Unlike banks, credit hedge funds do not take deposits, receive taxpayer bailouts, offer daily liquidity or otherwise hold themselves out as guaranteeing return of invested capital, as banks do, AIMA said.  

“They manage their liquidity profiles by agreeing investor redemption terms which correspond to the liquidity profile of the underlying investments. They therefore do not engage in significant maturity transformation,” AIMA said.

“Crucially, hedge funds do not benefit from implicit or explicit taxpayer guarantees”, it continued.

In October last year, the Financial Stability Board, an international group of national central banks and other regulators, said the “shadow banking system”, estimated to be worth around $60 trillion, covers “credit intermediation involving entities and activities outside the regular banking system”. The FSB said that “as the recent financial crisis has shown, the shadow banking system can also be a source of systemic risk both directly and through its interconnectedness with the regular banking system”.

The issue is controversial. Banks are able, due to use of products such as credit derivatives, to remove some of their credit risks off their balance sheets, transferring this risk to other parties, including hedge funds, insurers and other "shadow" institutions. The growth of debt securitisation, such as in the large US mortgage market, has also fuelled this “shadow” system, seen as more opaque and hard to regulate than traditional banking.

The role of hedge funds in the recent 2008 financial crisis is hotly debated. In the wake of the crisis, some governments, such as those of the UK and Germany, tightened restrictions on hedge funds, temporarily restricting the ability to short-sell securities, and increasing disclosure requirements. Defenders of the hedge fund sector point out that some financial blowups, such as the demise of UK mortgage lenders Northern Rock and Bradford & Bingley, had nothing to do with hedge fund activity. On the other hand, the US-led rescue in 1998 of hedge fund Long Term Capital Management remains a salutary example of how these vehicles can affect financial markets.  

Regulatory threat?

Industry groups such as AIMA are concerned that bank regulators may try and impose bank-style rules on hedge funds.  

“Credit hedge funds – and hedge funds in general - do not operate in the shadows. Managers are extensively regulated, are subject to reporting requirements and do not engage in any significant sense in credit, liquidity or maturity transformation, so their activity is not ‘bank-like’. Credit hedge funds do not belong in the same category as banks, let alone ‘shadow banks’,” Andrew Baker, AIMA chief executive, said.

Credit and credit-related hedge funds comprise up to one-third of the global hedge fund industry, AIMA said.

To view AIMA’s report in full, click here.

In its report in October, entitled Banking: Strengthening Oversight and Regulation, the FSB said the shadow banking system “can also create opportunities for arbitrage that might undermine stricter bank regulation and lead to a build-up of additional leverage and risks in the overall financial system. Enhancing supervision and regulation of the shadow banking system in areas where systemic risk and regulatory arbitrage concerns are inadequately addressed is therefore important”.