A group of leading hedge fund executives on Wednesday published recommendations for voluntary standards on governance and disclosure to address criticisms regarding the opaqueness of the fast-growing industry.
The Hedge Fund Working Group (HFWG), headed by Andrew Large, former deputy governor of the Bank of England, called for hedge funds to be more transparent to enhance the industry's reputation and boost confidence in the sector.
The consultation paper comes at a time when the $2 trillion hedge fund industry has come under pressure from some commentators and politicians who favor regulation or more stringent supervision, arguing that the activities of some hedge funds could undermine the strength of the financial system.
Hedge funds were not "central to the systemic issues" revealed by the recent subprime mortgage crisis and resulting credit crunch, even though some hedge funds have failed and their investors are nursing losses, Large wrote in the report.
But the group had learnt from the lessons of the recent turmoil and had used these in several of its standards, he wrote, in particular that hedge funds should adopt risk management models that emphasize liquidity, to ensure the funds have sufficient cash to meet their obligations in a crisis.
The credit crunch also influenced its recommendations that hedge funds should adopt clear and robust methods for valuing complex assets and disclose whether they own assets in their portfolio that may be hard to value and could be difficult to sell quickly to meet redemptions demands or margin calls.
On concerns at hedge fund firm's part in growing investor activism, the HFWG recommended that regulators should require all investors to disclose whether they have an economic interest in a firm such as through contracts for difference.
It also said that hedge funds should not vote on matters regarding firms in which they only own borrowed stock.
Framework For Global Standards
The paper primarily refers to the UK hedge fund industry -- which accounted for around $360 billion of the $460 billion of assets in Europe managed by hedge funds -- but could be used as the basis for an evolving framework of global voluntary standards for the industry, HFWG said.
"You need to see this as a first step, and a very important step, along a road," Large, former head of the Securities and Investment Board, the predecessor of regulatory body the Financial Services Authority, told Reuters.
"It's the first time a group of hedge fund managers have got together in this way and come up with a pretty serious approach to all the various issues" facing the industry, Large said.
Compliance with the group's recommended standards of practice would only be voluntary, but funds that do not meet them should be required to offer a valid explanation as to why they should not apply them, the group said.
The group said it expected that peer group and market pressure would be likely to encourage adherence to the standards, which are based on regulatory principles laid down by the UK watchdog the Financial Services Authority.
Asked whether he thought the recommendations were enough to prevent tougher external regulation of the industry, Large said: "I don't think there is much appetite for additional regulation."
Even in Germany, where a senior politician recently advocated new measures to limit the size of stakes that hedge funds are allowed to take in Germany companies, calls for reform have centered on an industry code of best practice, Large said.
"I think (that) is what we've come up with."
The HFWG recommended the establishment of a board of trustees to oversee the adaptation of the standards as the industry evolves and to co-ordinate their efforts with similar industry bodies in other countries.
The HFWG comprises 14 hedge fund managers, including Brevan Howard, Centaurus Capital, GLG, Gartmore and Man Group, the world's largest listed hedge fund firm, while over 30 other hedge fund firms are backing its efforts, along with industry body the Alternative Investment Management Association.
The group will consult on its paper until mid-December and expects to issue its final report in January 2008.