Zut alors! And we thought les Francais were all hedgie-haters. Mais non. Business school Edhec has struck back, eager to show that despite what the French president Nicolas Sarkozy might have to say on the subject the French are not laying the blame for the summer’s ructions at the door of the funds.
Mr Sarkozy has been banging the drum for tougher regulation of financial markets and measures to improve transparency in the wake of the turbulence.
To suggest that hedge funds are to blame is “simplistic but tempting,” says Noël Amenc, professor of finance and the director of the Edhec risk and asset management research centre. “As a counterpoint to these accusations that often come from France, it seemed necessary to us to provide a French perspective on the lessons to be learned with respect to financial regulation in France.”
The business school actually seems more than a little ticked off with its compatriots and the finger-pointing at hedge funds:
France and its president were quick to cast these funds in their usual role as scapegoats. In a country with a social and political tradition of blaming its woes on the market, on demands from abroad, and on international finance, this condemnation cannot but reverberate widely. We believe not only that the criticism of hedge funds is groundless but also that it helps to hide the true causes of this summer’s crisis.
Their three lessons from the subprime crisis are as follows, says Edhec.
- Hedge funds not to blame – investment in hedge funds makes up less than five per cent of total institutional investment, and strategies with high exposure to credit risk account for 20 per cent of less of total assets. Hard to believe, suggest Edhec, that the transfer of credit risk have been done with hedge funds alone as counterparties. In fact, “the problem is that banks, not hedge funds, have been affected by excessive investment in asset-backed securities and in structured credit that have turned out to be illiquid and those banks have thus appeared insolvent to their counterparties in the money market.” Thus, they argue, it is the most heavily regulated institutions that have required the intervention of central banks.
- Crisis is linked to over-regulation, not under-regulation – Edhec says: “the crisis of confidence in the financial information reported by lenders was caused by the unexpected halt by a major bank in the valuation, subscription, and redemption of so-called dynamic funds. So it was caused not by unregulated parties or by forbidden or murky practises but by regulation that failed utterly to take into account the major risk of illiquidity that goes along with the default risk traditionally associated with credit instruments.” The rules on the use of credit derivatives have done nothing to protect investors, they add, and in fostering the illusion of protection may have done harm. As it happens, French and European regulations that attempt to define rules for the eligibility of assets and the classification of investment funds are a failed approach to the protection of investors and to the resolution of the problems posed by asymmetric information, goals that justify regulatory intervention.. ..Regulators would do well to settle for a smaller but more effective role.”
- Regulation in the works will increase the risk of market illiquidity – new accountancy rules (IFRS) and insurance industry rules for risk management will have two consequences, says Edhec. The “better” of the two – they’ll encourage investors to stop taking risks, but will “lead to the disappearance of institutional investors capable of taking risks, a phenomenon that will discourage equity capital investment and, more generally, lead to the creation of a rentier economy with disastrous social consequences.” The worse of the pair is that the financial industry will “attempt to skirt these rules through risky financial engineering. The summer’s crisis is but an early warning.“
Mon dieu! Punchy stuff from the French. And there is more to come from the school – a larger work is planned on what they see as a crisis in regulation – where regulators, in attempting to relieve problems of uneven access to information, are actually increasing this asymmetry.
In the meantime, any French hedge funds feeling unloved know where to go for for a sympathetic ear.