FSA “no light touch” on hedge funds, says Sants

FSA chief executive Hector Sants outlines his approach to hedge fund regulation

LONDON – Hector Sants, chief executive of the Financial Services Authority (FSA), has defended the UK regulator from assertions it is “a light touch”, in his speech outlining the FSA’s regulatory stance on hedge fund managers at a London conference.

Sants described the FSA’s regulatory role as risk-based and proportionate, adding it did not run a no-fail regime to protect the fortunes of irresponsible investment behaviour, but rather a philosophy of orderly and controlled financial stability.

Speaking on the effectiveness of existing safeguards, Sants said: “We recognise that a six-monthly survey has its limits as a regulatory tool and indeed some moral hazard.”

Sants said such tests represent a useful part of the FSA’s toolkit, but that the summer’s unexpected credit crisis “reinforces the view that managers must ensure their stress testing seeks to model the implausible”.

“Undeniably, recent events strengthened the case for ensuring the industry has effective risk scenario planning and stress testing. I believe the Northern Rock experience is of direct relevance to this observation,” he added.

Sants went on to single out the 35 largest hedge fund managers – for which the FSA has a relationship management team – adding that, as these firms manage over half the funds in the UK, “it is entirely consistent with our risk-based approach that we devote more intensive regulatory attention to them”.

“I believe this two-pronged approach – monitoring the activities of the fund managers themselves and also the transmission mechanism to the prime brokers – provides us with an appropriate means of discharging our systemic risk agenda,” said Sants.

Sants also said the FSA sees contracts for difference (CFDs) and other opaque derivatives instruments – which have come under considerable criticism after the credit crunch – as “a useful market tool and does not seek to constrain their proper use”.

He said CFDs have been used to circumvent proper disclosure obligations and that the FSA’s recent consultancy paper included measures to increase CFD transparency, but added that industry feedback was crucial to the process.

Sants highlighted the importance of the Hedge Fund Working Group – formed at the request of the Financial Stability Forum under the chairmanship of Sir Andrew Large – as an industry-wide initiative.

“We are pleased UK hedge fund managers have taken this initiative to demonstrate to their critics that the sector is alive to areas where it needs to improve, and committed to constant improvement in its practices,” said Sants. He added industry-wide support was needed to ensure the initiative’s success.