The EuroZone Crisis & what it means for the Hedge Fund industry - A Global Perspectives consulting white paper - April 2012

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This White Paper looks at the current situation in the Euzo Zone, likely developements this year and the effects that will have on the Hedge Fund Industry.

This White Paper looks at the current situation in the Euzo Zone, likely developements this year and the effects that will have on the Hedge Fund Industry.

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  • 1. A Global Perspectives White Paper ` The Euro Zone Crisis & what it means for the Hedge Fund Industry? By Shane Brett, Managing Director Date 22nd April 2012
  • 2. ContentsIntroduction 2 IntroductionCurrent situation 2 “If the Euro fails, then Europe fails”Likely developments 2Effects on the Hedge Fund Industry 3 Angela Merkel, German Chancellor, 2011Conclusion 5 In this White Paper we will look at the current situation regarding the Euro zone crisis, potential developments over the remainder of the year, and examine what this means for the Hedge Fund Industry, as this crisis moves into its third year. Current situation When the ECB launched its avalanche of super cheap three year finance earlier this year, many thought the Euro Zone had bought itself a significant breather to try and get its fiscal problems in order. However only a couple of months later (Qtr 2, 2012) the crisis seems to be returning with a vengeance. In recent weeks the focus has shifted firmly from Italy to Spain The size and importance of th Spain’s economy (12 largest in the World) and the widely held view that it is too large to be bailed out, means it is likely to remain the focus of the crisis for the foreseeable future. The new technocrat Italian Prime Minister has made good initial progress in starting to open up the economy. Spain on the other hand is in a much tighter situation. The yields on its debt have risen precipitously through the 6% marker. The widely viewed unsustainable 7% rate isnt far away. The federal government recently unveiled an austerity budget (slashing €27 billion) which failed to convince the markets. Likely developments Even worse, the extremely devolved nature of Spanish Government means the 17 regional governments of the country enjoy huge power and have traditionally massively overspent. It is not clear the government in Madrid will be able
  • 3. to rein in their spending, even if it wants party duopoly which has reigned for 60 yearsto. Banks and households in Spain have looks certain to be coming to an end. This willbeen pummeled by the property crash likely be replaced with a large number of smallerand there is widespread fear regarding parties, some of which represent either extremethe health of its regional banks (the end of the political spectrum.“Cajas”). More worrying is the complete lack of anyUnsurprisingly Spain has held some coalition governance experience in the countriesrecent debt auctions that have failed to recent history. Given that Greece could veryraise the financing required. This has easily (some would say certainly) require a thirdspooked investors and is further bailout in the next year, there is huge uncertaintyincreasing the interest rate they want to regarding whether Greece can stay the coursehold Spanish paper. A vicious circle on its previous budgetary commitments.could easily ensue, culminating in abuyers strike for Spain government None of the above analyses what would happendebt. if Greece left the Euro zone, either voluntarily or was kicked out.If that wasnt enough two of the threebailed out countries on Europe’s It’s clear that Euro Zone is facing anotherperiphery could also spell trouble this massively risky year. The question in the Hedgeyear. Fund Industry is what this will mean for us?In Ireland, despite a general acceptanceof the savage cuts required to rescue Effects on the Hedge Fund Industrythe economy, an austerity wearypopulace is reaching the end of itspatience. The country particularly wants The likely affects of the Euro Zone crisis on theits enormous (and justifiably perceived industry are the following:-to be unfair) banking debts to berenegotiated. The ECB, however, is  Reappraisal of riskplaying hardball here. While the Hedge Fund Industry is set to enjoy itsThe problem for the Euro Zone is that best year of asset growth since before the globalthe Irish are due to vote on the German finance crisis, the problems on the Euro Zoneled "Fiscal Compact" treaty at the end of will leads to a reappraisal of risk. InstitutionalMay. This wills legal bind countries Investors in particular may be less willing tospending. Though the treaty can still make allocations to less transparent, illiquidpass even if Ireland rejects it, the market funds investing into perceived riskierupset caused by the only referendum investments (like exotic derivatives), particularlythroughout the whole 17 member Euro if they are using a lot of leverage.Zone rejecting the document could beconsiderable. This would also leave Investors may also be prompted toIreland without access to future bailout move/increase allocations to the larger shopsfunding and cause another fiscal crisis with well known and established brands. Theand its possible ejection from the previous experience of having lived throughcurrency. 2008 and come successfully out the other side will carry a lot of credence if the Euro ZoneThis referendum will come hot on the starts to implode.heels of a Greek general election at thestart of May. The Post-WW2 politicalGlobal Perspectives +353 (0) 42 9339951Mobile: +353 (0) 87 115 2173
  • 4. home countries and return to focusing on their Further pressure on investment core lending markets. returns  AIFM DirectiveHedge funds were down 5% in 2011 -seemingly unable to perform well in Rightly or wrongly Hedge Funds in mainlandtimes of sharp volatile being caused by Europe have an unenviable reputation. Despitethe Euro zone crisis. Reuters recently no Hedge Fund ever having required a publicreported that average Hedge Funds bailout, the EU has used the current economichave been negative in 2 of the last 4 crisis as a pre-text to increase regulation acrossyears. This means the pressure to the industry in Europe. The third and final draftperform is increasing and the Euro Zone version of the Alternative Investment Fundcrisis will reinforce this if 2012 is another Managers Directive (AIFMD) was publishednegative year for Hedge Fund earlier this month and unsurprisingly, against aperformance. Investors will want to see background of Euro Zone turbulence, they havemarket neutral funds able to effectively reintroduced many of the more prohibitivehedge the instability in the European requirements that were first seen in the originalmarkets and provide consistent returns. draft but had been successfully lobbied down in the second version. This final version has evenThe funds that can perform well in this been criticised by such unlikely sources ashigh volatility environment, regardless of ESMA (the EU’s own super regulator) and thewhat happens in the Euro Zone, will ECB but still looks likely to become law acrossprosper. Others could see an increase the EU in July redemptions as investors move theircapital to less risky investments with This means Hedge Funds will be trying topotentially more reliable investment implement the required operational reformsreturns (e.g. T-bills, cash instruments (including around liquidity, Assets underetc). Management calculations and depository liability) while the outcome of the Euro Zone saga is being played out in the background. It Buying opportunities will make for a challenging environment to try and implement substantial regulatory change.On a more positive note, the on-goingcrisis in the Euro Zone represents a  Move to cloud based computingmajor buying opportunity for manyHedge Funds. European banks are The industry (like the business world in general)under EU regulatory pressure to is moving to cheaper cloud based data storagesignificantly increase their capital solutions. This is easier and cheaper for vendorsbuffers. Many are selling off portfolios of to administer and maintain and will help keepgood quality assets at essential fire sale Hedge Fund’s IT costs down. This is importantprices. considering the general scrutiny fees and expenses have come under since 2008.Many US Hedge Funds have started toopen their first European offices in The Euro Zone crisis will accelerate this trend.London specifically to take advantage of The likely market turbulence in Europe willthis trend over the next couple of years, prompt Hedge funds to look again at the easiestas Euro Zone banks retrench to their and cheapest solution to their data needs – especially as new worldwide legislation (Dodd-Global Perspectives +353 (0) 42 9339951Mobile: +353 (0) 87 115 2173
  • 5. Franks/AIFMD) reinforces the required to ascertain the likely ramifications of arequirements for Fund Managers to Euro Zone extensive accurate fund data. Conclusion Greece exits the Euro To conclude, it is clear the Euro Zone crisis is having a number of substantial affects acrossThe Hedge Fund industry needs to the Hedge Fund industry.prepare itself for what was until a yearago an unthinkable, but currently quite While the likely course of events in the Eurolikely, outcome – Greece (and perhaps Zone is impossible to fully accurately determine,other peripheral economies like Portugal it is likely the remainder of 2012 will see furtherand Ireland) been evicted from the Euro turbulence across the region, as politicians onceZone, again seek to apply a band-aid to a problem that requires a comprehensive European fiscal andThis would lead an operational and legal monetary solution.nightmare. What it would mean for OTCand ISDA agreements in Euros? Eurosbalances at Greek custodian banks?Existing Forward and FX contracts? Noone really knows.The outcome will very much depend onwhether Greece leaves voluntarily, orhas a messy debt default and issummarily ejected. Many commentatorssee a third Greek bailout as a nearcertainty and if this prevails Germanywill no doubt be asking itself if it seesany point in getting its cheque book outfor a third time.If Greece does leave the Euro it will takeyears to mop up the legal mess acrossthe industry, especially consideringmany existing hedge funds haveinvestment exposure to Greekgovernment debt. The affects onliquidity as bond markets seize up andequity markets nosedive are hard toquantify but will no doubt be substantial.Hedge Funds around the world will becurrently assessing the liquidity of theirEuropean exposures to ensure theydon’t get caught out again as in 2008.Contracts in Euros will need to be re-examined and legal counsel will beGlobal Perspectives +353 (0) 42 9339951Mobile: +353 (0) 87 115 2173