The world of hedge funds: prejudice and reality – The AMF’s contribution to the debate on alternative investment strategies

M. Prada

Financial Stability Review, 2007, issue 10, 127-135

Abstract: Even if there is no uniform and legal definition of the term “hedge fund”, it is generally agreed amongst securities regulators that all hedge funds have potentially common characteristics: no self imposed rules in terms of diversification of assets, unlimited use of derivatives and of complex financial techniques, intensive use of leveraging and substantial performance commissions, and shares not frequently redeemable by the investors. At the international level, hedge funds cannot be considered any longer as a « black hole » in the financial sphere given the growing number of regulatory authorities that have already implemented supervisory systems in relation to such funds. It is obvious though that much remains to be done in this ever changing area, which is all the more complex to regulate that it today is the object of prejudice that can sometimes generate confusion. Hedge funds’ “shareholder activism” is both criticized and hailed as a mechanism creating value. Their risk-taking approach generates concerns as to financial stability and can nevertheless supply welcome liquidity to the markets. The transparency of their operations is considered as being insuffi cient, whereas their strategies make them truly successful with an increasing number of investors. The clarification of the specific risks attached to hedge funds’ activity is therefore a prerequisite to defining the regulators’ priorities for action. The AMF has identifi ed five main areas that may need further initiatives at the international level: • the systemic risk due to the potential failure of a large-size hedge fund or a chain of several smaller hedge funds leads to consider improvements of the investors’ credit risk assessment on hedge funds by, for example, urging hedge funds’ rating; • the risk of market abuse calls for ways to enhance the transparency of the hedge funds’ activities on OTC markets; • the risk for the governance of listed companies and of misbehaviour put into question certain practices such as stock lending at shareholders’ meetings; • the operational risk of incorrect valuation of illiquid or complex assets has pushed IOSCO to take initiatives on the valuation process and internal controls of hedge funds; • the risk of misselling to insufficiently informed investors requests new domestic and international standards before any further retail exposure to alternative products.

Date: 2007
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