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are also some other issues. First, we do not know how
well liquidity in credit risk transfer or securities
loan markets will hold up if the credit cycle turns
down sharply and defaults become more common. Second,
we know that individual market participants have increasingly
sophisticated risk-hedging strategies. But we do not
know the effects that these strategies—combined
with high leverage—have on the ability of the
system as a whole to dynamically hedge risks. A specific
example, the case of hedge funds. The assets under management
of hedge funds were estimated to be over US$1.4 trillion
by the end of 2006, more than three times their level
in 2000. And there are now estimated to be more than
9,500 hedge funds—fourteen times more than in
1990. This proliferation should itself raise concerns.
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"The
assets under management of hedge funds were estimated
to be over US $ 1.4 trillion by the end of 2006, more
than three times their level in 2000 and there are now
estimated to be more than 9,500 hedge funds fourteen times
more than in 1990." |
Article
by
Dr.
Zia-Ur-Rehman |
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Any time you see a rapid increase in the number
of businesses engaged in an activity, you have to wonder about
the quality of late entrants to the business. Since individual
hedge fund failures would probably have more significance
for the system as a whole than the disappearance of businesses
of other kinds, this suggests a need for careful oversight.
As to how this oversight should be managed, much has been
made of differences of view as to whether the main focus should
be on direct regulation of hedge funds or counterpart risk
management and indirect monitoring of their activities through
the major banks and brokers. But the significance of these
differences is overstated. In fact, there is a broad consensus
around the need to preserve the risk diversification and innovation,
which hedge funds have brought to the financial system, while
making sure that adequate precautions are taken against systemic
problems.
Turning to the policy implications of this, there is a need
for action in two areas. First, if reliance is placed mostly
on monitoring by counter parties, this should be complemented
by measures to increase the transparency of hedge fund operations.
Increased transparency is needed to enable counterparties
to exercise market discipline effectively and help regulators
get a better picture of what is going on in markets. Second,
there must be adequate international monitoring and cooperation,
so that potential cross-border spillovers from hedge fund
problems or other market disruptions can quickly be identified
and addressed. There is another financial sector issue, which
is the recent dramatic growth in large private equity buyouts,
which are being financed by a rising proportion of debt. The
risk from a financial stability perspective is twofold. First,
the banks that have underwritten deals could find themselves
exposed if some of the deals fail before completion. Second,
if some of these deals were to turn sour, this may trigger
a reappraisal of risk, which would curtail market access more
broadly. This could adversely affect investment and growth
prospects. In considering these deals, investors should exercise
due diligence, and regulators to remain vigilant about possible
systemic implications and broader effects on economies. A
third issue in financial markets, and one of particular relevance
to the International Monetary Fund, is the very substantial
flows of capital into emerging markets, and in some cases
into developing countries that have not previously received
significant private capital flows. To the extent that such
inflows reflect a reallocation of capital to productive investments,
they are welcome. But they also expose the countries concerned
to an abrupt reversal of flows when sudden shocks occur.
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