Working paper on hedge funds and private equity

							Working paper on hedge funds and private equity
Rapporteur : Poul Nyrup Rasmussen (PSE)

(Preliminary draft version)
The working document on Hedge Funds and Private Equity might turn in a much broader
approach responding to the current financial turmoil, the discussion in ECON Committee
revealed. There seem to be diverging views between socialist group members who intend
to favour the working paper to become a broader response to the recent financial turmoil
and members from the EPP and (partially) the ALDE group who will concentrate on hedge
funds and private equity only.

Rapporteur Rasmussen (PSE/DA) referred to the high trading activities of hedge fund
and Private Equity. He is most concerned about the high leverage of hedge funds and
private equity and its negative effects on the real economy. The way hedge funds and
private equity funds reacted to the crises shows that their business models have to be
adjusted, he said.

With regard to hedge funds he states that “regardless of the trigger, consequences of
any financial markets crisis (that usually lead to lesser liquidity) will affect vehicles and
institutions with higher leverage more than well capitalised conservatively run financial
institutions.”

“The question is, however, not only whether hedge funds have triggered the crisis, but
also whether they have managed to play their role (as always argued by the proponents)
and went against the market, thus acting as a stabilising factor and provider of liquidity.”

Rasmussen noted that hedge funds failed to demonstrate their stabilizing role. “There
have been several big hedge funds failures with the most leveraged ones being hit the
hardest and there are fears that more of them will face liquidity problems when trying to
de-leverage or fail when seeking returns as high as promised to the investors. It is early
days and the evidence of the recent crisis is not yet conclusive.”

He finally notes that any concerns raised should apply not only to hedge funds vehicle
but to every entity engaging in such activities.

Rasmussen concludes that “if the EU decides upon a stricter regulation, we could think of
incentives for funds to stay onshore, such as for example the establishment of an EU
level legislative framework for cross-border marketing and sale of hedge funds (as also
for other non-harmonised whole sale investment products).”

Responses from Committee members

John Purvis (EPP/UK) noted that although the report might be a good starting point for
arguments the conclusions to be drawn from it are different. The current crisis was not
caused by hedge funds or private equity, but by highly regulated banks, he noted and
warned to blame the hedge fund industry for having caused the crisis. Also, the report
should neither mix up with the targets of the Lisbon Strategy, nor with climate change.

Purvis finally stated that any regulation should define the level-playing field and called for
fiduciary standards.

Other EPP members supported Mr Purvis’ view. Astrid Lulling (EPP/LUX) made clear
that in contrast to the working paper the funds who were coping best with the crises
were highly developed funds.

Sebastian Bodu (EPP/ROM) pointed out that the difference between hedge fund and
private equity, and banks lies in the source of money. Hedge fund, therefore, cannot be
treated in the same way as banks. Gunnar Hökmark (EPP/SWE) also pointed to other
underlying reasons for the crisis such as the low US interest rates.

Sharon Bowles (ALDE/UK) also underlined that the current crises was not the fault of
hedge funds and private equity. Also, with regard to the role of credit rating agencies,
the conflict of interest issue should not be overblown. The extent, role and situation of
transparency and supervisory issues at a global level have to be analysed which might
then lead towards a ‘joining up’ between the EU, the US and other countries.

Olle Schmidt (ALDE/SWE) warned not to overload financial markets with regulation. To
his opinion, the working paper clearly shows that it is not clear how to react. “If we don’t
know what to do it might be best to do nothing”, he said and shared the opinion of Mrs
Bowles that even the best intentions to act might cause undesirable negative effects.

Daniel Daianu (ALDE/ROM) however, referred to structural deficiencies of the financial
market system. He warned that financial innovation can create more uncertainty in the
market and referred to a statement made by Andre Lamfalussy in 1997.

PSE members indicated that structural problems of the financial system have caused, or
at least triggered the crises. Ieke van den Burg (PSE/NL) agreed with Mr Daianu that
underlying structural deficiencies exist. There is an obvious lack of functionality, she said,
in particular with regard to transparency issues and the oversight of public authorities.
This view was also taken by Perenche Beres (PES/FR).

Working document

Timeline:
8 April: ECON hearing on hedge funds
5-6 May: Consideration of the working document

Committee also announced a forthcoming own-initiative report on supervision and the
3L3 Committees.


EXCHANGE OF VIEWS with Mrs. Neelie KROES, Commissioner for Competition

Commissioner Neelie Kroes focused in her speech on state aid, antitrust and merger
issues and announced a “Antitrust Damages White Paper” to be launched in the coming
weeks, and the final version of the “General Block Exemption Regulation on state aid”,
which is due to be adopted before end June 2008.

Questions from ECON members targeted, among others, on financial turmoil and the
Northern Rock and German Landesbanken cases. Jonathan Evens (EPP/UK) asked the
Commission to set out a way to maintain proper competition in the banking sector now
that the UK government has taken over Northern Rock.
Alexander Radwan (EPP/DE), Carsten Hoppenstedt (EPP/DE), and Wolf Klinz
(ALDE/DE) pointed to the German Landesbanken and the IKB. Margarita Starkeviciute
(ALDE/LIT) asked for the Commission position concerning the bail-out of banks.

Commissioner Kroes outlined that this is certainly a case for state aid. A level playing
field has to be guaranteed. Therefore, there has to be drawn a line between ‘rescue aid’
and the business plan which has to be ‘slimmed-off’

Ieke van den Burg (PSE/NL) was in particular interested in a possible dominant position
of investment banks and the major role they were playing in the recent financial turmoil.
Pervenche Beres (PSE/FR) asked the Commission also to look at competition aspects
with regard to credit rating agencies and the role of auditors.
Commissioner Kroes rejected that this is not that much a competition problem, but
more an aspect of regulation.

Full speech Kroes

The next meeting is scheduled for 24 June 2008.

Monetary dialogue with Mr. Jean-Claude TRICHET, President of the European
Central Bank

“Financial institutions will need to step up their efforts to effectively manage the risks
that may lie ahead”, ECB President Jean-Claude Triched said speaking before the EP
ECON Committee. “With the global financial system undergoing a process of de-
leveraging, the euro area financial stability outlook continues to be clouded by
considerable uncertainty.”

He made clear that transparency is the key to solve the current problems and referred to
the experiences during the Asian crisis back in 1997. We are in an “ongoing process of
very significant market corrections with episodes of turbulence, a high level of volatility
and overshooting”, he said and noted that “very highly leveraged institutions that are not
regulated are creating a problem”.

Trichet finally called for a ‘further significant change of culture’ at the national, European
and global level towards enhanced transparency and anti-cyclicality “as a large number
of rules, regulations and procedures have a tendency to foster behaviour that is largely
procyclical, amplifying the booms as well the busts in the cycle.”

Alexander Radwan (EPP/DE) posed the question who should take the lead in defining
the new culture and how this code should look like. Radwan doubted that this should be
done by those banking managers who signed responsible for the current crisis situation.
The question of rules and self-regulation was also raised by Jose Margallo (EPP/ES),
and Mia de Vits (PES/BE) who called for regulation of hedge funds. Guntars Krasts
(LAT/Greens) questioned the self-healing powers of the market. Pervenche Beres
(PES/FR) furthermore asked whether recent financial market events have not proved that
the concept of self-regulation finally failed.

Trichet called for a holistic approach with all relevant institutions and market players to
participate and noted that market participants should try to improve behaviour
themselves. “If it appears that self-regulation, codes of conduct, and other measures can
be worked out and appear convincing, then we should take it”, he said. However, “if their
response is not convincing or if they cannot do it, then the time has come for regulation.
I don't rule out regulation ex ante but it is good practice to see whether you can proceed
by setting out best principles and benchmarking.”

Jose Margallo (EPP/ES) and Robert Goebbels (PES/LUX) asked about different
measures undertaken by the US Fed and the ECB. Mr Trichet made clear that one should
not compare the policies of both central banks as they are working in different markets,
do not share the same problems and have to deal with different shocks.

Wolf Klinz (ALDE/DE) referred to the latest remarks of Mr Greenspan and asked
whether a crisis situation would have occurred anyway regardless of the sector and was
more a result of an ongoing globalization process.

In his response Mr Trichet made clear that the current market correction were not
abnormal and correspond to the predictions made by the ECBS which already noted in
2006 that the level of risk pricing in global finance might be a result of an underpricing of
risks. However, there is no quick-fix for any country that is not going along with its
international partners. Solutions have to be found at a global level and referred to the
FSF who is currently preparing its final report.

Responding to a question of Pervenche Beres (PES/FR) on how to deal with off-shore
centres, Mr Trichet made clear that the problems were not resulting from these. It were
highly regulated institutions who caused the problems.

Responding to the question of Daniel Daianu (ALDE/ROM) on possible systemic risks
caused by a ‘shadow banking sector’ as mentioned by Baron Lamfalussy, Mr Trichet
noted that Basel II took account of new products like SIVs, conduits, and others. He
reminded again that the commercial banks were already regulated and Basel II is
currently updated.

Full speech Trichet
Further information