What a difference a few months can make. In June, I heard a speech by Anthony W. Ryan, assistant secretary of the U.S. Department of Treasury, who spoke to the Managed Funds Association about the need for vigilance in protecting the markets from systemic events. At the time he said that a “perfect storm” for an event could include a situation that allowed for easy credit, highly correlated strategies, connected lenders, inadequate information and undeveloped markets. His conclusion: that risk assessment today is “anywhere but close to adequate.”
That speech was a call to action to funds everywhere to watch themselves. He said that “every set of stakeholders have work to do.”
I asked him afterward why last year’s Amaranth Advisors’ two-week blowout of $6 billion didn’t have the same impact on the markets, seemingly, as the Long-Term Capital Management (LTCM) failure several years before. He replied that most likely there was a wider distribution of risk in the portfolio. Well, perhaps not. Although Amaranth’s failure didn’t have the immediate market repercussions that LTCM did, that is, the need for a financial safety net spun by the Federal Reserve Bank utilizing some of the biggest financial players on the street to help calm the markets, it certainly has made a lasting impression — especially to those in Congress — and this could have an impact on regulations of funds and markets.
In this month’s Managed Money, “Manipulating a hedge fund blow-up,” (see below) Managing Editor Daniel P. Collins moves the Amaranth story forward, spotlighting the new controversy with the fund and its effect on the markets. A recently released Congressional report has accused Amaranth of causing major spikes in the natural gas markets that hit consumers with added heating costs, and that got Congress’ attention.
The initial response from regulators to the event was contradictory to the newly released report, but now they are nearly on the same page and actions are being taken: against Amaranth trader Brian Hunter and against the markets in which the fund traded. Now that the consumer — according to this study — has been affected, Congress is in fight mode and funds and exchanges best be prepared.
The courts will have their hands full with charges against Amaranth vs. charges by the Amaranth team against the regulators. But what these charges now bring into the spotlight is two-fold: more hedge fund regulation and regulation of the OTC markets.
Hedge funds have been fortunate so far to parry and duck away from regulatory restrictions. The Securities and Exchange Commission (SEC) tried to get them to register, and in fact did have something in place, which promptly was dismantled. Next it had tried to raise the financial level for accredited investors, and that was put in stasis. Finally, it passed a manipulation rule giving the SEC some additional authority, and the regulator called it a win.
But Congress didn’t sit back. With the report comes some recommendations, including closing the so-called “Enron loophole,” a rule pushed by former Senator Phil Graham that exempted electronic energy exchanges from regulatory oversight.
When this happened, it was very suspect as former Commodity Futures Trading Commission (CFTC) Chairwoman Wendy Graham (and the senator’s wife) was then sitting on the Enron board. Although this loophole may close, it doesn’t apply to the OTC markets, which is another recommendation: give the CFTC additional authority over these markets to prevent excessive speculation that may spill over from the futures markets to the OTC market, which may have been the case with Amaranth.
Hedge funds and OTC markets should realize the days of wine and roses are over.
They can thank the excesses of Wall Street, Amaranth, and Brian Hunter, who seemed to think he was not only Mr. Universe, but the Universe.
