The hedge fund industry should ward off threats of a damaging regulatory clampdown by giving clients legally binding contracts stating how it values their assets, said Laven Partners, a UK-based investment management firm.

Hedge funds and hedge fund administrators should adopt a standardised valuation agreement to increase investors’ confidence, protect the industry’s reputation and avoid political interference at a time when a number of funds have collapsed or blocked client pullouts, Laven Partners said.

“If the industry doesn’t do something then politicians will introduce new laws and regulations and that would not necessarily be good for this industry,” Jerome de Lavenère Lussan, managing partner at Laven Partners, told WealthBriefing.

The problem of lack of clear standards on how to value hedge funds’ assets has come under the spotlight owing to the recent blowups of hedge funds holding complex debt products that have been hit by the US credit crunch. A number of hedge funds, such as credit funds managed by stricken US bank Bear Stearns, collapsed with huge losses.

Organisations including the Alternative Investment Management Association have introduced principles to address the problems surrounding hedge fund valuations. However, Laven Partners said these principles, while welcome, do not go far enough.

“The only thing that will be fine is to take these principles and put them into legal contracts. For a client, making use of a famous hedge fund administrator is not sufficient (protection),” said Mr de Lavenère Lussan.

Laven Partners said industry practitioners should establish a binding master agreement, clearly setting out a reliable approach to asset valuation, and introduce legal liability for managers and administrators.

Most agreements between administrators and hedge funds currently leave neither party accountable for the accuracy of valuations, Laven said. Conflicts of interest can arise where there are hard-to-value assets because it is often an advantage to managers and administrators to value assets up rather than down because their remuneration is often based on assets under management.