The Regulation of Hedge Funds under the Prism of the Financial Crisis. Policy Implications

This paper deals with two issues. On the one hand, it shows that structural changes in financial markets and in the hedge funds industry make the “light-touch” arguments for regulating hedge funds no longer relevant. On the other hand, pleas for stronger regulation of hedge funds are getting more attention. In the first part of the paper the huge expansion of the industry is outlined and the state of current regulation is hightlighted. In the second part an in-depth analysis of risks associated with hedge funds is carried out. It is shown that systemic risks can arise from leverage and from concentration of exposures amongst hedge funds. The part played by hedge funds in the spread of the crisis of structured credit is portrayed. In the third section, the recommandations of professional organisations, regulatory authorities and international institutions are summed up within the framework of risk mapping. This oversight shows the way to reform: the need for direct regulation, the enhancement of indirect regulation and the overhaul of securitization. The prospective pattern of regulation encompasses macro- ans micro-issues, and impinges upon factors of demand and supply. It emphasizes the enhanced role of public regulators and displays the conditions for an effective market discipline performed by long run institutional investors.