Hedge fund regulation presents “moral hazard”

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NEW YORK - Attempts to regulate the hedge fund market will only serve to legitimise it in the eyes of small investors and should therefore be discouraged, according to a leading US economic policymaker.

Speaking at a meeting in Manhattan, Robert Steel, US Treasury undersecretary for domestic finance, suggested that rather than making alternative investment vehicles safer for investors, regulation will encourage previously wary individuals to become involved in hedge funds where they otherwise wouldn’t have.

“I don’t like the moral hazard of communicating a government all-clear. Regulation communicates confidence in a product that is riskier than normal investors should get involved in,” said Steel.

Steel’s comments came on the same day that Securities and Exchange Commission (SEC) chairman Chris Cox revealed to an audience in Berlin that as far as he is concerned, the issue of hedge fund regulation in the US now lies in the hands of Congress.

“I don’t think we could, in the US, do what has been proposed [in terms of regulation] for the simple reason that we [the SEC] don’t have legislative authority to do so,” said Cox.

“Whether or not Congress chooses to legislate this is very much an open question. As you know there is a series of hearings scheduled in the House of Representatives. We are at a very preliminary stage, and my understanding is that they will be purely informal,” he added.

Mandatory registration of fund managers – the SEC’s first tentative step towards regulation – had to be scrapped last year after a US Court of Appeal ruled that the Commission had no authority to order such a register. Nonetheless, around half of US fund managers remain registered with the SEC voluntarily.

The debate was revived in February by a set of principles put forward by the President’s Working Group on Financial Markets. The principles were designed to guide regulators as they attempt to address public policy issues surrounding private pools of equity such as hedge funds, given their rapidly growing stature.

The House Committee on Financial Services has expressed its intent to explore whether tighter control is needed around hedge funds and particularly around the investment of pension funds in the vehicles. The first of the planned meetings took place on March 13, ostensibly for the Committee to “know more about things”, according to chairman Barney Frank.

Several more such hearings are expected to follow in the coming months.