ANALYSIS: Germany concedes G8 defeat on hedge fund code of conduct

By Rohan Minogue Jun 4, 2007, 2:11 GMT

Berlin - Before the leaders of the world's most powerful countries even board their flights to this week's G8 summit, Germany has surrendered hope of securing commitment to increased control of hedge funds - largely in the face of unbending US opposition.

Summit host Angela Merkel conceded in a weekend interview that she 'could have wished for more' in the way of transparency and a willingness to adopt a code of conduct on the part of the funds.

Chancellor Merkel's G8 sherpa, Bernd Pfaffenbach, added: 'I acknowledge that we didn't get very far with this. But a voluntary code of conduct remains a good idea.'

A 'good idea' is what it is likely to remain.

In April, US Federal Reserve Chairman Ben Bernanke reiterated his view that 'the market-based approach to the regulation of hedge funds seems to have worked well.'

And a former US under-secretary of commerce in the Bush administration, Grant Aldonas, made clear last week that control - even a voluntary code - 'won't happen.'

Most estimates of the volume controlled by the world's 9,000 hedge funds run to 1.4 trillion dollars, although US Treasury Under-Secretary Robert Steel recently put the figure at as high as 2.1 trillion.

Well over half resides in the United States, with Britain - which takes a similarly light approach to financial regulation - another major player.

Without the cooperation of these two countries, the idea of greater control by the financial regulatory authorities is a non-starter.

Germany initially had high hopes, the forthright Finance Minister Peer Steinbrueck believing Merkel could push through a commitment to greater transparency in the workings of hedge funds and other highly leveraged investment institutions.

'We all agree we need greater transparency,' Steinbrueck said at the close of a European Union finance ministers' meeting in Berlin in late April.

Sitting next to him, EU Monetary Affairs Commissioner Joaquin Almunia said 'remarkable progress' had been made in establishing a voluntary code.

But British Chancellor of the Exchequer Gordon Brown was a notable absentee from the ECOFIN meeting and is unlikely to have felt included in Steinbrueck's sweeping claim of broad support.

Even the German finance minister was compelled to concede that requiring too much openness from hedge funds, which often buy suddenly into underperforming companies, could negate the very reason for their existence.

And he acknowledged their role in improving liquidity and efficiency and in helping to determine accurate prices.

Pfaffenbach concedes that the last time Germany raised the issue at the G8 - under Social Democrat former chancellor Gerhard Schroeder at the 2005 Gleneagles summit - 'we ran into a brick wall.'

'This time the US and Britain are at least prepared to talk about the issue,' he adds somewhat forlornly.

Steinbrueck, a Social Democrat in Merkel's broad coalition, steers clear of the 'locust' description of hedge funds once used by his fellow Social Democrat, Deputy Chancellor and Labour Minister Franz Muentefering.

But he remains concerned about what he terms 'systemic risk.'

'I'm worried that there are some hedge funds that have leveraged activities, for example, five or six or even seven times and that creditors could be damaged whenever such hedge funds become insolvent,' he said earlier this year.

But Bernanke takes the view that the financial institutions lending to hedge funds 'have the clout to demand the information they need to make their evaluations.'

After the losses they sustained in the LTCM collapse in 1998, they are taking their market discipline responsibilities seriously.

The Fed chief notes in addition that small investors are not allowed to put their savings directly into hedge funds under US law.

Merkel has pledged to keep the issue on the G8 agenda, but at best, all the Germans can hope for at Heiligendamm is for the respective financial supervisory authorities to monitor the funds closely.

'And that,' as Aldonas says, 'is happening.'