Hedge Fund Survey

Hedge Fund Survey

1.
Introduction

The Financial Conduct Authority’s role
The Financial Conduct Authority (FCA) supervises hedge fund managers operating in the UK. 
We collect data from hedge funds and hedge fund managers to inform our supervisory activity, 
with the aim of ensuring markets work well and of promoting market integrity. We also play 
a leading role in assessing the systemic risks posed by hedge funds, and developing potential 
policy measures to address these risks, working closely with the UK Financial Policy Committee 
(FPC), the Financial Stability Board (FSB), and the International Organisation of Securities 
Commission (IOSCO).
This public report outlines the key findings resulting from our data analysis of the hedge fund 
industry. Given the interest of other regulators and market participants in our findings, we 
decided to share these more widely, as we have done in previous years.
Hedge fund assets under management in the UK
The Hedge Fund survey presents an aggregated picture of industry activity in the UK, 
illustrating key trends and risks. The survey data was obtained from 52 management firms, 
which collectively manage USD 623 billion of hedge fund assets globally. Although none of the 
132 funds surveyed are domiciled in the UK, the 52 firms nevertheless manage a stated USD 
265 billion out of the UK. Data is reported as at September 2014.
Risk identification and mitigation
Hedge funds fail or close down on a regular basis without causing a significant impact on the 
financial system, but very large hedge funds potentially pose a risk. A large hedge fund which 
fails in a disorderly way might impact wider financial markets in two ways: by causing losses to its 
transaction counterparties (the credit channel) or by disrupting markets as its positions are closed 
out and/or counterparties rush to sell collateral at the same time (the market channel). The impact 
on markets could be greater if a fund has highly complex positions across a range of markets. 
Hedge funds use leverage to increase the size of the positions taken in financial markets. In 
some cases, the use of leverage allows them to become large enough to suggest they could 
impact the wider financial system in certain situations. Hedge funds obtain leverage either by 
borrowing money or securities directly from counterparties (financial leverage) or indirectly by 
using derivative instruments such as options, futures or swaps (synthetic leverage). Some hedge 
fund strategies use derivatives more intensively than others.

Our survey highlights that, by far, the largest proportion of total leverage used by hedge funds 
in the UK is acquired using derivatives, and that any unsecured financial leverage in aggregate 
appears minimal. Derivative transactions allow hedge funds to acquire market/economic 
exposures (this report refers to the Gross Notional Exposure) that are bigger than the capital 
of the fund. It should be underlined that all institutions, entering derivative transactions with 
hedge funds, require funds to provide collateral. This protects the counterparty against losses 
on the transaction if the hedge fund defaults on its commitments under the transaction. As 
hedge funds increasingly clear their transactions with central counterparties (CCPs), this will 
also help ensure appropriate collateralisation and default management. 
Identifying the probability of failure
Complexity of a fund can be an indicator of potential systemic risk. The Survey therefore 
explores a number of aspects that have been listed under the proposed Assessment 
Methodology for identifying Non-Bank Non-Insurer Global Systemically Important Financial 
Institutions (NBNI GSIFIs). These include among others the extent of OTC trading undertaken 
by funds, the liquidity buffer that is built into funds, and the degree to which collateral is 
recycled. Importantly, complexity also relates to the overall leverage of a fund and the position 
of unencumbered cash it holds. Hedge funds which are highly leveraged using derivatives can 
fail if they run out of cash or similar liquid assets to post as collateral. The amount of liquid 
and unencumbered assets in a hedge fund portfolio is therefore a key indicator of its financial 
health and of its ability to absorb losses on positions. 
Given the complexity of hedge funds, their often high trading volumes, and exposure to 
multiple asset classes and some markets, the FCA expects hedge funds to have an appropriate 
risk management framework in place that allows them to monitor the characteristics and risk 
profile of their portfolios. In addition to its oversight of individual funds and firms and their 
risk management, the FCA seeks to identify funds or trends with the potential to pose risks 
to wider financial markets, and to manage these risks in cooperation with other international 
regulators.

Hedge Fund Survey