Hedge fund ‘fire sale’ threat remains, says UK FSA

The UK Financial Services Authority said that there is still systemic risk of a hedge fund ‘fire sale’ of assets during periods of stressed markets.

The conclusion is contained in its latest report into the sector ‘Assessing the possible sources of systemic risk from hedge funds‘, which is based on findings in its own Hedge Fund Survey and Hedge Fund as Counterparty Survey – carried out in September and October 2011 respectively.

“The latest results from this HFS suggest that the aggregate footprint of surveyed hedge funds remains modest in most markets with possible exceptions in the convertible bond, interest rate derivative and commodity derivative markets,” the FSA said.

“Leverage remains relatively low for most funds, while there has generally been no significant change in the amount of unencumbered cash available. Surveyed hedge funds continue to report that they are able to liquidate their assets faster than their liabilities fall due, suggesting that maturity/liquidity transformation is not extensive, although there are some concerns that these measures may not be accurate in a time of market stress.”

The UK financial market regulator added: “Data from the HFACS suggests that counterparties have increased margining requirements and tightened other conditions on their exposures to hedge funds since the financial crisis, increasing their resilience to hedge fund defaults.”

“However, risks to hedge funds remain, particularly if they are unable to manage a sudden withdrawal of liabilities during a stress period. If a sudden withdrawal of funding was to occur in one highly leveraged fund or across a number of funds, this may in turn result in forced asset sales that exacerbate pressure on market liquidity and efficient pricing.”

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