Are hedge funds facing unexpected pressure to conform?

Richard Baker, Chief Executive of the Managed Funds Association and a former Senator, has recently pronounced, "It's wrong to say hedge funds are lightly regulated...you have vice of regulatory constraint, one from the investor side, and one from the lender side".  

 So perhaps hedge funds will escape the threat of regulation, because other factors will put pressure on them to conform.  The last year has been an interesting one; six months ago the FSA announced that hedge funds would face greater regulatory controls as it detected complacency towards risk in the industry. At the same time, the influential US GAO report on use of multiple prime brokers highlighted the lack of transparency in evaluating overall credit and counterparty risk. Then, in February the banks found themselves in the previously unheard of position of being grilled by hedge fund managers about their exposure and risk levels.  

Today, despite the talk about regulation, the main influence on the behaviour of hedge fund managers is coming from the investors and lenders. It is they who are driving hedge funds towards a greater focus on housekeeping.  Of course, hedge funds have been notoriously difficult to pin down; nimble and agile institutions, they can just up sticks if the regulatory climate doesn't suit them.  London is already recognised as a hub for hedge funds and is unlikely to want to turn up the heat enough to make life uncomfortable, but as winter turns into spring, guidelines and voluntary codes will abound.  

Aside from regulation, it is pure commercial pressures, which are driving Hedge Fund Managers and their brokers towards more efficient and transparent operating models. A number of leading hedge funds may have to survive 2008 on management fees alone as consistent out-performance of benchmarks becomes more elusive. The focus on value-for-money is also driving the "unbundling" of Prime Broker services as Hedge Funds own operational models evolve. 

So it seems that it is investors, lenders and the markets which will have most affect on hedge funds this year; regulation is likely to be much further down the list.

Graham Underwood, GFT UK