Although Richard Baker is not quite the gamekeeper turned poacher, his appointment as head of the Managed Funds Association was an interesting one for the lobby group. Kris Devasabai asks what his plans are for the organisation and the hedge fund industry Richard Baker is an unlikely champion of the hedge fund industry. A career politician with over 25 years of legislative experience, Baker took on the role of president and CEO of the Managed Funds Association (MFA) in February 2008. Based in Washington, DC, MFA represents US hedge fund professionals, funds of funds and commodity trading advisors as well as industry service providers. As a Congressman he gained a reputation as a crusader against excessive risk taking and shady deals in the financial services sector. During his time as chairman of the powerful House financial services subcommittee on capital markets, Baker sought reform of Fannie Mae and Freddie Mac and put pressure on investment analysts and rating agencies to improve transparency. He pushed for tougher regulation of the hedge fund industry in the aftermath of Long Term Capital Management (LTCM) failure and introduced the Hedge Fund Disclosure Act in 1999, which was fiercely opposed by the industry. "MFA and many of the most prominent hedge funds appeared before my committee to express their opposition to it being enacted," Baker recalls with a hint of amusement. His appointment as the head of MFA came out of left field. But at a time when the political wagons are circling the industry, it could prove to be an inspired move. Given his record in Congress, Baker is highly respected on Capitol Hill and is recognised as an expert on financial services. He is open and insightful, talking engagingly about hedge funds. Most importantly, Baker understands what motivates critics of the industry. He says one of the problems facing hedge funds is that "they are generally not well understood at all on the Hill". Part of the blame for this lies with the industry itself, he argues. For many years hedge fund managers resisted public and political engagement of any kind for fear that it would compromise their privacy and independence. Baker experienced this first hand during his time as chairman of the capital markets subcommittee. "At that time the industry's relations with Congress were more deflective than engaging," he says. Baker argues this approach has been a mistake. "One of the unfortunate consequences is that hedge funds lost control of their image," he says. They became characterised as secretive New York mavericks riding roughshod over the financial system for their own profit. He believes many people have misconceptions about the risk profile of hedge funds. "Too often hedge funds are seen as the guy trying to knock the ball out of the park with one swing, which could not be further from the truth," he says. The combination of these factors means hedge funds are cast as scapegoats whenever there are failures in the financial system, regardless of the reality. "If politicians do not understand the industry and do not believe it has any relevance to them, it is much easier for them to see it as part of the problem. That inevitably leads to regulatory restrictions and all manner of government oversight," says Baker. One of his main priorities as president of MFA is to engage with legislators and the media in a more meaningful way and set the record straight about hedge funds. "In the world of politics you quickly learn the importance of correcting misconceptions before they take hold. If the obituary incorrectly reporting your passing is not responded to, it will soon become part of the record," he comments. The story Baker and MFA want to tell centres on the entrepreneurial spirit of the industry and the relationship between hedge funds and US pension schemes. Hedge funds are "perhaps the last vestige of true free enterprise" in the modern US, Baker argues. "Hedge fund managers raise assets based on their skill and reputation and invest with their clients. Their interests are fully aligned. If the hedge fund is unsuccessful it goes out of business without any consequence for the taxpayer," he says. Lawmakers should remember hedge funds have never asked for direct assistance from the US taxpayer, he adds. While acknowledging the fallout from LTCM, he points out that a number of hedge funds have come and gone since 1998 with no impact on the taxpayer or the financial system. Speaking out Baker believes the hedge fund industry needs to shout louder about its positive contribution to both the financial system and the lives of ordinary people. One element of this story is the role hedge funds play in managing retirement assets. The state employees' retirement system in Baker's own home state of Louisiana, like many across the country, has made significant long-term investments in hedge funds. "Last year was bad for everyone, but hedge fund managers did a better job of protecting the retirement benefits of US citizens than just about anyone else out there. But there is little reason for members of the Louisiana Congressional delegation, let alone members of the public, to be aware of this. (Hedge funds) have not done a good job of explaining what they do, how they do it and the positive contribution they have on the economy. MFA will work very diligently to do just that, but there is a long way to go," he says. Turning around popular perceptions about hedge funds will take years rather than weeks or months. A more immediate challenge is responding to the avalanche of regulation and legislation aimed at the hedge fund industry. Baker's position on this issue is informed and nuanced. He has been engaged with the issue of systemic risk for more than two decades. As a member of the House banking committee, he was involved in the federal response to the savings and loans scandal of the 1980s and 1990s. Fast-forward to 1998. Baker was one of the first lawmakers on Capitol Hill to spot the systemic risks posed by LTCM. He wrote to the Federal Reserve and outlined his concerns more than a month before the collapse of the highly leveraged hedge fund forced the Fed to take action to prop up the markets. In 2000 he started pushing for regulatory reform of Freddie Mac and Fannie Mae after becoming alarmed by the systemic flaws which eventually necessitated the federal takeover of the mortgage giants in 2008. Supporting legislation Baker supports what he terms "smart regulation" of the hedge fund industry. He says the idea of creating a dedicated regulatory agency to oversee systemic risk is a good one but argues the issues are more complex than many people think. "I spent many hours discussing with various chairs of the Securities Exchange Commission (SEC), the Treasury and the Federal Reserve exactly what constitutes a systemic risk event and there was never any clear consensus," he says. Recent statements by top officials suggest this central question is no closer to being resolved. Surmising the current state of the debate, Baker says, "The definition of systemic risk is still not clear, what we can do to prevent it is not well understood, and the agency that should be given the task of regulating it has not been identified." But despite these unanswered questions many in Washington appear to have rushed to the conclusion that large hedge funds should be supervised by this new agency. Baker says this assertion needs to be carefully examined. "Concerns about systemic risk are directly linked to the size and interconnectedness of financial institutions and the amount of leverage they employ," he explains. He argues the hedge fund industry is not as large or systemically significant as many in Washington believe it to be. He points out the top five US mutual fund companies manage more money than the entire hedge fund industry, while the combined balance sheets of the regulated banking world is more than 10 times total hedge fund assets. On the question of leverage, he highlights the UK Financial Services Authority's recent study which found that 26% of the industry currently applies no leverage while 42% of hedge funds are geared at 2:1 or below. "I hold out the case that the size of the hedge fund industry is almost insignificant in relation to other financial institutions and their use of leverage is quite prudent," Baker says. He concedes the interconnectedness of modern financial institutions means the issue is worthy of further examination. If, for instance, several large hedge funds pursuing the same strategy simultaneously suffered losses it could create a domino effect constituting a systemic risk. Baker argues such an event would be "an aberration given the way most funds are managed today including the use of highly sophisticated risk management systems." However, he says MFA is "fully prepared to discuss the issue with regulators and Congress because we recognise it is a significant concern." "What constitutes a systemic risk will ultimately be in the eye of the beholder and the regulator should be broadly empowered to collect data through a reporting system so they can make enquiries where they see fit," he says. To date MFA has not taken a firm position on the Hedge Fund Transparency Act introduced by Senators Carl Levin and Charles Grassley. The proposed legislation bears similarities to the Hedge Fund Disclosure Act introduced by Baker in 1999. Both include a requirement for hedge funds to make basic disclosures about their business and respond to requests for information from regulators, although the current proposal also authorises the SEC to impose a registration rule. This is a polarising issue in the industry and many managers are vehemently opposed to the idea. Baker was a vociferous proponent of disclosure and transparency during his political career. In the early 2000s, in his capacity as chairman of the House capital markets subcommittee, he launched an inquiry into financial analyst conflicts of interest and put pressure on banks and investment firms to reveal their relationships with the companies they rated. Following the accounting scandals at Enron and WorldCom, he was instrumental in crafting the Sarbanes-Oxley Act which set a new standard for corporate accountability in the US. The latter has its detractors in the business world but Baker remains a firm believer in the power of disclosure. "I examined a number of financial sector failures during my time in Congress. In many cases the root cause of the problem came down to the failure by financial institutions to make proper disclosures about their activities and relationships," he says. The hedge fund industry will be supportive of registration if it is handled in the right way, Baker believes. He points out that 70% of MFA's members continue to register voluntarily with the SEC even after the rule was overturned by the courts in 2006. He says MFA's reluctance to make wholesale statements on the topic stems from the fact that registration and its associated responsibilities can come in many forms. "We would like the chance to comment and be positively involved in the construction of the registration process," he says, adding MFA will outline the concerns of members about some elements of registration to Congress. He concedes that at some point, perhaps later this year, the Senate banking and House financial services committees are likely to produce a Bill which will set the registration process in motion. "We do not want to be viewed as being opposed to or reluctant to participate in the development of smart regulation. We will be engaged in the process," he says. His main concern is that legislation should be subject to an orderly process. Legislative proposals should be tabled only after problems have been clearly defined and understood. Emotional knee-jerk responses rarely stand the test of time, he says. "Much of this debate has become rather emotional and detached from logic. No one has demonstrated that hedge funds contributed to the financial crisis in any way. In fact, hedge funds have been instrumental in providing liquidity to the market during the turmoil and have acquired troubled assets from those desperate to sell. In the midst of an economic crisis, Congress needs to think carefully before adopting any measures that could impair an industry that can actually help the larger recovery effort," he concludes. RICHARD BAKER: QUICK CV February 2008-present: appointed president and CEO of Managed Funds Association 1986-2008: US House of Representatives from Louisiana's 6th district 1971-1986: Louisiana House of Representatives from East Baton Rouge Parish During his time in Congress, Baker was a member of the House financial services committee and was chairman of the subcommittee on capital markets for 12 years. He also served on the House transportation and infrastructure committee and was a member of the committee on veterans' affairs. He was elected to the Louisiana House of Representatives in 1971 at the age of 23 and served for 15 years. During that time he was chairman of the House committee on transportation, highways and public works. Baker was born and still lives in Louisiana, commuting to his job in Washington....
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