Continued US market discipline, not new regulations, is the underlying premise of a set of principles and guidelines publicly issued on February 22, 2007, by the President's Working Group on Financial Markets (PWG). The PWG, which consists of the Secretary of the Treasury and the chairs of the Federal Reserve Board, Securities and Exchange Commission and Commodity Futures Trading Commission, originally was formed in 1988 to study the October 1987 stock market meltdown, and since then has periodically issued reports on various issues affecting the US markets, including a 1999 report on hedge funds assessing lessons learned in the wake of the near-collapse of Long Term Capital Management.

In the latest report, titled "Agreement Among PWG and US Agency Principals on Principles and Guidelines Regarding Private Pools of Capital," highlighting investor protection and systemic risk, the PWG addressed itself to the principal participants involved in hedge funds:

  • Managers: Clear disclosures to potential investors about the investment objectives and risks posed by funds are critical. Risk management systems and valuation policies should comply with sound industry practices.
  • Investors: Investors should be sophisticated, undertake appropriate due diligence with respect to any new investment in a hedge fund, including evaluation not only of the objectives and risks of the fund's investments but also the caliber of the fund's managers, and only expose themselves to risks that they can tolerate.
  • Fiduciaries: Fiduciaries that manage investments such as pension funds have an ongoing duty to act in the best interests of the beneficiaries and if intending to place monies they manage into hedge funds, must conduct sufficient due diligence on any potential fund management and investments and evaluate the investment as to where it would fit into their overall portfolio and investment strategy.
  • Creditors and Counterparties: Market discipline by creditors, counterparties and investors is the most effective mechanism for limiting systemic risk from hedge funds, and key creditors and counterparties must commit resources and maintain appropriate policies, procedures and protocols to define, implement and enhance best risk management practices.
  • Regulators: Regulators should clearly communicate their expectations regarding prudent management of counterparty credit exposure, taking into account the latest market developments and best practices, and consult and coordinate with regulators in other jurisdictions with respect to funds organized and managed internationally.

The Agreement can be found here.