Both the United States and the European Union, following the decisions that were taken in the G20 summit meetings, are seeking to establish new regulations that speculative funds (hedge and investment funds) would be subject to, and which would otherwise immunize these funds against financial collapse, while simultaneously protecting the major financial institutions from the repercussions of such collapses. The industry of such funds has grown significantly since 2002, up until the peak of the global financial and economic crisis in mid-2008. Their numbers have grown from 3800 in 2002, to more than 10 thousand in 2007, while their assets rose from 490 billion dollars in value to 1860 billion dollars between 2002 and 2008, but only to be reduced by the crisis to 530 billion in 2009. In truth, the sheer magnitude of such losses became a matter of public interest. This is because speculative funds are not only private institutions that manage private wealth: in 2005, Thomson Financial reported that private investors hold 6 percent of these funds' assets, while welfare funds, insurance companies, governmental agencies and academic institutions held 61 percent, whether directly, or indirectly through secondary funds. This is while major customers, such as the banks, directly linked to those funds held 18 percent of their assets. Hence, many professors and international economic experts tackled the problem of these funds. In fact, three of such individuals, Michel Aglietta, Sabrina Khanniche, Sandra Rigot, wrote a book entitled ‘Hedge Funds, Entrepreneurs or Financial sharks?' (Paris – January 2010). According to the summary conclusion reached by ‘Problemes Economiques' (a bimonthly periodical), “The recent financial crisis is a new opportunity to reflect on the role of hedge funds in the world of finance. The risks incurred by these funds go in fact hand in hand with the lofty wagers that they make in their search for higher yields. Their modus operandi, which is based on a combination of debt leverage and dependence on the liquidity of markets, makes them especially vulnerable to financial crises, while their reactions spread systemic risk. Hence, recent events have caused concern among regulators who have hitherto been rather lenient vis-à-vis these funds. They are now conducting a revision of the regulations that apply to hedge funds, but the new regulatory proposals are still subject to debate.” In reality, the main thrust of the primary modus operandi of hedge funds lies in the fact that they borrow money against their assets, or close deals in financial instruments and derivatives, allowing these funds to increase returns on their capital. However, these leverages endanger financial markets as they increase the exposure of stocks and assets, or also endanger sectors or markets with weak initial investments. These funds are virtually ‘banks for ghosts' markets relative to their debt leverages and illiquid assets, and also to their links with the liquidity of wholesale financial markets. Moreover, hedge funds are not subject to regulation, and adopt the same strategies in their search for higher yields. As a result, the interconnection of yields among funds grows further within the scope of their duplicate strategies. Then from within these mechanisms, the shakeup in the markets takes place, and leads to the collapse of similar express financial positions. Subsequently, market instability soon becomes contagious and causes huge losses. Manifestly, this contagiousness causes maximum losses within the structure of the negatively interconnected strategies present in normal market conditions. And because hedge funds are strongly linked to the investment banks that finance their credit leverages, an excessive leverage and non vigilance in regards to the risks of bank credit lead to compounded exposure to credit risk. Hence, when illiquid markets that finance investment funds during the crisis hardened, the funds were no longer able to meet the requests imposed by investment banks, thus becoming propagators of systemic risk. Then the sheer force of the collapse of their leverages caused an outbreak in the markets, within an idiosyncratic circuit of behaviour. Usually, the loss of liquidity in certain parts of the markets engenders a self-strengthening process between increased costs of credit and the deterioration in stock value, which is the core manifestation of systemic risks in financial markets. Furthermore, the mandates created by the hedge funds in the banking system also had a systemic echo of repercussions given the fact that the possible losses resulting from exposure of the large-asset funds to the banks represented a large share of these banks' capital. This was the case of the LTCM (Long Term Capital Management) Bank, and also the Carlyle Capital investment fund that led Bear Stearns to collapse. Moreover, the results are similar when large investment funds adopt strategies that expose them to risk in similar directions, only for any repercussion to cause prices to spirally collapse downwards. These manifestations were devastating in the securitized debt markets and also in capital markets during the 2007/2008 crisis. It seems that investment funds, closely linked to corporate banks, and their aggressive bid to achieve outstanding yields are quite possible to diverge, as their leverages are not subject to regulation, and also because the investors who deal with these funds are not capable of fully seeing through the opaque shroud that covers the risks inherent to these funds. In fact, most investment funds are based in offshore markets such as the Cayman Islands, alongside other institutions, with the aim being to avoid the strongly anti-hedge funds international financial regulatory bodies. These funds also benefit from systemic exemptions since they are private funds. They differ from other funds also in that they do not publish any information regarding their liquidity, capital or value of their financial leverages and the amounts involved in their naked short-selling. Such a lenient regulatory framework has allowed the funds to benefit from absolute freedom in investments, and to work in absolute secrecy in an unjustifiable manner. What this subsequently entails is that there is a need to put regulations in place for the operations of these funds, which must primarily address the issue of their loans, and impose mandatory monitoring as these funds virtually operate as non-formal banks. In addition, the entire regime that is comprised of these funds and the banks that credit them - primarily through the derivatives markets- must also be monitored. Finally, there must be parameters imposed as part of a system that compels hedge funds to transparently disclose their operations.
