Hedge funds pose little risk to financial system – FSA

Hedge funds do not pose a real systemic risk to the financial system, despite the criticism they have received for their perceived role in the global credit crunch, the Financial Services Authority (FSA), said today . Hedge funds, which have almost $2tn (£1.3tn) of assets under management globally, do not "pose a potentially destabilising credit counterparty risk across the surveyed banks," said the FSA after questioning 50 London hedge funds and 14 investment banks. The findings were welcomed by the industry, which hopes the report "should help silence the unjustified criticism that they are a destabilising factor in the markets," said the Association for Financial Markets in Europe, in a statement. The usually secretive hedge funds -mostly based in London's Mayfair or in New York – were blamed for exacerbating the credit crunch by betting on the fall of banking shares such as the Royal Bank of Scotland's. This practice – known as "going short" – was temporarily banned by the FSA as a preventive measure, but was soon re-established. The regulator now says that hedge funds do not have a big enough footprint in the financial markets to bring the system to the brink of collapse – as did the fallout from the demise of Lehman Brothers. London funds surveyed by the FSA, which have about $50bn of assets under management, or 20% of the industry, barely control 1% of the entire European equity market – a sign that if the industry were to collapse, a sale of their assets would not pose a risk big enough to destabilise the system, the report says. Also, contrary to market perception, the average "leverage" or debt used by hedge funds to invest, is about twice their assets – compared to about 30 times used at large retail banks. The largest investment bank's exposure to a single hedge fund is no bigger than $500m, a sum that would not sink a large institution. "While these are large numbers, they are manageable in the context of the overall credit risks and capital requirements of the surveyed banks," the report says. The FSA will use the data gathered and plans to continue surveying hedge funds on a bi-annual basis to prevent any potential issues, it said. Hedge funds will probably use some of the findings in their battle against a proposed European Union directive aimed at introducing tougher rules in the industry. Market participants have also warned that regulators should focus on other industries other than hedge funds, such as derivatives – the multi-billion over-the-counter market where investment banks trade millions of contracts which are not recorded on any public exchange. Hedge funds say they have been the "scapegoat of the credit crisis for being an easy target".