Controlling the hedge funds
SEOUL - Hedge funds are the pirates of modern global finance. This is the unspoken view of Asian financial policymakers, who after the collapse in August 1998 of Long-Term Capital Management, a US hedge fund, have been trying to create a broad regulatory framework to bring hedge funds under control.
At the Seoul Apec forum which ended last week, the destabilising role of hedge funds was highlighted as part of an effort to create a new global financial structure. If the new financial architecture is to be fair and transparent to all participating countries, hedge funds have to be tamed.
The reason is that most highly-leveraged hedge funds are managed secretively. They are registered in offshore financial centres to escape the watchful eyes of regulatory authori ties. When they take on financial markets with their sheer leverage power and intense speculative trad ing practices, they can create panic and instability in the financial system.
Medium-sized open economies are particularly vulnerable to hedge funds.
Kim Dae-jung, the South Korean president, kicked off the debate by proposing that a "hedge fund moni toring channel" be established to closely look after the speculative activity of hedge funds.
Deputy Thai Prime Minister Dr Supachai Panitchpakdi said he sup ported Kim's proposal, which should help authorities keep a close watch on - but not control - the hedge funds.
Countries have different methods in coping with hedge funds. After the baht crisis, Thai authorities have moved to curb baht trading in off shore markets. Local banks are restricted from supplying local baht to hedge funds or foreign investors in the offshore market.
Hedge funds aggravated Thailand's financial crisis when they joined the attack on the baht in 1997. They were viewed as a necessary evil then, because they stepped in to impose market discipline. With Thai author ities refusing to face the reality of an unsustainable baht, hedge funds launched a US$10 billion (Bt378.5 billion) attack on the currency on May 14, 1997.
After victory over the baht, hedge funds went on a regional rampage, attacking national currencies and creating a regional crisis. The Hong Kong dollar was also subject to a brutal attack, but hedge funds could not bring the currency down due to Hong Kong's strong fundamentals and effective defence tactics.
Ever since, Asian authorities have been discussing ways to curb hedge funds. But the proliferation of off shore financial centres, such as the Cayman Islands, has made it increas ingly difficult to regulate them.
"If we impose more restrictions on domestic financial markets to pre vent huge capital inflows, these hedge funds will move to these offshore banking units, rendering the restric tive measures ineffective," said Paul Chiu, Taiwan's finance minister.
For this reason, the approach being adopted by the advanced economies is to further strengthen disclosure requirements, and to require banks to enhance their risk management capabilities in order to curb excessive lending to hedge funds and other highly-leveraged institutions. In this regard, hedge funds are being con trolled indirectly.
The G-7 countries began to take a serious look at the destabilising effect of hedge funds only after the collapse of Long-Term Capital Management. In the end, the bankrupt US hedge fund had to be bailed out by other US investment banks, because if it could not unwind its $1 trillion (Bt37.85 tril lion) worth of positions, it could have brought down the global financial market.
The failure of Long-Term Capital Management also pointed to poor risk management by the banks, which allowed the hedge fund to leverage 20 times its capital base.
However, Chiu said these disclo sure or risk-management measures were not enough to shield emerging market countries from the hedge fund threat.
In Taipei, he said, foreign investors were required to register as quali fied investors and to disclose pertinent information, including the names of their beneficiaries.
"At the same time, Taipei has reg ulated hedge funds in a manner sim ilar to regulating securities investment trust funds by prohibiting transactions supported by margin financing," he said.
Malaysia's measures have been more direct. In September 1998, the authorities declared offshore ringgit to be inconvertible to curb speculative currency trading, thereby creating heavy losses among hedge funds and currency speculators.
Shafie Mohd Salleh, deputy finance
minister of Malaysia, said when Prime Minister Mahathir Mohamad stressed that hedge funds needed to be regulated, the international community staunchly opposed and condemned Malaysia's stance.
"We're pleased to note that world opinion has changed, particularly following the LTCM debacle in August 1998," he said.
"The international community has now widely accepted the dangers associated with unfettered liberalisation of financial markets and the destructive role played by hedge funds and currency speculators."
BY THANONG KHANTHONG