to include all hedge funds categorically in "shadow banking." Though the green paper does not specifically list entities in the definition of "shadow banking system," it does mention hedge funds by way of example. The Annex to the green paper lists various entities in the "credit intermediation chain." A category of credit intermediation includes hedge funds as part of "Distributions/Wholesale Funding." MFA says that this example may be misleading.
Simply to refer to hedge funds as being part of the "shadow banking" system in the Background Note may therefore be misleading. It would also mean that any regulatory approach which seeks to single out and regulate hedge funds in the shadow banking context would be inappropriate.
First, we believe that there is no particular reason for mentioning hedge funds specifically. To the extent the category "Distribution/Wholesale funding" is an appropriate category in the credit intermediation chain, we believe that every kind of institutional investor in the financial markets is relevant for that category. In this regard, hedge funds are no different from other non-bank institutional investors such as long-only mutual funds, insurance companies, pension funds, private equity funds and other large corporate investors.
Second, we believe that only those entities which are systemically important should be identified as being relevant to the shadow banking system (and thus identified for purposes of the credit intermediation chain).
MFA further explains that the hedge fund industry, though important to capital markets and the financial system, is not systemically important in the context of the broader financial markets because of its relatively small size. According to MFA, the entire hedge fund industry pales in size when compared to the global mutual fund industry and the US banking system. Further, MFA says that hedge funds are widespread and not concentrated in any single adviser or group of advisers.
Though they support the effort to explore approaches and regulatory measures for monitoring the shadow banking system and address systemic risks concerns posed by shadow banking, MFA feels that the FSB should know the facts about hedge funds, and consider all of the reforms that are already implemented or in the works before making substantive proposals.
. . . MFA believes that it is important that the FSB should have a clear understanding of the size of the broader financial system, before making recommendations on a regulatory approach for the shadow banking system. It is also important that the FSB consider the improvements made by hedge fund counterparties (such as banks and broker-dealers) over the past few years to risk management practices, as well the new regulatory requirements which have been put in place since the advent of the financial crisis.