Monday, February 7, 2011

Europe Establishes Principal of Hedge Funds Disclosing Current Investment Positions

An article in the NY Times Dealbook discusses how the French have begun to require current asset-level disclosure from hedge funds on their short positions. [emphasis added]
The hedge fund manager David Einhorn does not seem to mind revealing his bets against a company, at least on his own terms.  Over the years, Mr. Einhorn, the founder of Greenlight Capital, has announced several major short positions, most notably in 2008 when he publicly derided Lehman Brothers just months before the investment bank collapsed. 
But now Mr. Einhorn and other large investors do not have a choice in France, where regulators started requiring money managers to disclose on a daily basis the stocks they bet against in the country. 
On Feb. 3, Greenlight Capital reported it was short more than 1 percent of the shares in Neopost, a French mailroom equipment supplier. 
While hedge funds have long had to report their long positions on a quarterly basis, the decision by French authorities brings a new level of transparency to some of the most closely guarded investment moves in the hedge fund world.
As readers of this blog know, your humble blogger has been calling for an even higher level of transparency since before the start of the credit crisis.

Now that the French authorities are requiring current asset-level disclosure of hedge funds, they and the other global regulators need to extend this requirement globally.  After all, why should this requirement be restricted to France? Why should this requirement not apply equally to long and short positions?  Why should this requirement not apply to all positions and not just those where the position reaches 0.5% of a company's outstanding stock?
In February, the Autorité des Marchés Financiers, the French financial markets regulator, began requiring hedge funds and other investment managers to disclose their short positions when they reached 0.5 percent of a company’s outstanding stock. 
The initiative mirrors a plan by European Union regulators who, in the wake of the financial crisis, want to monitor the potential risks of short-selling. The European Commission is considering a proposal that would require all member countries to publish details on investors’ short holdings. Authorities are expected to vote on the measure this year. 
It’s definitely a step in the right direction in terms of providing transparency,” said Andrew Lo, professor of finance at theMassachusetts Institute of Technology, who has studied hedge funds for more than a decade. “While it is good for the public, there is a potential for unintended consequences.” 
The action in Europe goes well beyond the efforts of regulators and policy makers in the United States. 
...There is scant information on short-selling. Limited details are often published on a delayed schedule or in aggregate form, making it hard to know the size and scope of such positions.
...As lawmakers across Europe search for ways to prevent another crisis, countries in the region have adopted their own policies around the investment strategy, with the French rules sitting on the more stringent end of the regulatory continuum.
...The European Union is moving to create a uniform policy for its 27 member countries. The plan, issued last September, would require firms with short positions of 0.5 percent of an available stock to publicly disclose it. The proposed legislation, which could change as it wends its way through the system, is expected to come up for a vote this year. 
The patchwork of regulation — and the looming threat of comprehensive rules in the euro zone — have prompted hedge funds to beef up their lobbying efforts. The industry’s main trade group in the United States, the Managed Funds Association, said it planned to open an office in Brussels, the headquarters of the European Commission. The trade group has also sent letters asking European authorities to maintain the records privately, or post them anonymously or in aggregate. 
As discussed in an earlier post, rather than fight the regulation, the hedge fund industry should embrace the legislation and make sure that it covers all the sell-side firms.  After all, wouldn't the managers of the hedge funds like to know what the sell-side is shorting too?
The industry argues that such disclosures could spawn copycats, unsophisticated investors who see the moves of respected hedge funds like Greenlight and decide to follow suit. Such piling on could lead to unfair downward pressure on a company’s stock. 
...Others say that if market participants stop shorting to avoid the regulatory disclosures, liquidity will dry up and the market will be less efficient. A study by the British financial regulator in the aftermath of the crisis found that liquidity and pricing suffered for those stocks that investors were banned from shorting. 
But there isn’t a lot of research on how disclosing individual short positions will affect the market. Two industry-financed studies suggest that investors will be at risk if the proposed legislation passes. One study, commissioned by the Managed Funds Association, found that trade volume dropped 13 percent in those stocks subject to disclosure rules in Britain and the gap between the buy and sell offers on a stock increased 45 percent. 
The research, however, is hardly definitive, experts say. Indeed, many feel the rules would be a good way to balance what is good for the markets with what is good for the public. 
“It’s going to affect just large hedge funds who are putting on fundamental shorts,” said Charles Jones, a finance and economics professor at the Columbia Business School. “It might discourage them from doing that, and it might mean that prices take longer to adjust to negative information. But it won’t destroy market quality in the same way the ban did.”

Long Term Capital showed why it is important that hedge funds disclose both their short and long positions.  It was their highly leveraged long positions that represented the systemic risk when the markets moved against them. 

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