Are Hedge Funds Becoming Regulated Banks?

It seems like the Treasury’s Tim Geitner is getting behind the Federal Reserve to promote uniformity in derivatives. Specifically, in February several banking industry major players (Goldman Sachs Group Inc., JPMorgan Chase & Co., Credit Suisse Group AG and Barclays Plc) voiced their opinion to the Treasury arguing that the banking industry should require that traditional bank regulatory practices with regards to derivatives. It seems Geitner is trying to get his ducks in a row after some initial stumbling regarding the specifics of his plans to deal with toxis assets.

Banks want to level the playing field by requiring regular corporations, energy companies and hedge funds to face the same capital adequacy requirements and margin levels that bank do with regards to OTC derivatives.

Putting banks and hedge funds on the same playing field makes sense to promote transparency in derivatives. While there is some good in this, this type of move by the Fed is fraught with peril for hedge funds. This can represents a dangerous precedent and a slippery slope of hedge funds to be regulated alongside of banks in regards to other issues such as leverage requirements, position disclosures, overall risk budgeting and operational information disclosure.

These regulations focus on establishing the Fed as a systemic risk regulator. Systemic risk is extremely important but it is not the entire regulatory equation. This focus on systemic risk is important but once again it is of growing concern that the government is being steered by powerful lobby groups to ignore the continued threat of operational risk (aka: unsystemic risk) including fraud. Perhaps the hedge fund industry should take a page from the bank’s playbook and be more vocal in Washington with actionable recommendations, instead of the general pat on the back fodder that has been stated by most hedge fund lobby groups, to further craft future regulation before the hedge industry becomes regulated away.

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