News Analysis: Biggest and bravest gamblers retreat from the credit crunch

Regulatory backlash and tougher times loom, but don't write off Soros and company just yet

UNTIL JUST a few months ago, hedge funds looked unstoppable. The seemingly all-powerful investment partnerships could not put a foot wrong.

They successfully predicted the magnitude of the Tokyo stock fall in the late 1980s. They bet correctly that sterling would fall out of the Exchange Rate Mechanism in 1992. George Soros, one of the most famous and infamous hedge fund managers, attained an almost mythical status as well as a swollen bank account.

But in a few weeks all that has changed. The Russian default and subsequent market turmoil wrong-footed many of the best-known hedge funds. The regulators are on their backs and credit lines are being withdrawn. Suddenly, the world's biggest and bravest gamblers are in retreat.

Even before the latest bout of market turmoil, things were not looking too rosy. Although the term "hedge fund" is often applied to a wide range of investment partnerships, a particular class of funds - the so-called "tactical trading" funds or speculators - was widely blamed for exacerbating the emerging markets crisis.

These funds drove down exchange rates - and in some case stock markets - to excessively low levels, making life more difficult for struggling emerging market economies.

Malaysia imposed capital controls to protect its embattled markets from the speculators. The Hong Kong administration intervened directly in the financial markets to make sure that the speculators lost out from what they termed "market manipulation".

Some of the most influential figures on the world stage had begun to argue that "something must be done" about the speculators, and the issue was expected to figure heavily in the forthcoming annual meetings of the International Monetary Fund and the World Bank, even before the latest developments at Long-Term Capital Management.

However, the chronic financial difficulties of Long-Term Capital Management, and others, have focused regulators' minds on the dangers the funds can pose to the health of the international financial system.

The majority of large asset managers and investment banks have some exposure to one type of hedge fund or another. Some institutions invested in hedge funds because they wanted to diversify their portfolio. For instance, a bank trading mostly in equities could help to spread its risk by investing in a specialist hedge fund operating in the US mortgage market. But others invested in hedge funds simply because they wanted to raise returns on their investments.

According to Christopher Cruden, managing director of Tamiso & Co, a US hedge fund: "People were seeking higher and higher returns. In many cases, it was just naked greed." The upshot of all this is that if a major hedge fund goes under, it could pull other institutions with it.

Hence the eagerness of the US Federal Reserve to organise a bail-out for Long-Term Capital Management. And hence the announcement today from the Financial Services Authority (FSA) in London that it was seeking to clarify the exposure of 55 financial institutions to hedge funds.

In the wake of recent events this could be just the beginning for hedge funds, which will face unprecedented regulatory scrutiny in coming months.

But many of the hedge funds have more pressing problems than regulatory meddling. In numerous cases, their creditors are banging on the door. And even those funds which have escaped relatively unscathed so far will find that their ability to obtain new credit has been severely dented. Mark Turner, managing director of Schooner Asset Management, said: "We are in the middle of a major global margin call [a calling-in of loans]. A massive credit crunch is on its way."

Another leading fund manager said: "Put it this way: the heads of credit at many of the banks are being hauled over the coals right now. I can't see them being willing to go out and lend more to the industry."

The problem of liquidity is not confined to the hedge funds. According to Rick Deutsch of Merrill Lynch, hedge funds are "big drivers of business in many markets". If hedge funds are forced to scale back their activities, there will be all sorts of knock-on effects. Companies - or countries - trying to raise capital may find themselves unable to do so because the traditional high-volume buyers of debt and equity are simply not around any more.

But, although the hedge funds may be down, they are certainly not out. The political and the regulatory will to crack down on the funds may have hardened, but it is not immediately obvious that officials have the power substantially to affect the hedge fund industry.

Regulators may be able to force institutions to detail their exposure to the funds. They may be able to force a small number of funds to detail their own exposures to markets. But, as one leading fund manager put it: "A lot of these people are simply untouchable. A lot are based offshore and, in short, there's not a great deal the Bank of England or anyone else can do to control them."

Other experts argue that a regulatory backlash against the entire hedge fund industry is not desirable. Some funds are not highly leveraged, do not place one-way bets on currencies or markets, and do provide a vehicle through which institutions can diversify risk. "At one time, using hedge funds was simply a more efficient way of doing business," said Mr Cruden.

Neither is it obvious that liquidity problems will persist over the longer term. Although most experts agree that hedge funds will have difficulty obtaining credit for the next six months, or perhaps even for the next few years, financial markets tend to have short memories. One credit analyst said: "It might take a year or two, but liquidity will slowly creep back up again."

As Mr Cruden said: "I don't think all this spells the end of hedge funds at all. As long as people, banks and institutions continue to seek out higher returns, the industry is not only going to continue to exist - it will grow."

PROMOTED VIDEO
Life and Style
fashionHealth concerns and 'pornified' perceptions have made women more conscious at the beach
Arts and Entertainment
tv
Sport
Ojo Onaolapo celebrates winning the bronze medal
commonwealth games
Arts and Entertainment
Rock band Led Zeppelin in the early 1970s
musicLed Zeppelin to release alternative Stairway To Heaven after 43 years
Arts and Entertainment
High-flyer: Chris Pratt in 'Guardians of the Galaxy'
filmHe was homeless in Hawaii when he got his big break. Now the comic actor Chris Pratt is Hollywood's new favourite action star
Sport
Van Gaal said that his challenge in taking over Bobby Robson's Barcelona team in 1993 has been easier than the task of resurrecting the current United side
footballA colourful discussion on tactics, the merits of the English footballer and rebuilding Manchester United
Life and Style
Sainsbury's could roll the lorries out across its whole fleet if they are successful
tech
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Travel
The shipping news: a typical Snoozebox construction
travelSpending the night in a shipping container doesn't sound appealing, but mobile crash pads are popping up at the summer's biggest events
Arts and Entertainment
'Old Fashioned' will be a different kind of love story to '50 Shades'
film
Arts and Entertainment
Tracey Emin's 'My Bed' is returning to the Tate more than 15 years after it first caused shockwaves at the gallery
artTracey Emin's bed returns to the Tate after record sale
Arts and Entertainment
Smart mover: Peter Bazalgette
filmHow live cinema screenings can boost arts audiences
Environment
Neil Young performing at Hyde Park, London, earlier this month
environment
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Project Manager (HR)- Bristol - Upto £400 p/day

£350 - £400 per annum + competitive: Orgtel: Project Manager (specializing in ...

Graduate / Trainee Recruitment Consultant - IT

£25000 per annum + OTE £40,000: SThree: Orgtel are seeking Graduate Trainee Re...

HR Business Partner - Banking Finance - Brentwood - £45K

£45000 per annum + Benefits: Ashdown Group: ** HR Business Partner - Senior H...

PA / Team Secretary - Wimbledon

£28000 - £32000 per annum + Benefits: Ashdown Group: PA / Team Secretary - Mat...

Day In a Page

Save the tiger: The animals bred for bones on China’s tiger farms

The animals bred for bones on China’s tiger farms

The big cats kept in captivity to perform for paying audiences and then, when dead, their bodies used to fortify wine
A former custard factory, a Midlands bog and a Leeds cemetery all included in top 50 hidden spots in the UK

A former custard factory, a Midlands bog and a Leeds cemetery

Introducing the top 50 hidden spots in Britain
Ebola epidemic: Plagued by fear

Ebola epidemic: Plagued by fear

How a disease that has claimed fewer than 2,000 victims in its history has earned a place in the darkest corner of the public's imagination
Chris Pratt: From 'Parks and Recreation' to 'Guardians of the Galaxy'

From 'Parks and Recreation' to 'Guardians of the Galaxy'

He was homeless in Hawaii when he got his big break. Now the comic actor Chris Pratt is Hollywood's new favourite action star
How live cinema screenings can boost arts audiences

How live cinema screenings can boost arts audiences

Broadcasting plays and exhibitions to cinemas is a sure-fire box office smash
Shipping container hotels: Pop-up hotels filling a niche

Pop-up hotels filling a niche

Spending the night in a shipping container doesn't sound appealing, but these mobile crash pads are popping up at the summer's biggest events
Native American headdresses are not fashion accessories

Feather dust-up

A Canadian festival has banned Native American headwear. Haven't we been here before?
Boris Johnson's war on diesel

Boris Johnson's war on diesel

11m cars here run on diesel. It's seen as a greener alternative to unleaded petrol. So why is London's mayor on a crusade against the black pump?
5 best waterproof cameras

Splash and flash: 5 best waterproof cameras

Don't let water stop you taking snaps with one of these machines that will take you from the sand to meters deep
Louis van Gaal interview: Manchester United manager discusses tactics and rebuilding after the David Moyes era

Louis van Gaal interview

Manchester United manager discusses tactics and rebuilding after the David Moyes era
Will Gore: The goodwill shown by fans towards Alastair Cook will evaporate rapidly if India win the series

Will Gore: Outside Edge

The goodwill shown by fans towards Alastair Cook will evaporate rapidly if India win the series
The children were playing in the street with toy guns. The air strikes were tragically real

The air strikes were tragically real

The children were playing in the street with toy guns
Boozy, ignorant, intolerant, but very polite – The British, as others see us

Britain as others see us

Boozy, ignorant, intolerant, but very polite
How did our legends really begin?

How did our legends really begin?

Applying the theory of evolution to the world's many mythologies
Watch out: Lambrusco is back on the menu

Lambrusco is back on the menu

Naff Seventies corner-shop staple is this year's Aperol Spritz