LONDON Many of Europe's hedge funds will sign up to a voluntary code of standards to appease institutional investors and avoid punitive regulation, but even those that don't will be unable to ignore it.
The standards on governance and disclosure, unveiled in October by the Hedge Fund Working Group, comprising powerful hedge fund managers including Brevan Howard and Man Group (EMG.L), were devised to counter criticism that the industry was opaque, secretive and destabilising the financial system.
Take-up so far has been slow, however, with only one other hedge fund having signed up to the standards beyond the original 14 in the working party.
But with the spotlight having shifted to the behaviour of banks following the credit crisis, senior hedge fund figures have warned the industry against ignoring the standards and becoming complacent about the threat of formal regulation.
"The industry mustn't delude itself into thinking this will go away," Christopher Fawcett, head of the hedge fund trade group the Alternative Investment Management Association (AIMA), told a recent industry conference.
Hedge funds have a limited time to act. "The industry has been given six to nine months to do something," said Fawcett, referring to the regulatory environment.
CONSEQUENCES OF INACTION
Antonio Borges, the former Goldman Sachs executive appointed last month as the first chairman of the new Hedge Funds Standards Board HFSB.L, the custodian of the standards, warned hedge funds of the consequences if they ignored the opportunity to regulate themselves.
"We should not underestimate the fact that there is in some segments, especially in the political world, a movement in favour of very tough regulation, which I think would be quite detrimental to everybody."
Widely mistrusted in continental Europe, where senior German politicians have branded them as "locusts", new rules may seriously constrain hedge funds' activities, perhaps limiting the stakes they can build up in firms or curbing their ability to short-sell investments.
Borges's first priority is to get as many as he can of the hundreds of European hedge funds to sign up to the standards.
He acknowledges that not every hedge fund, many of whom employ only a handful of staff and manage tiny amounts of cash, will sign up to the standards, which require firms to either comply with HFSB rules on valuation of assets, conflicts of interest and governance, or to explain why they do not.
But Borges is determined to ensure the rules become seen as the accepted standards in the industry. "Even if people don't sign up, they should know these are the standards by which the industry operates."
DE FACTO STANDARDS
There are already signs this is starting to happen.
"We have seen an increase in funds asking for help and advice on addressing the standards and expect to see a further increase in the latter half of the year," said Paul Larche, a director of the London office of hedge fund consultancy Carne Global Financial Services.
Hedge funds that want to attract or keep institutional investors will be under pressure to meet the standards, said Larche. "Institutions such as pension funds will want to see funds sign up."
A recent survey by KPMG said more than half of pension funds would require the hedge funds they invest in to comply with the standards within three years.
Meanwhile, fund managers who invest in hedge funds on behalf of clients are already adopting some of the HFSB standards into their due diligence procedures.
"We predict they will become the de facto standard in the UK. It's just a matter of when it hits that level," said Sunil Chadda, head of alternative investments at Carne.
Martin Cornish, managing partner of law firm Katten Muchin Rosenman Cornish, said his advice to hedge fund clients is that even if they don't sign up to the standards then they should look closely at whether their actions match the standards.
"I don't think you can take the view that this sounds terribly difficult and I'm just going to ignore it. I think you're going to have to look at these standards and say I'm likely to be held to this test, whether I have signed up or not," said Cornish.