For the hedge fund industry, facing the threat of heavy regulation, it comes down to the old maxim: If you want something done right, do it yourself.
Hedge funds were vilified for feeding the U.S. housing bubble, for pushing Europe to the brink of crisis, and pretty much anything else bad that befell investors in the global crisis and since. Even though plenty of hedge funds did nothing wrong, the perception of managers as a bunch of over-levered gamblers put the industry on the regulatory hit list.
However, rule makers have been so tied up with trying to fix the banking system in recent years that hedge funds have largely gotten a pass. It’s not going to last, and hedge fund managers and investors know it. So those in the industry are scrambling to put its image and its practises right before the regulators do it for them.
At the head of the effort is a former Morgan Stanley senior executive, Dame Amelia Fawcett, who is now at the helm of the four-year-old Hedge Fund Standards Board.
The board is an attempt by a growing group of the industry’s large investors to work with managers to improve the way funds are run, by enforcing a high bar in areas such as risk management and disclosure. Backers include the Government of Singapore Investment Corp., the world’s third-largest sovereign wealth fund, and Australia’s $73-billion Future Fund.
It’s a simple exercise in economic power. Hedge fund investors have the money. Managers need it. The investors should be able to demand more of managers.
“We have a window of 18 to 24 months where the hedge fund industry can, if they can really make this sing, prove to regulators that the industry is a well-run, well-governed part of the capital markets,” Dame Amelia said in an interview during a swing through Canada to drum up support.
Dame Amelia, a Boston native who was honoured by Queen Elizabeth for services to finance, acknowledges that there’s a view among some folks on Main Street that hedge fund managers “are just a bunch of cowboys.”
The board wants to change that, she said, to ensure that regulators don’t unnecessarily quench a source of capital that the world’s economy needs as banks pull back from lending. “We need to provide a culture where people think they [hedge funds]are part of the mainstream,” she argues.
The standards are 36 pages of requirements, and fund managers who join the board are expected to comply or explain to investors why they do not.
Regulators in places like Asia are eyeing the board as potential ally. Senior people in the industry believe that the dynamic – with investors using their wallets to force compliance – has the potential to seriously improve governance of hedge funds.
“We are a complement to regulation,” Dame Amelia said. “We know more about what’s going on in the industry before anyone else does.”
For all the logic to her pitch, the board is a long way from having a majority of hedge funds on side. There are big names, such Brevan Howard, Europe’s largest hedge fund manager, and the list is steadily growing. Canada’s Fiera Sceptre and Formula Growth recently applied.
But at about 60 managers and $215-billion of assets, managers who have signed on to the standards board account for only about 10 per cent of the global hedge fund industry.
It will take more investors demanding change to ensure more managers join. That’s where Canada has the potential to have an outsized influence on the future of the hedge fund industry.
While the hedge fund manager community in this country is small, the investor community is very large. That’s thanks to huge pension funds such as the Canada Pension Plan Investment Board, Ontario Teachers’ Pension Plan and Caisse de dépôt et placement du Québec. They put enough money in hedge funds to be big agents of change.
Yet of the really big Canadian pension fund managers, only the Caisse is so far a backer of the board. When Dame Amelia visited the others during her Toronto stop, the reaction was “interest and curiosity,” said one of the organizers of the visit.
There’s no good reason not to join. If pension funds are going to put Canadians’ money into hedge funds, they ought to have a seat at the table, demanding more from the people running that money.
“The biggest impact that Canada is going to make in this process is thanks to the clout of its investors,” Dame Amelia said.