February 21, 2006

Hedge Funds’ EU-Banks Connections

In wake of the rapidly expanding role of hedge funds as key elements in financial markets and counterparties to financial institutions, monitoring their activities and assessing the implications for financial stability has become increasingly relevant.

In a study carried out some time ago by the Banking Supervision Committee (BSC) of the European System of Central Banks (ESCB), with the help and assistance of its Working Group on Macro- Prudential Analysis, investigations were carried out into the links between large EU banks and hedge funds. This was particularly crucial, knowing the fact that the former played an important role in hedge fund operations.

The report was aimed at continuing the efforts to gain a better understanding of the implications of such rapid expansion of hedge fund activities for the European financial system.

It is well known in the financial sector that hedge funds by virtue of their active risk-taking, provision of liquidity, elimination of market inefficiencies and potential enhancements to investment diversification are in a vital position to contribute to the efficiency, integration and even stability of the global financial system.

Furthermore, hedge funds have changed the asset management industry and, according to one scenario, over time the differences between them and traditional funds may become blurred. However, the recent explosive growth of the sector has also raised concerns about possible negatives in regards to financial stability.

Hedge funds can in fact affect financial stability through their influence on financial markets or thru their largest creditors and counterparties. The two channels are pretty closely linked and a hedge fund-related triggering event associated with either could potentially snowball further with reinforced pace and cause volatile and unstable changes in the market.

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February 21, 2006 in Research | Permalink




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