Panels to set out hedge fund ‘best practices’

A group of hedge funds and investors will release on Tuesday a set of sweeping new standards aimed at reducing systemic risk and promoting investor protection.

The “best practice” guidelines, drawn up by two committees formed under the President’s Working Group on Financial Markets last September, is part of efforts by Hank Paulson, Treasury secretary, to formulate a private sector-led response to concerns about the activities of secretive hedge funds and avoid potentially draconian regulations.

The question of how best to regulate hedge funds has dogged US regulators for years. There have been growing concerns that hedge funds are being stuffed into pension funds without proper assessments of the dangers they pose. Several hedge funds in which public pension funds were invested have blown up spectacularly in the past two years.

A law requiring funds to register with the US Securities and Exchange Commission was thrown out by the courts, and politicians have debated various proposals on ways to oversee the industry.

The recommendations by the asset managers’ committee call on hedge funds, which manage about $2,000bn in assets, to adopt new standards in the areas of disclosure, asset valuation and conflicts of interest, among others.

One recommendation is that hedge fund mangers disclose hard-to-value financial products, such as complex derivatives, which have been at the heart of the current market turmoil.

“There will soon be new accounting standards in place that require financial institutions to categorise assets in three levels based on how difficult they are to value,” according to a summary of the report released on Monday.

“This report calls on hedge funds both to implement these new standards and then go beyond them by disclosing, on a quarterly basis, the portion of their assets and profit (or loss) attributable to assets in each of the three levels.”

Another recommendation is that hedge funds provide investors with summaries of their performance, annual and quarterly reports, and independently audited financial statements – based on disclosure models used by public companies. Managers should also assess the creditworthiness of counterparties and understand the complex legal relationships they may have with these counterparties.

These and other new standards will be adopted by hedge funds with over $140bn in assets under management, according to the report summary.

Separately, the investors’ committee – which includes public and private pension funds, endowments and labour organisations – makes various recommendations aimed at helping fiduciaries considering or already investing in hedge funds determine if such investments are appropriate for their clients.

“Not only are we trying to provide the very best practices recommendations, our goal is to have those practices be accepted by both investors and hedge fund managers and perhaps most importantly, to have those recommendations become common practice throughout the industry,” said Russell Read, chair of the investors’ committee and the chief information officer of the California Public Employees’ Retirement System.

Last year, the world’s first voluntary regime for industry conduct was unveiled in Britain. Under that plan, which is supported by the 14 largest managers in London and is due to take effect at the end of the year, hedge funds would have to ”comply or explain”, agreeing to meet the standards or tell people why they were not meeting them.

In addition to increased transparency through better disclosure of information about managers on their websites, the UK plan sets out three main standards to protect investors: the disclosure of holdings of complex and hard-to-value securities, and the methods used to value them; clear risk management plans, including steps to address liquidity risk, the danger of running out of cash; and clear policies on dealing with conflicts between investors and managers.