Hedge Fund Regulation

The new topic on the Street is the impending hedge fund regulation (as written by Blooomberg everyday).  It is popular opinion that the hedge fund industry will come under strong scrutiny in the next couple of months and years. That legislators will move to force managers to register, similar to the 40 Act registration for mutual funds.  

This would defeat the entire purpose of hedge funds as risk capital.  People get invovled with hedge funds for their ability to take on more risk, their ability to keep their positions secret, and the talent that hedge funds attract because of their compensation structures.  

It is quite possible that moves to regulate the industry will have unforeseen consequences. Among the consequences, it could result in the closing of many funds, which will result in the loss of high paying jobs (New York needs those jobs to support their Tax Revenue).  Moreover, the increased regulation of hedge funds could result in loss of competitive advantage (if disclosure of positiosn is required), arguably the most important feature of any hedge fund.  Also, regulatiosn might limit the risks that hedge fund can take, reducing the change for the high returns for many funds.  There are a host of other consequences beyond my reach at this point.

Besides, the possible consequences, some of the actual consequences will be the increase of expenses, for attorney fees.  Hedge funds already pay thousands of dollars to ensure that they avoid as many of the SEC and legal requirements as possible (40 Act Requirements, Registration of securities).  By now requiring for more disclosure and more oversight, that will undoubtedly result in more legal fees.  Thus, lower margins for the industry, which will result in lower employee pay and a loss of tax revenue for the state and federal government (arguably at a time the government(s) needs revenue more than ever).  

Instead of increasing regulation on hedge funds, a better approach would probably be increased oversight by the SEC, without any more requirements or add ons that come with regulations.  By simply requiring dislcosure to regulatory officials on positions, leverage and accounting for those positions (similiar to what any fund does anyway), they can avoid adding needless filing requiremnts and ending the competitive advantage of funds.  

The increased regulation will likely only burden an industry that is already under fire.  In our world, of supposed capitalism, hedge funds are the very notion of this principle.  Harming their ability to work as currenty structured, will only hurt main street (lower tax revenue) and harm a future generation of fund service providers.  It will not eliminate the possibility for financial disaster, because only actualy oversight can accomplish this.  

One final proposal that might have merit, however, would be the imposition of caps on leverage.  Currently, many funds are leveraged 30 to 1 or greater.  By imposing a limit on leverage for funds above a certain range of assets (say 5 Billion), to say 25 to 1, would decrease the changes of another Long Term Capital Management debacle.