BIS Review 116/2006  5  One important difference between the two hedge funds was how much they had borrowed in relation to their capital. The debt/equity ratio at LTCM was between 25 and 30, while that at Amaranth was around 5. A further problem for LTCM was that the fund was partly involved in very complex positions on the derivatives market that were difficult to close. Many other funds and banks held the same types of positions. Amaranth, on the other hand, was largely alone in its part of the market – most others had no positions, or contrary positions, in energy derivatives. This made settlement easier, if not cheaper. A further explanation is probably that Amaranth’s losses occurred under very favourable economic and financial circumstances, where the market had good access to capital. This was far from the case when LTCM tried to settle its positions in the midst of the Russia crisis. Under more strained conditions, perhaps the sequence of events for Amaranth would have been entirely different and the risks to the financial system much greater. However, the fact that the financial system could manage the problems in Amaranth may also imply that it has become more resilient. The markets have demonstrated that they can manage a number of major strains in recent years, both macroeconomic shocks and unexpected market events, without any tangible effect on their functioning. The banks’ management of risk and their collateral requirements do appear to be stricter than they were in 1998.
As I see it,  3  See “Hedge Funds Regulation in Europe – A comparative study”, European fund and asset management association, November 2005 and “The regulation and distribution of hedge funds in Europe – Changes and challenges”, Pricewaterhousecoopers, June 2005. 4  In Italy the minimum limit for investment is EUR 500 000, in Ireland it is EUR 250 000 and in Spain it is EUR 50 000. 6  BIS Review 116/2006  such regulation could result in liquidity disappearing from the markets where the hedge funds operate just when it is needed most. Increased disclosure of funds’ risks, on the other hand, could help the market to function efficiently. If the hedge funds’ risk positions can be assessed externally, market discipline ought to improve. I consider that both LTCM and Amaranth are good examples that transparency rather than regulation is the problem. As I have already mentioned, LTCM was a very large fund and at the same time had heavy loans. The fact that the banks concerned accepted such a high level of indebtedness is in itself remarkable – one explanation was probably confidence in the prominent figures behind LTCM, who included Robert Merton and Myron Scholes. However, the banks did not have any overview of the fund’s size and total risk position. In their own interest, they should have required greater disclosure, and the authorities should have required this of the banks. With regard to the positions in Amaranth, there are similar questions.