Hedge funds and Private Equity - PES

Furthermore, since their strategies cannot be deciphered because of their opacity, they must
keep those stabilising processes rolling on through their own market power, not through market
discipline. This is where the argument goes astray.
To insist that HFs and PEs enhance efficiency by themselves is a strange argument. If they can
drive the market on their own, it is through sheer market power. Whenever a particular group has
market power, it has the incentive to exploit the market in order to draw a quasi-rent at the
expense of other market participants. How can it be beneficial for market efficiency and, further,
for the whole economy? Market dominance should in theory be eliminated by competition
between hedge funds and the outcome should always be equilibrium, just as it should if market
transparency disseminated information to all market participants. (If the alternative investment
industry is still of the same opinion, why are they against transparency and disclosure?)
The lesson of LTCM, for instance, is that it entailed the Fed’s extraordinary lender-of-the-lastresort
intervention to forestall the impending flight to quality. Observing that the same outcome
was not needed in May 2005, in the turmoil provoked by the slump in GM and Ford derivative
contracts after the downgrade in their rating, is no assurance that hedge funds have gotten more
robust or “society responsible”. The difference between 2005 and September 1998 was the
situation of global financial markets. In 1998 they were under extreme stress in the aftermath of
the Russian crisis. In 2005 they were awash with cash after many years of loose monetary policy.
While the investment industry keeps on repeating that maximum value should be returned to
shareholders, because shareholder decisions are inevitably beneficial to society as a whole; and
that taking companies private shields managers from the short-term pressures of financial
markets – all the evidence contained in this report suggests the contrary.
The question of appropriate regulation basically depends on what kind of investment strategy is
desired in Europe – and that is directly defined in our Lisbon goals and New Social Europe for
the development of our societies in the next decade.
Some HFs and PEs would argue that regulations would “force them” to seek out other locations
outside Europe. We think there are three answers to this attitude:
Europe’s single market is the world’s largest economy (10% bigger than that of the US). This
market is enormously attractive for foreign investors – and with the high growth rates of the
new member states, its importance will increase in the coming years.
“Creativity” and “financial engineering” to avoid the effect of regulators will always be a fact
of life. As we have learned from national experience, regulation is an ongoing, permanent
process during a changing environment.
We are aiming for appropriate and carefully targeted regulations, not disproportionate, general
prohibitions or over-detailed regulations.
The aim of regulation in this sector of the financial market should be to exclude certain characteristic
risks and to compare results with preordained aims or have the ability to influence the
development in the interest of society. No company should have substantially worse results due
to LBO in its results, than before. No company that is the object of LBO should lose assets or
sacrifice labour standards because its financial assets are plundered due to unwarranted
charges and fees or predominantly debt-based financing.
Better investor protection, proper corporate governance, long-term investment and prospects
of safe and decent jobs should be our road map for reforming the real economy as well as regulating
the financial markets.
Part III – Lessons to be drawn for future regulation
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