Vol 4 (2007) - Issue 6

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The End Game in Insolvency for Hedge Funds: Special Case or No Favoured Treatment? – Part One

I. Hedge funds, resolution of financial distress, and insolvency: the core dimensions

A. The current situation – the August Quant Crisis and its discontents

Whether talking about international military security, mergers and acquisitions, or even the down side of marriage (divorce), the issue of preparing for the end game is essential. Without thorough consideration of the negative implications of, for example, the use of leverage in hedge fund management, those parties involved such as fund managers, investors, prime brokers, banking supervisors or securities regulators may not be prepared for significant credit events and, even worse, potential liquidation.

Recent events include the rescue of Sowood Capital Management, the appointment of Cayman provisional liquidators of two Bear Stearns funds, and the appointment of non-statutory Receivers of Cheyne Finance Plc have highlighted the current need to address those issues concerning such an endgame.

The response so far shown by several of the largest central banks, the US Federal Reserve, the European Central Bank (ECB), and the Bank of Japan has been to inject liquidity to maintain the lending rate within or near to the levels previously set. This suggests that there has been concern about the impact of illiquidity (even if not credit solvency) as financial stability was affected by volatile trading activity in the financial markets. Notably, the Bank of England has not intervened. The US Federal Reserve has, however, indicated its willingness to take actions needed to contain the crisis, and has provided additional liquidity to financial institutions whose credit line limits have been used up, to borrow from a ‘discount window’.