Should hedge funds' speculative powers be restrained? Advocates on both sides of the argument appear to have reached a compromise with a powerful financial body this week recommending higher transparency in hedge funds' books but stopping short of imposing direct regulatory controls.
The Financial Stability Forum, a panel made up of the Group of Seven industrialized nations plus Australia, Hong Kong and Singapore, has proposed hedge funds and other highly leveraged financial institutions with more than US$1 billion in capital should adopt minimum disclosure standards to ensure market stability. The details on how much hedge funds should reveal are unclear.
While some hedge funds are likely to play even more complicated numbers games to fudge the markets, some are likely to move to offshore financial centers to avoid scrutiny. Governments of tax haven countries can expect to come under pressure from such organizations as the IMF to lift their supervision practices to match international standards.
Countries with fixed foreign exchange policies and high level of short-term debt also may have to maintain a larger foreign exchange account than their current reserves.
That the forum did not prescribe high-handed direct interventions was predictable - very few countries that allow the free flow of capital would underestimate hedge funds' abilities to defy regulatory controls. There are, however, different opinions on how closely the movements of such swift and sophisticated funds should be scrutinized.
Hong Kong, for instance, has suggested that some form of disclosure requirements be imposed on the OTC (over the counter) markets where, it argues, highly leveraged institutions use their market power to influence the prices in smaller markets while hiding their identities through the use of investment banks to execute their orders.
Hong Kong's concerns echo Germany's proposal that an international credit register be created to collect information on how much global financial intermediaries are exposed to single counter-parties, ie hedge funds, that have the potential to create substantial risk in the international markets.
But the US attitude on this issue is resolute. It maintains that government oversight of leverage should be the exception, not the rule, arguing the primary responsibility for addressing the weaknesses in risk management rests with private financial institutions. The creation of a credit register will do little to encourage these companies' desire to improve their level of safeguard, if not actually diminish it.
Singapore has suggested incentives be created in the supervisory framework for the counter-parties of hedge funds to become more vigilant. But the US says self-interest, more than anything else, should be incentive enough for companies to be more prudent when dealing with hedge funds.
Meanwhile, a US Senate banking committee has recently passed a bill to require hedge funds with more than $1 billion of capital or $20 billion in aggregate assets to disclose more financial information.
Australia also is studying the effects of highly leveraged financial institutions in its financial market. It believes hedge funds were partly responsible for the Aussie dollar's fall to an all-time low in 1998.