Why didn’t the markets and clearing institutions react to the large build-up of risk? And why didn’t the lenders adjust their margin calls to correspond to the risk concentration? Better disclosure of Amaranth’s risk profile, from the authorities, the markets, the clearing institutions and individual lenders would probably have increased the chance of detecting the risk positions being built up. Conclusion New financial crises will occur and hedge funds, which have become an integral part of the modern financial markets, will probably be involved. The large capital flow to the sector has meant, not unexpectedly, that profitability has declined and it is not unreasonable to expect that a number of funds will consequently be forced to close down after more or less substantial losses. However, the advantages of the hedge funds’ operations exceed the risks from a welfare perspective. The Riksbank’s view as regards further regulation is that the focus should be on the hedge funds' counterparties - particularly the systemically-important banks - being able to manage their risks. Improving the banks’ risk management with regard to hedge funds has been the objective of a number of initiatives by the Basel Committee on Banking Supervision and other organisations ever since the LTCM crisis in 1998. From a stability point of view, the central issue is that the systemically-important banks should manage their counterparty exposures correctly – take sufficient collateral, have appropriate limits and be capable of managing potential liquidity problems. The arguments for further regulation of hedge funds are in this context weak.
This may mean, for instance, the willingness to take progressively tougher measures where the situation warrants. This in essence is what the MAS and other agencies in Singapore have done recently on the property cooling measures. Let me add that these measures are not a substitute for banks’ own risk assessment processes. Banks should continue to maintain prudent lending practices. This includes taking into account potentially higher interest rates in their credit assessments, and not assuming that current low interest rates will last indefinitely. MAS will continue to monitor banks’ activities and practices closely. Understanding Asia 12. Asia’s growth prospects have attracted global interest and a surge of capital inflows. Asia is now the second highest contributor to global trade, and is expected to overtake Europe in a few years. China, India and Indonesia are growing rapidly, registering GDP growths more than four times that of US and Europe. The prospect of greater Asian currency appreciation has drawn greater fund flows into the region. In 2010, inflows into Asian local bond markets reached record levels. 13. However, investing in Asia is not without risks. The huge capital inflows, if left unchecked, have the potential to increase inflationary pressures and fuel asset-price bubbles. In an informal survey by MAS of 30 major fund managers, almost half cited the possibility of a hard landing of major emerging economies in Asia as a key risk. While inflows have been swift, we must be prepared for a rapid outflow as well.