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.

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. Contents
Introduction 2 Introduction
Current situation 2
“If the Euro fails, then Europe fails”
Likely developments 2
Effects on the Hedge Fund Industry 3 Angela Merkel, German Chancellor, 2011
Conclusion 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 isn't
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 years
to. Banks and households in Spain have looks certain to be coming to an end. This will
been pummeled by the property crash likely be replaced with a large number of smaller
and there is widespread fear regarding parties, some of which represent either extreme
the health of its regional banks (the end of the political spectrum.
“Cajas”).
More worrying is the complete lack of any
Unsurprisingly Spain has held some coalition governance experience in the countries
recent debt auctions that have failed to recent history. Given that Greece could very
raise the financing required. This has easily (some would say certainly) require a third
spooked investors and is further bailout in the next year, there is huge uncertainty
increasing the interest rate they want to regarding whether Greece can stay the course
hold Spanish paper. A vicious circle on its previous budgetary commitments.
could easily ensue, culminating in a
buyers strike for Spain government None of the above analyses what would happen
debt. if Greece left the Euro zone, either voluntarily or
was kicked out.
If that wasn't enough two of the three
bailed out countries on Europe’s It’s clear that Euro Zone is facing another
periphery could also spell trouble this massively risky year. The question in the Hedge
year. Fund Industry is what this will mean for us?
In Ireland, despite a general acceptance
of the savage cuts required to rescue Effects on the Hedge Fund Industry
the economy, an austerity weary
populace is reaching the end of its
patience. The country particularly wants The likely affects of the Euro Zone crisis on the
its enormous (and justifiably perceived industry are the following:-
to be unfair) banking debts to be
renegotiated. The ECB, however, is  Reappraisal of risk
playing hardball here.
While the Hedge Fund Industry is set to enjoy its
The problem for the Euro Zone is that best year of asset growth since before the global
the Irish are due to vote on the German finance crisis, the problems on the Euro Zone
led "Fiscal Compact" treaty at the end of will leads to a reappraisal of risk. Institutional
May. This wills legal bind countries Investors in particular may be less willing to
spending. Though the treaty can still make allocations to less transparent, illiquid
pass even if Ireland rejects it, the market funds investing into perceived riskier
upset caused by the only referendum investments (like exotic derivatives), particularly
throughout the whole 17 member Euro if they are using a lot of leverage.
Zone rejecting the document could be
considerable. This would also leave Investors may also be prompted to
Ireland without access to future bailout move/increase allocations to the larger shops
funding and cause another fiscal crisis with well known and established brands. The
and its possible ejection from the previous experience of having lived through
currency. 2008 and come successfully out the other side
will carry a lot of credence if the Euro Zone
This referendum will come hot on the starts to implode.
heels of a Greek general election at the
start of May. The Post-WW2 political
Global Perspectives Consulting
www.globalperspective.co.uk
Email: Shane@globalperspective.co.uk
Phone: +353 (0) 42 9339951
Mobile: +353 (0) 87 115 2173

4. home countries and return to focusing on their
 Further pressure on investment core lending markets.
returns
 AIFM Directive
Hedge funds were down 5% in 2011 -
seemingly unable to perform well in Rightly or wrongly Hedge Funds in mainland
times of sharp volatile being caused by Europe have an unenviable reputation. Despite
the Euro zone crisis. Reuters recently no Hedge Fund ever having required a public
reported that average Hedge Funds bailout, the EU has used the current economic
have been negative in 2 of the last 4 crisis as a pre-text to increase regulation across
years. This means the pressure to the industry in Europe. The third and final draft
perform is increasing and the Euro Zone version of the Alternative Investment Fund
crisis will reinforce this if 2012 is another Managers Directive (AIFMD) was published
negative year for Hedge Fund earlier this month and unsurprisingly, against a
performance. Investors will want to see background of Euro Zone turbulence, they have
market neutral funds able to effectively reintroduced many of the more prohibitive
hedge the instability in the European requirements that were first seen in the original
markets and provide consistent returns. draft but had been successfully lobbied down in
the second version. This final version has even
The funds that can perform well in this been criticised by such unlikely sources as
high volatility environment, regardless of ESMA (the EU’s own super regulator) and the
what happens in the Euro Zone, will ECB but still looks likely to become law across
prosper. Others could see an increase the EU in July 12013.
in redemptions as investors move their
capital to less risky investments with This means Hedge Funds will be trying to
potentially more reliable investment implement the required operational reforms
returns (e.g. T-bills, cash instruments (including around liquidity, Assets under
etc). 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-going
crisis in the Euro Zone represents a  Move to cloud based computing
major buying opportunity for many
Hedge Funds. European banks are The industry (like the business world in general)
under EU regulatory pressure to is moving to cheaper cloud based data storage
significantly increase their capital solutions. This is easier and cheaper for vendors
buffers. Many are selling off portfolios of to administer and maintain and will help keep
good quality assets at essential fire sale Hedge Fund’s IT costs down. This is important
prices. considering the general scrutiny fees and
expenses have come under since 2008.
Many US Hedge Funds have started to
open 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 will
this trend over the next couple of years, prompt Hedge funds to look again at the easiest
as Euro Zone banks retrench to their and cheapest solution to their data needs –
especially as new worldwide legislation (Dodd-
Global Perspectives Consulting
www.globalperspective.co.uk
Email: Shane@globalperspective.co.uk
Phone: +353 (0) 42 9339951
Mobile: +353 (0) 87 115 2173

5. Franks/AIFMD) reinforces the required to ascertain the likely ramifications of a
requirements for Fund Managers to Euro Zone collapse.
store 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 across
The Hedge Fund industry needs to
the Hedge Fund industry.
prepare itself for what was until a year
ago an unthinkable, but currently quite
While the likely course of events in the Euro
likely, 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 further
and Ireland) been evicted from the Euro
turbulence across the region, as politicians once
Zone,
again seek to apply a band-aid to a problem that
requires a comprehensive European fiscal and
This would lead an operational and legal
monetary solution.
nightmare. What it would mean for OTC
and ISDA agreements in Euros? Euros
balances at Greek custodian banks?
Existing Forward and FX contracts? No
one really knows.
The outcome will very much depend on
whether Greece leaves voluntarily, or
has a messy debt default and is
summarily ejected. Many commentators
see a third Greek bailout as a near
certainty and if this prevails Germany
will no doubt be asking itself if it sees
any point in getting its cheque book out
for a third time.
If Greece does leave the Euro it will take
years to mop up the legal mess across
the industry, especially considering
many existing hedge funds have
investment exposure to Greek
government debt. The affects on
liquidity as bond markets seize up and
equity markets nosedive are hard to
quantify but will no doubt be substantial.
Hedge Funds around the world will be
currently assessing the liquidity of their
European exposures to ensure they
don’t get caught out again as in 2008.
Contracts in Euros will need to be re-
examined and legal counsel will be
Global Perspectives Consulting
www.globalperspective.co.uk
Email: Shane@globalperspective.co.uk
Phone: +353 (0) 42 9339951
Mobile: +353 (0) 87 115 2173