Mathieu Vaissié

Solvency II: Regulation Change and Hedge Fund Evolution

The growing complexity of financial markets makes it increasingly challenging for institutional investors to manage their asset–liability profile efficiently. This is especially true for financial institutions that are facing their own changes in the regulatory framework and in accounting rules. For example, although the benefits of hedge fund strategies in asset–liability management have been documented in the academic literature, the integration of these strategies into the global asset allocation of European insurance companies may be jeopardized by recent developments on the regulatory front. The Solvency II Directive is an EU directive that codifies and harmonizes EU insurance regulation. It defines the target level of capital that an EU insurance company should hold so that it can absorb significant unforeseen losses and give assurance to policyholders that payments will be made as they fall due. The Solvency II Directive is due to come into force on January 1, 2014. The author argues in this article that a solvency capital requirement of 49% does not reflect the risks inherent in hedge fund strategies. He finds that a capital charge of no more than 25% is appropriate for a diversified hedge fund allocation and concludes that hedge fund investing is appealing from both a risk-adjusted performance standpoint and a capital efficiency perspective.

Regulation: Threat or Opportunity for the Funds of Hedge Funds Industry?

A tidal wave of regulation is hitting financial markets worldwide as a result of the credit crisis of 2008–2009 and this time around the hedge fund world will not be immune. We argue in this chapter that, unlike conventional wisdom, regulation could be an opportunity for the funds of hedge funds (FoHFs) industry. The only necessary condition is fair treatment of hedge fund investments. We take the Solvency II framework as an example and show how the implementation of the granularity adjustment, first introduced for implementation in the Basel framework, makes it possible to take into account the diversification potential of FoHFs and in turn reconcile the outcome of the standard formula with empirical evidence.

The fund of hedge funds reporting puzzle: Reconciling investors' expectations and fund managers' constraints

Purpose – The development of alternative investment has not yet been accompanied by genuine consideration of the specific characteristics of the risks and returns of hedge funds with regard to the provision of information to investors. To fill the gap, in 2004 EDHEC launched an international consultation process, seeking to implement a new framework for funds of hedge funds reporting. Design/methodology/approach – The consultation process was based on a series of recommendations proposed by EDHEC with regard to the academic state-of-the-art on risk measurement in the alternative universe. The findings of the survey, which brought together the opinions of 98 institutional investors and fund managers, allow a consensus to be established on the information required for the implementation of a relevant reporting method in the field of alternative investment. Findings – Interestingly, despite somewhat conflicting goals, investors and fund managers, except for slight discrepancies, globally agree on the definition of relevant information, and as a result on the content of the reports of tomorrow. Originality/value – A very large majority of hedge fund managers are satisfied with a reporting method based on a mean-variance structure, which is totally inappropriate for the risk and return profiles of alternative investment. To address this issue, the paper presents a series of indicators relying on a basic return-based analysis that allow a true and fair picture of the risk and return characteristics of alternative investment to be drawn. This paper therefore offers a pragmatic but robust answer, for both investors and fund managers, to the fund of hedge funds reporting quandary.