Financial Regulatory Forum

The best way to handle risk: hedge funds


The following is a guest post by Sebastian Mallaby, the Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations and the author of More Money Than God: Hedge Funds and the Making of a New Elite. The opinions expressed are his own.

If only U.S. lawmakers were better acquainted with Jim Simons. If they understood this hedge-fund billionaire, the financial regulation now emerging from Congress might look different.

Simons is a poster child for the hedge-fund industry. His team of scientists in Long Island manages a black-box fund called Medallion, which has been up every year since 1990, usually posting gains of well over 50 percent. In several years over the past decade, Simons is said to have earned more than $1.4 billion—the amount, in today’s dollars, that J.P. Morgan accumulated during his entire lifetime. The legendary Morgan was known as Jupiter because of his godlike power over Wall Street. Hence the title of my history of hedge funds: More Money Than God.

The golden algorithms that drive Medallion’s profits derive partly from the mathematics of code-breaking, and partly from the related field of computerized translation. But lawmakers don’t necessarily need to know that. All they need to grasp is that Simons and his scientific colleagues are not the sort of people whom you find on Wall Street—and that the flaws that brought on the financial crisis are much less pronounced at hedge funds.

Crises occur when everybody crowds into the same misguided trade—emerging-market assets in the mid 1990s, mortgage securities in the mid 2000s. But Simons doesn’t follow crowds; he is a nonconformist and contrarian. When he worked for the Pentagon’s code-cracking unit, he not only refused to respect his overlords’ Vietnam policy—he denounced it in the New York Times, and was fired for his outspokenness. He chain-smokes intensively and refuses to wear socks. He seldom drives without exceeding the speed limit.

ANALYSIS-Even with new rules, life goes on for Wall Street

By Steve Eder

NEW YORK, June 25 (Reuters) – U.S. lawmakers have hammered out a law that is designed to fundamentally change Wall Street, but financial professionals largely yawned.

Legislators took steps that at first blush could change the industry, including limiting banks’ swaps-dealing operations and their investments in private equity and hedge funds.

But in the end, banks like Goldman Sachs Group Inc, JPMorgan Chase & Co and Morgan Stanley won concessions that watered down the proposals that could have been most damaging to their profits, staving off a watershed overhaul like the one that took place after the Great Depression.

ANALYSIS-Wall Street still in the hedge fund game

By Svea Herbst-Bayliss and Matthew Goldstein

BOSTON/NEW YORK, June 25 (Reuters) – It appears Wall Street investment banks can stay in the highly-profitable hedge fund business after all.

An overhaul of financial regulations hammered-out by U.S. lawmakers after weeks of negotiation would permit Wall Street banks to continue to manage and sponsor hedge funds along with private equity funds, according to lawyers and Wall Street officials familiar with the massive bill.

For months Wall Street bankers and hedge fund managers have worried that the legislation, which could be signed into law by President Obama within two weeks, would prohibit investment banks from running hedge funds and possibly force them to sell these often very profitable businesses.

COLUMN-Carried interest and the big lie: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Greensboro, Alabama, May 31 (Reuters) – As an investment strategy, making private equity and hedge fund managers rich is a probable loser. As a tax policy, it is a guaranteed one.

The U.S. House of Representatives passed a bill last week that would raise the taxes that private equity and other investment managers pay on “carried interest,” their share of the takings when a holding such as a startup or turnaround is sold at a profit.

Carried interest is currently taxed at the lower capital gains rate, meaning that many private equity barons can pay less in tax than the people who clean their swimming pools or mind their children. This is patently unjust. Carried interest is compensation for labor, earned income in other words, rather than gains on capital that might be lost.

ANALYSIS-Europe won’t go as far as Germany on CDS, bonds

By Huw Jones and John O’Donnell

LONDON/BRUSSELS, May 19 (Reuters) – The European Union, struggling to calm volatile financial markets, intends to curb speculation in government debt but remains very unlikely to imitate harsh steps announced by Germany.

The difficulty of enforcing any prohibition on speculative trade, and concern that any ban might backfire by depriving investors of ways to hedge their risks, mean many governments are reluctant to try to introduce regional or global bans.

Instead, the EU is likely to focus on increasing transparency in the markets — forcing traders to disclose more information about their activities, so that regulators can see risks emerging — and on introducing limits to the size of derivatives positions which traders can hold.

FACTBOX-How European rules will curb hedge funds

May 19 (Reuters) – The European Union’s 27 countries and the bloc’s parliament agreed to tighten controls of hedge funds and private equity this week.

Negotiations will now begin between the two to hammer out a final version of the law to regulate the secretive industries by 2012.

Although some issues remain contentious, such as how the new law will treat foreign funds, both parliament and European countries have committed to set up broad controls on a sector many suspect exacerbated the financial crisis.

Paulson-linked IPO delayed

WLB-logoIn the aftermath of the Goldman Sachs fraud charges, Propel Capital said it was delaying the Canadian IPO of its Propel Multi-Strategy Fund – until recently called the Propel Paulson Diversified Fund. Propel says it’s just a delay, but there is no indication when the offering might be resurrected.  Westlaw Business Currents, a Thomson Reuters product, looks at the issues. 

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US watchdogs may still get ‘Volcker rule’-consultant

    FRANKFURT, April 12 (Reuters) – U.S. banking supervisors could get indirect powers to ban proprietary trading by banks even if the “Volcker rule” is not in the financial reform bill, a banking consultant with close contact to decision-makers said. (more…)

FACTBOX – How does the EU plan to shake up financial services?

BRUSSELS, April 7 (Reuters) – The European Union (EU) is embarking on an overhaul of financial services that politicians hope will send bankers back to their roots of no-frills lending to households and business.

Michel Barnier is the EU commissioner in charge of the shake up on regulations ranging from curbs on banker pay to a clampdown on speculators betting on government debt.

Here is a guide to the overhaul:

* One of Barnier’s priorities is writing a rule book for trading derivatives, a financial instrument whose value is linked to an asset such as a government bond or currency.

Meeting on CDS market helps shape EU derivatives law – regulator

BRUSSELS, March 5 (Reuters) – The European Union’s executive body said a meeting on Friday with supervisors and investment industry officials has helped shape a planned law on derivatives due later in the year.

The meeting was held amid pressure from France, Germany and Luxembourg to crack down on what they see as hedge funds using credit default swaps to push Greek government bonds and the euro lower.

“It was a useful meeting and it will feed into preparation for rules on derivatives that we will propose in the Summer,” a spokeswoman for EU Internal Market Commissioner, Michel Barnier, said.