In America, implementation of Basel II is hardly witnessed. In Western Europe, it is not present at all.

Yet it is alive and kicking in Japan, and three of the megabanks command IRB status under the Basel II rules. That means the directors of those banks are supposed to understand the nuances of its risk implications. Assuming that they do understand their risk portfolios might be a case of 'EmperorÆs New Clothes'. The knee-jerk reaction to Basel II caused a flight from hedge fund investment last year.

ôI think the regional banks have started to migrate back to hedge funds,ö says Shinichiro Shiraki, the CIO of Monex Alternative Investments, speaking at the Hedge Funds World conference in Tokyo.

Basel II is not likely to be limited just to the banks and in time will roll-out to other institutions, including the Japanese life insurance industry.

Whilst high profile, Basel II is just one part of the risk management cocktail for Japanese hedge funds. It is a highly regulated environment in Tokyo, but remains one that puts most onus on the investor himself to conduct his own due diligence.

Moderating the Tokyo panel was Bear StearnsÆ Stefan Nilsson. (And Bear Stearns knows a bit about hedge fund risk management.) He is also founder and president of the Tokyo Hedge Funds club.

ôPeople here talk a lot about risk management, but often don't do an awful lot [about it],ö said Nilsson. ôThey frequently have nothing more than in-house spreadsheets and thatÆs scary. Some might make great returns in spite of that, but thatÆs not skill, it's just pure luck.ö

Japan remains an opaque space for hedge funds, made harder by the linguistic and cultural skills required to operate here. One who has done so is Ed Rogers, an ex-prime broker who set up his own shop in 2006 and is now the CEO and CIO of fund of funds advisory Rogers Investment Advisors.

ôSometimes the hedge fundÆs 125-page offering memorandum does not correspond with their pitch book,ö says Rogers. ôSo I hire a girl with an MBA who reads every single page of it and writes me a report. But managers can still æwalk off the reservationÆ. So if I catch a hedge fund unexpectedly betting the ranch on say, a cut in Fed interest rates, then IÆm redeeming.ö

Daunting. So what do the managers themselves think of the risk parameters by which they elect to abide?

Lilik Takahashi set up Piala Capital Management in 2007, after working at Pequot Capital Management. ôThe best risk management tool I have is to figure out what I can lose in a one month value-at-risk,ö he says.ö IÆd draw investorÆs attention to managers who have suffered drawdowns and then are trying to recoup their losses. That is where you might see them taking on more risk.ö

HSBC looks at approximately 1,000 hedge funds and reckons that half of failures are due to operational issues rather than lousy performance. In Japan they assess that the key topics for risk management discussion today include liquidity, gates and leverage.

ôI also think that a manager performing too well might be a flag for over-concentration and low risk controls,ö says Frank Packard, head of HSBCÆs north Asia Alternative Investment Group. ôAnother matter I like to think about is which service providers a Japanese hedge fund uses. If theyÆre using, say, Deutsche Bank as prime broker, you know that theyÆre getting a certain level of service, but if theyÆre dealing with someone that youÆve never heard of, then it might be a whole lot different.ö

So, there are the risk tools available in Japan. Secondly, there are the zen-like levels of analytical intuition required to fathom it all. A third component are the new ôOQö hedge fund ratings from Moodys. A new product from the ratings agencies, a nice little earner for them no doubt, but tarnished by the fact that they currently give 90% of the funds they rate the highest mark possible.

ôRelying on those OQ ratings could be a danger,ö says Frank Packard. ôThese are very difficult questions surrounding hedge funds.ö

The ratings agencies missed the Asian crisis in 1997. Then, oops, they missed the credit crunch too, with all those triple-A ratings theyÆd dished out to CDOs. So, it must be third time lucky. The industrious ratings agencies surely couldnÆt get hedge funds wrong, could they?