LONDON (Reuters) - No single hedge fund today poses a systemic risk to the global financial system, said a former partner at Long Term Capital Management (LTCM), as lawmakers continue to hammer out rules to control the industry.
Even though many funds are now much larger than LTCM, which collapsed in 1998 and received a $3.5 billion bailout to avert widespread financial chaos, Hans Hufschmid, currently chief executive at fund servicing firm GlobeOp, said prime brokers now act as an effective brake on hedge fund risk. “I find it hard to believe -- I don’t think a hedge fund today is big enough to pose a systemic risk,” he said.
“Prime brokers would manage that -- they would say ‘we’re not lending you that much money’... The market regulates it to some extent, you couldn’t have a situation where one hedge fund takes excessive risk with one prime broker.”
Connecticut-based LTCM, which collapsed after its mathematical model failed to foresee the Russian debt crisis, estimated that a default could have cost its 17 top counterparties between $3 billion and $5 billion.
The fund was leveraged at up to 100 times at one stage, according to some estimates. In contrast, average prime broker leverage in the UK fell to around 1.15 times in October 2008 from around 1.9 times in October 2007, according to data from Britain’s Financial Services Authority.
In a report in March, FSA chairman Adair Turner noted that hedge fund leverage is typically well below that of banks.
Hufschmid’s comments, however, come as lawmakers in the U.S. and Europe draw up plans to step up regulation of the hedge fund industry.
In April the European Commission unveiled draft proposals for hedge fund managers to register and be subject to close scrutiny in an effort to control vehicles believed to pose systemic risks. France has since said the rules do not go far enough to control such dangers.
Hufschmid, who says LTCM “by today’s standards ... was insignificant,” said hedge funds had not caused the global financial crisis but were involved in subsequent deleveraging as they sold securities they’d bought with credit.
“The triggers of this crisis (mortgages, house prices, credit deterioration etc.) caused the excessive leverage in the system to tumble,” he said.
“The de-leveraging that followed involved hedge funds -- to the extent they were risk-takers they too had to downscale like everyone else.”
Editing by Rupert Winchester
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