European leaders meeting in Berlin on February 22 said they want to subject the US$1.4 trillion industry to more regulation because hedge funds “may present a systemic risk” to world economies, according to German Chancellor Angela Merkel.

Systemic risk could broadly be defined as positions that lead to a “buildup of pressures in financial markets,” Baker said. That may result from excessive leverage, or use of borrowed capital to magnify wagers. He said prime brokers, who provide lending to hedge funds, could help collect data, which would then be reported to regulators.

AIMA also endorses aggregate reporting of short positions, or bets on security declines, to national regulators, Baker said. More nations should adopt the UK regulatory model that requires all funds to register with the Financial Services Authority, the trade group said. About half of US-based hedge funds are voluntarily registered with the Securities and Exchange Commission.

More ‘compulsion’

“That is not good enough,” said Baker. “We want a greater degree of compulsion attached to it.”

Politicians have stepped up their scrutiny of hedge funds after their worst year in two decades, dropping 19 percent in 2008, according to the Hedge Fund Composite Index compiled by Chicago-based Hedge Fund Research Inc.

Hedge-fund managers have said they are not to blame for the collapse last year in stock markets, such as the 38 percent drop in the Standard & Poor’s 500 Index, the biggest annual drop in seven decades.

Paul Marshall, co-founder of $6.6 billion investment firm Marshall Wace LLP, told Parliament that hedge-fund leverage was reduced to 1.4 times assets in 2008 from 1.7 times, compared with banks’ leverage of 40 to 50 times.

Hedge-fund managers including Philip Falcone and George Soros testified before a US congressional committee in November, defending their industry while splitting over whether the US should impose stricter regulations.

‘Ill-considered’ rules

Falcone, senior managing director of New York-based Harbinger Capital Partners, urged Congress to require more disclosure. Soros, founder of Soros Fund Management LLC, cautioned against “ill-considered” rules because the industry is reeling from market losses and client defections.

AIMA’s plan is not the first time the industry has proposed voluntary disclosure measures. Last year some of Europe’s biggest funds started the Hedge Fund Standards Board to promote transparency. As of last month, only 34 hedge funds had signed up, prompting UK politicians to criticize the industry for being too slow to adopt their own rules.

Source: Bloomberg