The canary in the coal mine

The US House Committee on Financial Services recently held a hearing to examine the risk posed by hedge funds to financial markets. Many of the concerns raised in the hearing with regards to hedge funds could have been easily applied to private equity, and may foreshadow future moves to regulate other alternative assets (or to leave them alone). The hearing began with representatives arguing that the industry warranted their interest for two reasons. First, the hedge fund industry has seen massive expansion over the past five years, with multiple members of Congress citing 400 percent growth in that time. Second, pension funds, among other institutional investors, are highly committed to the asset class, and, many suspect, without the workers and retirees aware of the risks involved. But representatives made pointed critiques of the President’s Working Group findings, particularly its recommendations against regulatory oversight.
The President’s Working Group advised investors in hedge funds to gather all necessary information on the “strategies, terms, conditions and risk management” before making any commitments and found that no government agency should require any information on hedge fund activities.
Congressman Michael Castle, a Republican from Delaware, argued that hedge funds investors may not get sufficient information with the current disclosure guidelines. Rep. Castle also noted that the last President’s Working Group that examined hedge funds in the wake of the collapse of Long Term Capital Management in 1999 recommended that very large hedge funds be required to disclose their financial activities.
He inquired as to why the subsequent group would be less cautious, when the industry has grown so much.
Many of the witnesses testifying on behalf of the industry responded that pensioners, and investors of all stripes, had lost far more due to the collapse of ordinary stocks than through any involvement with hedge funds.
On the issue of disclosure, Gerald Corrigan of Goldman Sachs expressed skepticism on the value of public disclosure demands for hedge funds. Far more important, he said, are three forms of disclosure at which hedge funds and other private pools of capital already excel: highly detailed disclosure counterparties such as prime brokers, disclosure to investors and disclosure to regulators when requested.
According to Corrigan, public disclosure—even something as mild as registering with the US Securities and Exchange Commission—can create a moral hazard. It gives the impression to some that the government is vouching for the safety of a set of funds, where no such safety can possibly be determined, or given.
But most telling for the fate of other alternative assets was how frequently congressmen and witnesses alike noted that one cannot discuss “hedge funds” without also including the many other forms of private investment pools, including venture capital, and yes, private equity.