FSA: Assessing the possible sources of systemic risk from hedge funds

21 August 2012

This paper sets out the results of the FSA's latest Hedge Fund Survey (HFS) conducted in March 2012, and the Hedge Fund As Counterparty Survey (HFACS) conducted in April 2012.

The key findings of the March 2012 HFS and April 2012 HFACS are:

• Aggregate assets under management increased in the survey period, predominantly due to positive returns, but also helped by generally positive net subscriptions. Aggregate assets below their high-water mark (HWM) have remained stable and low.
• The footprint of surveyed hedge funds is modest in most markets when measured by the value of their exposures and by turnover. Possible exceptions are the convertible bond, interest rate derivative and commodity derivative markets. The HFS only provides a partial view of global hedge fund exposures and so, globally, hedge funds will have a bigger footprint.
•  Leverage remains largely unchanged and modest for most funds. Fixed-income arbitrage strategies report the highest leverage, both in terms of gross exposures relative to Net Asset Value (NAV) and total borrowings relative to NAV. Most cash (or on-balance sheet) leverage comes from repo borrowing, which is continually rolled; however, borrowing from this source has declined in aggregate in the latest survey. Understanding the source of hedge fund borrowings is important in assessing systemic risk through ‘market’ and ‘credit’ channels. The latest survey results suggest that unencumbered cash as a multiple of total borrowing has declined in aggregate.
• In aggregate, surveyed hedge funds report that they are able to liquidate their assets in a shorter timeframe than the period after which their liabilities would fall due. Almost all funds state that they can suspend investor redemptions and/or create side pockets, and over half report that their investors have side letters. Nonetheless, there is still a risk of a sudden withdrawal of funding during stressed market periods (such as a withdrawal of repo financing), resulting in forced asset sales.
• Counterparty exposures of surveyed hedge funds remain fairly concentrated among five banks. From the banks’ perspective, they have tightened financing terms for hedge funds post-crisis, increasing their resilience to hedge fund defaults.
• Measures of portfolio concentration, including qualifying funds’ top ten positions as a percentage of gross market value (GMV) and the number of open positions, has remained largely unchanged for most surveyed funds.

The FSA intends to repeat the HFS in September 2012 and the HFACS in October 2012.

Full report

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