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If Congress gets involved, you can be sure any regulation they will attempt to pass will be a disaster. Politicians pander to special interest groups and when Polyanna cries, they will respond with knee-jerk reactions and legislation which has no forethought.

I can envision the SEC possibly revising the definition of a Qualified Purchaser (QP) to reflect the impact of inflation on the original QP criteria. If hedge funds (HF) continue to be packaged under a HF of HF product to target clients with lower minimum requirements, then I can see the regulators stepping in and mandating more client disclosures (similar to other "suggested" regulatory disclosure documents).

I agree with Mr. Piglia that one important point missed in all this is the fact that the annointed "rating agencies" play a key part in all this. While they have n important role in the financial services industry, they do not always prove themselves to be leaders in clear disclosure and, more importantly, analysts of potential problems based on their review of the data and "kicking the tires" of the entities they cover. They are great, however, at jumping on the bandwagon and issuing negative reports after an issue has arisen. As a financial services professional, I am required to carefully review a company's/vendor's financials, management style, performance track record, underlying philosophy, experience of the portfolio managers and executive team, etc. We have to ask the tough questions and "get under the covers" initially and periodically thereafter. We must stay in tune with market conditions, economic factors, changeing regulatory environment, etc. to constantly insure our selection is correct for our clients - the investor - before it blows up and a regulator knocks on our door. It only makes sense that these Publically Recognized Statistical Rating Agencies also receive oversight - what are the credentials of these analysts, are there any conflicts of interests, what are the minimum standards of what must be reviewed and tested (and how often), etc.

Like all other financial entities and services, I believe the HF offers a viable market tool - liquidity. Just like you have speculators and hedgers in the commodities market that provide liquidity and risk taking, the HF world also provides the same important provisions. With the push for more private equity, PIPES and unique debt offerings, the HF can offer an avenue for those corporations in need to float these products to QP. The HF can provide a pool of QPs who can accept a diversied (the key here) portfolio of investments and spread this risk accordingly. Each style of HF affords a unique market component whether Equity Long/Short, Event Driven, etc. In may very well be that to offer more of a comfort level to the regulators, more transparency of holdings may be the answer. This would permit for better calculation of market exposure, leveraging and concentration that a regulator would want to monitor as part of risk management. It may well be that the regulators may/should require the clearing firms and custodians that help faciliate the trading of registered products to provide information on positions, leverage, loans, etc. provided to the HF they service. While the HF may remain unregulated (depending on how it is qualifying for an exemption from registration under the Company Act), it may make regulatory sense for them to report assets under management (as they do now under Reg D, Schedule 13 G and Schedule 13 F) on unregistered positions and leverage just so that the SEC has a heads-up on possible adverse situations. This would afford the SEC the opportunity to discuss with the HF General Partner and portfolio manager how the HF is managing exposure, contingency plans in the event of adverse market conditions, meeting any margin calls, liquidity needs, etc. A proactive risk management plan, periodic stress testing and transparency between the SEC and the HF community is the key.

posted July 26, 2007

Simple. Put mechanisms in place that limit the leverage you can take up and strictly link it to historical volatility of the underlying asset.
Plus put in place clear cut measurements of liquidity and liquidity risks implied in the undelying asset.
But regulating the Hedge Funds is a mistake in itself...hedge funds are, per definition, risky assets that should be left to big boys that can make calculations....and take losses.

The point is that murky CDOs have been sold directly by Banks packaging them to Pension Funds!!! Regulate Pension Funds and remove for fiduciary breeches those Pension Managers who relied only on the name and relationship of the Banks to avoid looking into them. Regulate the bloody Rating Agencies who gave AAA rating to stuff who contained also "toxic waste" i.e. subprime equity unratable by anyone.
Any Pension Manager who cannot use a Bloomberg for at least checking the % of collateral backed loans for which the borrower is 60 days or more behind should be replaced...along with any Hedge fund Manager who tought to get away holding dangerous illiquid stuff forever.
Regulate the packagers and the raters...regulating something that bears in front of any Offering Memo that investing can be dangerous and lead to big losses like Hedge Funds...is regulating the wrong target!!!!

posted July 24, 2007