Hedge fund chief fights for his industry

The European Union is pushing through controversial legislation to curb hedge funds, seen as the main speculators in financial markets, but the industry body chief Antonio Borges tells David Walker the move is simply an ill-concealed attack by European nations on the “Anglo-Saxon” model of finance.

If you think markets are difficult for investors, spare a thought for Antonio Borges. In mid-May the chairman of the Hedge Fund Standards Board (HFSB) saw two votes at the EU seeking to regulate Europe’s alternative fund managers go against the hedge fund industry. In the same week, Germany banned naked short selling, reviving memories of Berlin’s politicians and Frankfurt’s businessmen calling alternative fund managers ‘locusts’.

But Borges says the $1.7trn hedge fund industry aids markets and businesses. “Europe perceives hedge funds as creating problems, whereas in fact they move prices to where they should be more quickly than would otherwise be the case,” he said. “They actually mitigate crises – contrary to the view they cause or expand them – because they step in when prices are wrong and push them in the right direction early.”

This typically involves short selling, a practice much maligned during the crunch, and widely held responsible for global bank share prices falling just before Lehman Brothers’ collapse. They then fell a further 57% in six months after Lehmans’ bankruptcy, with bans on shorting financials in place in 14 countries, including Germany.

On 19 May, Berlin acted unilaterally by banning naked shorting of 10 months for 10 leading financial stocks and eurozone sovereigns, citing excessive volatility in fixed income markets. Germany’s Dax index fell 2.6% the day it took effect.

But research by short selling analysts Dataexplorers found shorting of the 10 German banks and insurers was no more prevalent than at the start of 2010. Bets on the wider German market falling were up about 25% from 1 January.

Leonard Charlton, manager of Dalton Strategic Partnership’s Melchior European equities hedge fund, said: “The market is thinking, what does the German Government know that we do not? It is speculation to assume there is something, but that is why markets are nervous.”

Borges said a better curb on naked shorting – agreeing to deliver a security on sale without having first borrowed it – would be harsh penalties for funds that failed to deliver. Far from harming markets, shorting can help investors stay in longer-term long positions, as shorts cushion downside blows.

Borges is in a position to know. He sits on the boards of insurance companies and endowments that invest in hedge funds. Large institutional investors such as these could also short securities directly as a cushion to remain in long positions, he noted.

“If you removed short selling investors will easily disappear from the market, and be more reluctant to buy because you remove a way for them to protect themselves. Investors would be far more conservative about their allocation of risk.”

The HFSB represents some of the world’s biggest institutional investors in hedge funds including Australia’s public pension fund the Future Fund; New Holland Capital, the hedge fund investment adviser for Dutch pension ABP; and Man Group.

Borges is establishing an HFSB chapter for such investors to promote the standards for hedge fund managers, and suggest modifications where necessary to existing standards.

If hedge funds shorted Greek debt more heavily two or three years ago, Borges added, the precipitous price falls, concomitant yield hikes, and general volatility of those securities this year might have been averted.

“Many investors might have sold their Greek debt earlier and we would not have had the extreme overhang of it. Some treated Greek and Portuguese debt as though it was equivalent to German debt, without political risk.” Increased short interest more recently suggested it wasn’t, he says.

For hedge funds and their investors the main political risk currently is not the shorting ban, but the EU’s draft Alternative Investment Managers Directive, aimed at clamping down on European hedge fund managers.

Due to take effect in 2012, it currently has two versions – one from EU finance ministers, the other from the EC council of economic and financial affairs. The two must somehow be gelled into one before a ballot in Europe’s Parliament in July.

The drafts’ provisions impose on EU managers disclosure about short positions and fund leverage; introduce precepts and disclosure on remuneration; stipulate independent valuation or audit of assets, and their independent custody, and ban naked short selling.

The most contentious provision would effectively ban EU-based allocators, including many HFSB members, from investing in non-EU funds.

Borges says the plans are protectionist, and barring non-EU managers from Europe’s investors comes at the very time international coordination on financial matters is crucial.

He is not alone in disparaging the AIFM. Phil Irvine, co-founder of consultants PiRho Investment Consulting, added: “The rules are not only unnecessary, but also limit [pension funds’] investment choice.”

Borges says: “The idea of limiting choice is a bad move. No industry will ever thrive out of protectionist deals. At the very time we need to co-operate with America on global financial regulation, we are amassing against them. The US is the financial centre of the world, we should be welcoming them to the table to discuss and negotiate, and put in place a set of plans in the interests of the whole world. It is the complete opposite of the inclusive G20 approach.”

He added that it was unprecedented for US Treasury secretary Timothy Geithner to write twice to Europe’s finance ministers during the drafting of a bill, as had happened with the directive.

Borges regards the Continent’s move as a reflection of a “perpetual conflict” between what Anglo Saxons and Europeans think capital markets are there for. He says: “In Europe, big shareholders control companies directly and minority shareholders are supposed to be suppliers of cheap capital. They certainly should not be exercising powers as investors.

“In Britain, financial markets exist for investors. Markets should make it possible for them to demand an appropriate return on capital, and intervene if they are not happy. Tough customers make for good companies.”

European politicians seized on the near collapse of large UK banks in 2008/2009 as an opportunity to launch a “massive campaign to discredit the UK approach,” Borges said.

“Then [they] moved immediately on hedge and private equity funds, as the clearest symbols of the Anglo Saxon system, because they are the most activist funds.”

David Walker is a senior asset management writer at Investment Week

David Walker

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