February 25, 2008 / 6:08 PM / 9 years ago

UPDATE 2-Hedge funds still pose systemic risk -US study

(Adds industry reaction, background in paragraphs 7-10)

By Kevin Drawbaugh

WASHINGTON, Feb 25 (Reuters) - Hedge funds still pose a potential systemic risk to the economy, despite having improved their management and disclosure practices, according to a study released on Monday by U.S. congressional investigators.

The loosely regulated capital pools favored by the rich and by large financial institutions "require continued monitoring by regulators and counterparties," according to a Government Accountability Office report released by Democratic lawmakers.

The report detailed improvements made recently in the $1.8 trillion hedge fund industry, "but concludes that there is still the potential for systemic risk," Pennsylvania Democratic Rep. Paul Kanjorski said in a statement.

Kanjorski, chairman of the House of Representatives Capital Markets Subcommittee, said Congress must be watchful. But neither he nor other lawmakers involved in releasing the report proposed any new legislation.

"The dynamic nature of the financial markets requires that we continue to examine evolving practices in this area," said Massachusetts Democratic Rep. Barney Frank on the report. Frank is chairman of the House Financial Services Committee.

The GAO study comes at a tough time for hedge funds, which last month reported heavy average losses in a slumping stock market. In December, new money invested in hedge funds hit its lowest level in two years as investors cooled to the sector.

As it has grown in size and gained public attention, the hedge fund industry has fought a series of battles over regulation and taxation on Capitol Hill and with the U.S. Securities and Exchange Commission, with mixed results.

The Managed Funds Association, which represents the industry in Washington, recently hired former Louisiana Republican Rep. Richard Baker as its chief executive.

After the GAO report was released, Baker said in a statement that the association was studying it. "It is my expectation that remedies may be found, for any meaningful concerns, that will enable the preservation of market function for an increasingly significant market sector," he said.

Baker added that he expects "important steps" to be taken soon by a Bush administration inter-agency capital markets group "that will represent the interests of investors and the marketplace, including managers and counterparties, with respect to risk management and disclosure." (Editing by Lisa Von Ahn and Braden Reddall)

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