A "Voluntary Code of Conduct" for Hedge Funds? It's Face-Saving Time in Germany

Poor Germany. Why are their regulators so consistently out-of-step with their cousins, the FSA in the UK and the SEC in the US? Their urge to regulate industries - especially those they don't understand -  has become the ultimate indicator of future growth. When private equity firms started becoming more active, and Europe became a center of growth for PE-driven deals, German regulators referred to PE professionals as a bunch of "locusts." And what happened? The growth in private equity assets under management exploded to unprecedented levels. And when German regulators started banging the drums for greater transparency and disclosure from "dangerous hedge funds," you could be certain that hedge fund assets were going to go through the roof. Which they have. In each case German regulators have stood apart from those in the two largest centers of finance, the US and the UK, and have looked pitifully weak, ineffective and lacking in power and influence.

So what we have this week is an attempt by Germany, with support from ECB President Jean-Claude Trichet, to put into effect a "Voluntary Code of Conduct" governing hedge fund disclosure and transparency. In short, a face-saving measure for Germany. Because if they had any less face, they'd be lacking a head entirely.

From today's Financial Times:

A proposed voluntary code of conduct for hedge funds is winning increasing backing around the world as a way of controlling risks created by the fast-growing industry, according to Jean-Claude Trichet, president of the European Central Bank.

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Germany has long been pushing for measures to boost transparency in the hedge fund sector but the UK and US have resisted proposals that might involve unnecessary regulation. Mr Trichet's intervention offers Berlin powerful backing as it seeks agreement by the end of the year.

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A voluntary code could, he said, cover risk management within hedge funds and the exchange of information between funds and their bankers and between funds and their investors.

"I trust that in a number of areas we can proceed very much through the way of such voluntary codes," Mr Trichet said.

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The ECB has been among the global financial institutions most vocal in warning about possible risks created by hedge funds. Its last financial stability report, released in December, warned that in their dealings with hedge funds "the prime brokerage businesses of banks have continued to test the boundaries of their risk appetite and prudence in risk management".

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But amid scepticism in the US and Britain, senior German finance ministry officials said the proposal has been removed from the final communiqué to be agreed at this weekend's two-day meeting in Potsdam.

So, notwithstanding JC Trichet's support, it is pretty much acknowledged that Germany is not a thought-leader in financial services regulation. In fact, it is having a hard time gathering support for voluntary hedge fund guidelines that have a fraction of the teeth of what they'd really like to see. They've boxed themselves into a corner, and they're getting crushed.

An even harsher view of Germany's position is offered by the International Herald Tribune in a story titled "Germany fights lonely battle to rein in hedge funds:"

Germany will make a last-ditch effort Friday to persuade the world's top economic powers to tighten their grip on hedge funds and private equity firms.

But even before these countries' finance ministers convened at a Group of 8 meeting, the push was being written off as futile - illustrating Germany's isolation in its desire to rein in the booming industry.

In the run-up to a two-day meeting near Berlin that will begin Friday, the United States, Japan, Britain, and Canada - where the bulk of hedge funds and private equity firms are based - have signaled their desire for a hands-off approach toward regulation.

"Central banks and other regulators should resist the temptation to devise ad hoc rules for each new type of financial instrument or institution," Ben Bernanke, chairman of the U.S. Federal Reserve, said in a speech this week.

Henry Paulson Jr., the U.S. Treasury Secretary, has said he would skip the meeting this weekend altogether because of a heavy workload.

Other members of the club - France, Italy and Russia - have given little or no public support to Germany's effort.

Their stance is an embarrassment to Germany, which has made increased transparency of the industry a top priority in its role as the current president of the G-8.

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Ouch. When you've got Ben Bernanke talking smack and Hank Paulson blowing you off, you know you've been marginalized. I just don't know what it will take for German regulators to wake up to a simple fact:

The key issue with oversight of the hedge fund industry is the management of systemic risk, not single-fund risk, and that this oversight can be performed through a review of and data from institutions that are already regulated.

I've written about this in excruciating detail on a number of occasions, but for some reason it is clear that Germany's leaders and the BaFin just aren't reading my blog. Too bad. Hopefully, at some point, they'll ingest some of these insights and join the rest of us on this planet.

FYI, some of my earlier posts on the this and related topics are as follows:

• 02/23/2007: The Presidential Working Group on Hedge Funds Has Been Reading My Blog! Amen.

• 02/12/2007: The G-7 on Hedge Fund Risk: Politics Abound, But Getting the Right Answers

• 01/30/2007: "Implicit" Hedge Fund Regulation: Moving in the Right Direction

• 01/09/2007: Who Says Hedge Funds Aren't Regulated?

• 07/27/2006: Do Hedge Funds Give Rise to Externalities?

• 07/16/2006: Much Ado About Nothing - the Hedge Fund Regulation Debate

Comments

[Yaser Anwar]

While I'm all for transparency, I think having a 'Voluntary Code of Conduct' is of no use at all.

As I've said before, the best HFs have very stringent risk mgmt policies (but we already knew that) and the second, third-tier HFs these days are going the "Managed Accounts" way, which gives ample transparency.

You would think Germany would learn/consult from its fellow citizen, DB, about issues concerning HFs. I guess the thought train has left the building, a long while ago!