We have been hearing a lot recently about the “shadow banking” sector. Senior bankers and lawmakers seem to have found a new bogeyman. The International Monetary Fund has called for enhanced oversight of “shadow banking activities”, while the G20 has instructed the Financial Stability Board to develop regulatory recommendations by the autumn.
Who will be covered by this new system of oversight? The term “shadow banking”, first coined in 2007, is usually meant to refer to a wide variety of non-bank financial institutions including money market funds, structured investment vehicles and insurance companies. The implication is that such organisations are engaging in bank-like activities out of the sight of regulators, creating unmonitored risks to the system.
But not everyone agrees on the exact definition, raising the risk of mission creep as the scope of the new regulations is expanded to cover an ever wider array of institutions and sectors. Take hedge funds, which are sometimes included as being part of the “shadow banking system”. Depending on who is speaking, this mysterious system includes either the entire hedge fund industry or only credit hedge funds (those which employ a credit strategy). There are significant regional variations too, so that someone speaking about “shadow banking” in the US is not necessarily talking about the same thing as someone in Europe or Asia.
Is it even fair to include hedge funds? For the record, hedge funds are part of the asset management industry – not the banking industry. They do not take deposits, do not undertake maturity transformation nor benefit from implicit or explicit taxpayer guarantees. Hedge funds manage investment capital on behalf of third party investors, most of them institutional investors such as pension funds and university endowment funds. And they bring the considerable advantage of enabling investors to customise their asset mix more precisely to their liability profile, thereby reducing mismatches, boosting investment returns and making capital allocation more efficient.
The broader point made by critics of “shadow banking” – that hedge fund managers are part of a vast, unregulated sector that threatens the stability of global financial markets – is wrong too. Hedge funds do not inhabit the regulatory equivalent of the shadows. All the major jurisdictions where they operate – whether in North America, Europe or Asia-Pacific – regulate the industry rigorously. The only big jurisdiction that did not require managers to register with their regulator, the US, has now rectified that. Already significant levels of regulation are being further increased by legislation introduced since the financial crisis.
As a global body, the Alternative Investment Management Association is well placed to judge the scale of global regulatory reform. One measure of the volume of new regulations is that we have submitted more than 100 consultation responses in the past two years – that is roughly one every week, somewhere in the world. It is a telling statistic.
It is of course no accident that the re-emergence of the “shadow banking” term has coincided with the efforts of the US Financial Stability Oversight Council, among others, to identify systemically-important financial institutions that will be the subject of additional supervision. But there is no evidence to suggest that a single hedge fund is sufficiently large, leveraged, complex or interconnected that its failure or financial stress would cause such severe disruption.
Do not just take Aima’s word for it. The UK Financial Services Authority conducts twice-yearly surveys of the 50 largest UK-based hedge fund managers, including some of the behemoths of the global industry, and has yet to find an individual hedge fund that poses a systemic risk.
Of course it is possible that individual hedge funds could act together to create systemic impacts. But the hedge fund industry’s heterogeneous and contrarian nature makes such unified action highly unlikely.
Hedge funds, for their part, are not unregulated, shadowy or even bank-like. They are, as independent academics have noted, rigorously regulated, transparent to their supervisors, not systemic, and “small enough to fail”.
Source: www.ft.com
Who will be covered by this new system of oversight? The term “shadow banking”, first coined in 2007, is usually meant to refer to a wide variety of non-bank financial institutions including money market funds, structured investment vehicles and insurance companies. The implication is that such organisations are engaging in bank-like activities out of the sight of regulators, creating unmonitored risks to the system.
But not everyone agrees on the exact definition, raising the risk of mission creep as the scope of the new regulations is expanded to cover an ever wider array of institutions and sectors. Take hedge funds, which are sometimes included as being part of the “shadow banking system”. Depending on who is speaking, this mysterious system includes either the entire hedge fund industry or only credit hedge funds (those which employ a credit strategy). There are significant regional variations too, so that someone speaking about “shadow banking” in the US is not necessarily talking about the same thing as someone in Europe or Asia.
Is it even fair to include hedge funds? For the record, hedge funds are part of the asset management industry – not the banking industry. They do not take deposits, do not undertake maturity transformation nor benefit from implicit or explicit taxpayer guarantees. Hedge funds manage investment capital on behalf of third party investors, most of them institutional investors such as pension funds and university endowment funds. And they bring the considerable advantage of enabling investors to customise their asset mix more precisely to their liability profile, thereby reducing mismatches, boosting investment returns and making capital allocation more efficient.
The broader point made by critics of “shadow banking” – that hedge fund managers are part of a vast, unregulated sector that threatens the stability of global financial markets – is wrong too. Hedge funds do not inhabit the regulatory equivalent of the shadows. All the major jurisdictions where they operate – whether in North America, Europe or Asia-Pacific – regulate the industry rigorously. The only big jurisdiction that did not require managers to register with their regulator, the US, has now rectified that. Already significant levels of regulation are being further increased by legislation introduced since the financial crisis.
As a global body, the Alternative Investment Management Association is well placed to judge the scale of global regulatory reform. One measure of the volume of new regulations is that we have submitted more than 100 consultation responses in the past two years – that is roughly one every week, somewhere in the world. It is a telling statistic.
It is of course no accident that the re-emergence of the “shadow banking” term has coincided with the efforts of the US Financial Stability Oversight Council, among others, to identify systemically-important financial institutions that will be the subject of additional supervision. But there is no evidence to suggest that a single hedge fund is sufficiently large, leveraged, complex or interconnected that its failure or financial stress would cause such severe disruption.
Do not just take Aima’s word for it. The UK Financial Services Authority conducts twice-yearly surveys of the 50 largest UK-based hedge fund managers, including some of the behemoths of the global industry, and has yet to find an individual hedge fund that poses a systemic risk.
Of course it is possible that individual hedge funds could act together to create systemic impacts. But the hedge fund industry’s heterogeneous and contrarian nature makes such unified action highly unlikely.
Hedge funds, for their part, are not unregulated, shadowy or even bank-like. They are, as independent academics have noted, rigorously regulated, transparent to their supervisors, not systemic, and “small enough to fail”.
Source: www.ft.com
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