Lawmakers at a House Financial Services Committee hearing Wednesday shied away from committing to legislative action on hedge funds unless a crisis emerges.
At the hearing on the President's Working Group task force on hedge funds, legislators admitted that such firms pose a market risk, but that they preferred self-regulation of the industry for now.
"We have a kind of uneasy consensus that there is a potential problem here that we wish we were more sure about how to approach," said House Financial Services Chairman Barney Frank, D-Mass. "What we are talking about is, are we now ready to deal with a potential problem, and, if so, what should we do about it?"
Rep. Frank did not offer many clues about how he would handle a broad systemic problem, but Rep. Spencer Bachus of Alabama, the committee's ranking Republican, was clear that now is not the time to address it.
"We should not be taking legislative action," he said. "If Congress attempts to regulate or tax any specific sector of the financial services industry without a thorough understanding of the role it plays in our financial system, the risk of unintended, unnecessary, burdensome, or harmful regulation is real. The last thing we want to do is to drive hedge funds or private-equity funds — and their capital — offshore. … The last thing we need is taxation and legislation that would cause a flight of capital out of the United States."
Guidance released in February by the President's Working Group on Financial Markets steered clear of specific new requirements for banks or hedge funds, but it offered a broad outline of risk-based procedures for creditors, counterparties, and regulators.
"The growing size and scope of private pools of capital merit appropriate attention," Treasury Undersecretary Robert Steel, said at the hearing, "particularly given possible challenges posed by private pools in areas of investor protection and the potential for systemic risk."
By the end of last year there were more than 9,000 hedge funds, and they managed more than $1.5 trillion of assets, according to the Federal Reserve Board.
The House hearing was not the only one addressing hedge funds Wednesday on Capitol Hill. The Senate Finance Committee also met to discuss a proposed bill by Chairman Max Baucus, D-Mont., and Sen. Charles Grassley of Iowa, the committee's ranking Republican, to increase taxes on certain managers. In that hearing, Sen. Charles Schumer, D-N.Y., echoed some of his congressional counterparts in declining to single out hedge fund managers for increased regulation.
"I will not stand for treating financial services partnerships" such as hedge funds and private-equity firms "one way while all the other partnerships are treated another way," Dow Jones quoted him as saying. "If we are going to change how we tax financial partnerships, we should treat oil and gas and venture capital and real estate and everything else the same. My state may depend more on financial services, and Texas may depend more on oil and gas — it's unfair to treat one region differently than another."
Both Democrats and Republicans in the House signaled Wednesday that they preferred to let the alternative investment community regulate itself, and they did not call on the Treasury Department to expand upon its guidance.
"If self-regulation in the market does not work and we have an unforeign event, the resulting actions of this Congress will be very unhelpful to the market at large," said Rep. Richard Baker, R-La. "This is no casual warning. This is a plea for the market to act."
Kevin Warsh, a member of the Fed's Board of Governors, said that the working group saw a role for both the market and regulators in overseeing the industry.
"The emphasis on market discipline neither endorses the status quo nor implies a passive role for government," he said.
The working group's guidelines advise creditors to put an enhanced focus on the level of information about a hedge fund, including quantitative and qualitative indicators of the pool's asset value, performance, and risk exposure.
Similar guidelines the working group released in 1999 left open the possibility of requiring hedge funds to make more disclosures. However, in this year's guidelines the Treasury decided that management practices had improved sufficiently without requiring more data. But some legislators were not satisfied.
"The frequency of the reporting is so infrequent in light of the trading strategies that all you would be able to get is the license plate of the truck that just ran over you," Rep. Baker said.
Mr. Steel said he recognized the importance of disclosure, but he would not say whether further action was needed.
More than 1,900 investment advisers to hedge funds are registered with the Securities and Exchange Commission, but not all hedge fund advisers are required to be registered.
Rep. Frank questioned whether unregistered managers should have document retention requirements and whether legislation would be necessary to give the SEC authority for such documentation. But Erick Sirri, the director of the SEC's division of market regulation, warned members to be careful of a "trade-off" for such a move.
Legislators also expressed concern over the risk for pensions and pension holders who might not know how their money is being invested, particularly with institutional investors increasingly using hedge funds and hedge funds of funds.
"This increase at a very high rate creates a new potential problem, particularly for fiduciaries, and we may have to do new things," Rep. Frank said.
