Precy Dumlao, Opalesque Asia: Australian hedge funds do not currently pose a systemic risk to the local financial system, an ASIC report claimed and added that the country's hedge fund industry manages only a small share of Australia's $2.1tln managed funds industry with more than half of these holding less than $50m each.
In its survey of Australian hedge funds, it found that the local fund management space uses low leverage and appeared to have adequate liquidity to meet obligations.
In a speech by Australian Securities and Investments Commission (ASIC) Commissioner Greg Tanzer during the AIMA Australia Hedge Fund Forum today, he said that there are no Australian examples of hedge funds causing systemic risk, but there are overseas.
"The collapse of Long Term Capital Management (LTCM) in 1998, where the Federal Reserve Bank of New York had to orchestrate a bail - in by its investment bank counterparties is the most famous," Tanzer said. "This is an example of a hedge fund raising systemic risk through the channel of credit risk. Ten years later, Morgan Stanley faced the simultaneous blows of massive withdrawals of hedge fund assets from custody while having to satisfy contractual rights to provide uncollateralized loans to other hedge funds. This led to tri-party repo (repurchase agreement) lenders questioning its credit and to the firm applying to become a bank holding company," he added.
He told delegates of the conference that hedge funds may also contribute to systemic risk through the market risk channel, for example, where their activities lead to a liquidity problem or mispricing in a particular market for securities or futures.
Tanzer said, "Examples include the distorting impact of Amaranth Advisors' investing over the northern summer of 2006 in US natural gas futures for the 2006-07 winter, and the shorting and resulting short-squeeze of Volkswagen stock in 2008 which distorted the German equity indexes over several days."
ASIC's findings were based on 2010 and 2012 surveys undertaken in coordination with other
The survey was representative of the state of the Australian hedge fund industry as a whole, with the assets of the 12 surveyed qualifying hedge funds representing approximately 42% of the assets held by single-strategy hedge funds in Australia.
Australian wholesale investors are the main investors in the surveyed funds. Their hedge-fund investment relative to their total investments is minimal, which tends to reduce systemic impact of any problems in the sector.
By asset class, listed equities (over $19bn) are the surveyed fund managers' greatest gross exposures, with almost one-third of this being Australian equities. Equity derivatives and G10 sovereign bonds are the next two most significant asset classes, with exposures of $8.2bn and $6.9bn respectively.
Hedge fund redemptions exceeded applications in 2012, compared with the substantial inflows in 2010. However, the 2012 redemptions are unlikely to result in liquidity pressures because the average redemption size is relatively small as a percentage of funds' net asset value.
The average time in which surveyed funds can liquidate 92% of their portfolio is less than 30 days. However, creditors can demand 99% of fund liabilities in less than 30 days. If the Australian market were subject to significant stress, the sector may struggle to meet redemption requests. However, this risk is offset by all the surveyed funds being able to suspend redemptions, if required.
Surveyed funds use relatively low levels of leverage, with synthetic leverage being the largest source in 2012. Average leverage, by gross market value as a multiple of net asset value, increased from 1.25 times assets in 2010 to 1.51 times assets in 2012.
The survey found that hedge funds' investments have in the past adversely affected the financial system by disrupting liquidity and pricing in markets (market channel risk) or by causing creditors to lose money (credit channel risk). The potential for systemic risk depends on the size, significance and interconnectedness of hedge funds.
This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.