Iosco recommends compulsory registration of hedge funds

Hedge funds and fund managers should be subject to mandatory registration and an international system of oversight should be established for the hedge fund industry, the International Organisation of Securities Commissions' (Iosco) Technical Committee has said.

In the final draft of its hedge funds oversight report on June 22, Iosco called for the registration of hedge funds and fund managers across all jurisdictions. When registering, details on the background of senior personnel, assets under management, and risk management systems should be disclosed, along with investment strategies, the type of investors targeted and fee structure used.

Funds should also be subject to ongoing regulatory reviews, the report said. They would be assessed on how comprehensive and independent risk management functions are; whether funds employ an enterprise-wide approach; and whether this includes stress testing of their positions.

It is also necessary to monitor funds' compliance function, valuation practices, the segregation of client fund assets, and whether the accounts of the fund manager or funds managed are audited on an annual basis, Iosco said. Some members of the Technical Committee even suggested that capital requirements should be imposed on hedge funds to ensure fund managers can handle the risks facing them.

If Iosco's recommendations are adopted, hedge funds will not be the only institutions facing greater disclosure requirements. While the Madrid-based regulator highlighted the "possible role of hedge funds in amplifying the consequences of the crisis", it did not attribute full blame for the crisis at their door. "The main transmission mechanism of systemic risks to the wider financial markets is via the hedge funds' prime brokers and banks," Iosco said, and therefore these institutions should also be subject to mandatory registration and supervision.

Regulation would include assessments of banks' systems for managing risk, especially their counterparty credit risk exposures to hedge funds, and their ability to obtain enough information from funds to evaluate the risks facing them.

In addition, securities regulators should assess non-public information on the prime brokers' and banks' most "systemically significant" and/or "higher risk" hedge fund counterparties. Assessments should focus on leverage by fund and strategy, the liquidity profile of funds, whether hedge funds have multiple prime brokers, and what margin requirements and contract terms are specified.

For Iosco's recommendations to have full effect, international regulators will need to co-operate and share information. "It is very important to emphasise that any regulatory measures or standards need strong collective global action and application - as the hedge fund industry is highly global and mobile," the report explained. But before the desired regulatory framework can become a reality, the patchwork of national and regional regulation must be overhauled.

With regard to hedge fund registration, for example, Iosco noted that in most member jurisdictions hedge fund managers are subject to licensing, registration or eligibility requirements. However, in a number of jurisdictions, managers may be exempt from registration under local law.

A more "direct" global approach to hedge fund supervision is a significant change of direction from Iosco, which has advocated an "indirect" approach to hedge fund regulation for most of the decade. The international regulatory community is also moving in that direction, the report said.

"Managers of private pools of capital that employ substantial borrowed funds should be required to register with an appropriate national prudential regulator," recommended the Group of 30 nations in a January report. "The prudential regulator of such managers should have authority to require periodic regulatory reports and public disclosures of appropriate information regarding the size, investment style, borrowing, and performance of the funds under management."

In April, the Group of 20 nations also called for increased regulatory oversight of funds. "Hedge funds or their managers will be registered and will be required to disclose appropriate information on an ongoing basis to supervisors or regulators, including on their leverage, necessary for assessment of the systemic risks that they pose individually or collectively. Where appropriate, registration should be subject to a minimum size. They will be subject to oversight to ensure that they have adequate risk management."

See also: Cap it all
When hedge funds attack