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U.S. approach to hedge funds falls short, Germany says

Date: Tuesday, April 24, 2007
Author: Rainer Buergin and Simon Kennedy, Bloomberg

BERLIN: Finance Minister Peer Steinbrück of Germany said that the U.S. policy of providing guidelines to hedge funds was "not enough" as he sought European support to subject the funds to a code of conduct.

Germany and the United States are at odds over how to toughen oversight of the $1.5 trillion hedge fund industry, with Steinbrück pushing a formal code while Treasury Secretary Henry Paulson Jr. of the United States supports a set of principles that informs investors and leaves them to monitor risk.

"We need to see what kinds of benchmarks are developed to ensure these practices are implemented," Steinbrück told reporters Saturday after a meeting of finance ministers and central bankers from the 27-country European Union in Berlin.

The EU is planning to form a joint proposal when its finance ministers next meet in Brussels on May 8 before those from the Group of 8 governments convene in Potsdam, Germany, a week later. Jean-Claude Juncker, the prime minister and finance minister of Luxembourg, said that there was a "good chance" that the German initiative would be endorsed.

German officials view the surge in the size and complexity of hedge funds as a risk to financial markets, and have used their presidency of the EU and Group of 8 to push for regulation. Assets managed by hedge funds have more than tripled since a bailout of Long Term Capital Management in 1998, and are back in the spotlight after Amaranth Advisors lost a record $6.6 billion in September.

"We need to realize we have a very favorable context in the world economy, but we need to be sure in a less favorable context these new players in the market work properly," the president of the Bundesbank, Axel Weber, said in Berlin.

The lightly regulated pools of capital allow managers to participate substantially in investment returns. That creates an incentive to make leveraged bets with borrowed funds, a tactic that can both stoke returns and magnify loses.

Finance ministers also discussed a report saying that the activities of private equity funds posed a risk to market stability, noting a "need for great vigilance in enforcing existing provisions on market abuse in order to sustain market integrity and confidence in private equity business."

Steinbrück that said his proposed code would be "successful" if the 15 or so hedge funds that dominate the industry could be persuaded to sign it. "It should be market-driven, but the industry itself should have a deep interest to support us in stabilizing financial markets and in protecting the investors," Steinbrück said during an interview Saturday. "A self-regulating system would be important."

The German approach won backing from the Financial Stability Forum, which the Group of 8 has charged with studying the issue before the Potsdam talks. A draft of its report obtained by Bloomberg News urged funds to disclose more information about their strategies and the risks they involve.

In a separate report to the ministers Saturday, the European Commission was more equivocal. While it agreed that transparency was "important" and that some investors needed to be protected, it also praised funds for improving the liquidity and efficiency of financial markets and questioned whether regulators would be able to use additional information on them.

The United States has opposed a code of conduct, and Robert Steel, the top finance official at the U.S. Treasury, said during an interview last week that it "sounds like a policeman and that's not what I'm into."