Asia has lived through more than its share of market meltdowns. But as devastating as 2008’s credit-induced global collapse has been, many investors in the region say that for them it pales beside the Asian financial crisis of a decade ago, when several countries teetered on insolvency.
That crisis began in Thailand in July 1997 with the collapse of the baht and quickly spread to other countries and their currencies. In a flash, liquidity dried up and businesses went bust, as a flood of Western capital fled the region. Mahathir Mohamad, then prime minister of Malaysia, accused billionaire hedge fund manager George Soros of masterminding the speculative attacks and called for a ban on currency trading, which he blasted as “unnecessary, unproductive and immoral.” Soros fired back that he had not been speculating on the Malaysian ringgit and accused Mahathir of being “a menace to his own country.”
Eleven years later memories of that clash live on. Mahathir, now a blogger, continues to warn anyone who will listen not to forget how “American hedge funds destroyed the economies of poor countries by manipulating their national currencies.” His views these days, however, have more in common with politicians in the West than in the East. Although there has been a groundswell of sentiment in the U.S. and Europe in favor of a clampdown on hedge funds, many Asian countries are taking a more moderate, Soros-like approach toward regulation. That’s especially true in Australia, Hong Kong and Singapore, where the authorities have taken steps to make it easier and cheaper for hedge funds to operate, such as streamlining licensing and limiting taxes. Even Japan, where regulators in the past have been openly hostile toward hedge funds, may be starting to loosen up. To be sure, Asia has its hardliners, including South Korea and Indonesia, which like their Western counterparts put a clamp on short-selling this fall.
The relatively moderate views toward hedge fund regulation across much of Asia reflect in part the fact that the region has been far less hurt by the credit crisis than the U.S. and Europe. Although the rest of the world has fallen into a painful and potentially protracted recession, most Asian countries continue to see economic growth. The World Bank forecasts that China will increase its gross domestic product by 7.5 percent in 2009, down from the estimated 9.4 percent rise in 2008, because of lower demand for its exports. Although the bank is predicting slowdowns for other Asian countries — India is expected to see GDP growth slide from 6.3 percent to 5.8 percent and Indonesia from 6 percent to 4.4 percent — the overall economic environment is rosier than in the West, as the world’s industrial center of gravity continues to shift eastward.
Still, like their peers in Europe and the U.S., most Asia-Pacific hedge funds struggled in 2008. The Eurekahedge Asia hedge fund index was down 21.6 percent for the year through November (most Asian equity indexes were down at least twice that). Peter Douglas, founder and principal of GFIA, a Singapore-based consulting and hedge fund research firm, estimates that the combination of redemptions by disappointed investors and falling share prices may cut by as much as 50 percent the value of Asian hedge fund assets under management, which peaked at $250 billion last spring. He says that about 80 of the estimated 1,000 funds in Asia had closed by the end of October and predicts that substantially more will do so by year-end.
Cheah Cheng Hye, chairman and CIO of Hong Kong–based Value Partners, one of the biggest hedge fund firms in Asia, thinks the industry should be prepared for regulatory changes and challenges. “Politicians and regulators are under huge public pressure to put tighter control over financial services providers, especially hedge fund managers,” Cheah says. “Many current practices of hedge funds, such as adoption of side pockets and valuation of illiquid investments, will be subject to regulatory review.” Value Partners had $3.1 billion in assets under management at the end of October, down from $5.9 billion in the spring.
Christophe Lee, CEO of SHK Fund Management, believes that Cheah’s concerns are overblown — at least when it comes to Hong Kong. Lee, whose $800 million hedge fund firm is based there, points out that the Chinese territory did not follow the lead of the U.S. and the U.K. this fall when they banned short sales in the shares of financial services companies. “Just when the whole world is speaking out on regulations, the outlook is that there will not be that much direct action in Hong Kong,” he says.
Secretary for Financial Services and the Treasury K.C. Chan and other officials have been actively promoting Hong Kong as Asia’s hedge fund hub. Speaking at a conference a year ago, Chan trumpeted rule changes enacted by the territory’s Securities and Futures Commission that enable firms already registered as investment advisers in the U.K., the U.S. or other well-regulated countries to obtain a license to operate in Hong Kong within a few weeks. Offshore funds in Hong Kong are also exempt from profit taxes, which were reduced from 17.5 percent to 16.5 percent this year. “We will continue to review our regulatory model to ensure that it will not hamper financial innovation nor stifle further development of Hong Kong’s financial services industry,” Chan said at a luncheon in Washington late last spring.
Japan has been a notoriously difficult place for hedge funds to operate. Obtaining a discretionary fund management license there can take years, and on the surface the official stance is as tough as ever. Shoichi Nakagawa, who serves concurrently as Finance minister and as head of the Financial Services Agency, didn’t give an inch during a press conference in Tokyo on November 21: "[There is] no question of relaxing the regulations on hedge funds.” Yet senior officials at the FSA, working under Nakagawa, caution that Japan has “no concrete plans” to expand registration and reporting requirements for investment fund managers, as some international Tokyo-based lawyers, such as Christopher Wells of White & Case, believe will happen in Japan and elsewhere.
Kenichi Watanabe, president and CEO of investment banking giant Nomura Holdings, for one, is betting that Japan will, if anything, ease the rules (see sidebar story, Nomura’s Big Hedge Fund Bet). In October, Nomura bought Lehman Brothers Holdings’ Asia-Pacific operation out of bankruptcy. Lehman had been a leading prime brokerage in Japan, with a huge amount of hedge fund business on its books.
Most countries in Asia have made huge strides since the financial crisis a decade ago by building up free-market institutions, strengthening foreign exchange controls and training qualified financial officers. Yet there is at least one nation that still seems prone to chaos and confusion — South Korea. Its currency, the won, plummeted from about 1,000 to the dollar in early August to a historical low of 1,500 to the dollar in November. Short-term funds are cascading out of the country, including money from hedge funds, according to one former banker in Tokyo. The government has exacerbated the exodus by pursuing what the authorities perceive as an approved international strategy of tightening regulations.
“South Korea is just following the worldwide trend,” says the Tokyo-based banker. In the last week of September, the country’s Financial Supervisory Commission adopted rules that temporarily prohibited short-selling on all individually listed stocks on the Kospi and Kosdak exchanges (the shorting of baskets of stocks, however, was not banned).
Australia, Indonesia, Japan, Singapore and Taiwan also imposed short-selling restrictions in the fall, with varying degrees of stringency. Indonesia and Taiwan eliminated short-selling altogether. (On November 27, Taiwan announced it would partially lift the ban, which is scheduled to expire on December 31, 2008; Indonesia’s ban is indefinite.) Japan and Singapore were more moderate, putting in measures simply to prevent naked short-selling — selling shares without first borrowing them or securing an agreement to borrow them. Australia restricted short-selling of nonfinancial stocks through November 2008 and financial stocks through January 2009 but had exemptions for arbitrage-related strategies and market makers.
Despite the restrictions, Australia continues to be seen by hedge fund managers as one of the most appealing countries in the Asia-Pacific region in which to put out a shingle. Angus McKinnon, an Australian based in Tokyo, describes the Australian Securities and Investment Commission, which oversees the licensing requirements for financial institutions, as “very gung ho” when it comes to hedge funds.
“They want to try to encourage hedge fund managers to settle in Australia,” says McKinnon, formerly a senior partner and fund manager for Tozai Investment Advisory, a Tokyo-based hedge fund adviser that closed in early December after a four-year struggle in the Japanese market. Jens Muenster, a former Tozai colleague of McKinnon’s based in Sydney, says that getting a license in Australia is on par with getting one in Hong Kong.
Singapore, where hedge funds can be up and running in as little as two weeks, is probably the easiest country in Asia in which to operate. The island nation’s attractive tax code and regulatory environment more than offset the penalties for failed trades that were instituted in the fall to stop naked short-selling. Consulting firm GFIA’s Douglas says that Singapore’s regulators are unlikely to change their fundamentally positive view of hedge funds. “My feeling is that a lot of the hedge fund regulation story will take a lot longer to play out, and have less effect, than we currently see,” he says. “Risk-takers of all sorts will be well rewarded over the next few years.”
Regulators in India, one of the more restrictive markets in Asia for outside investors, have been relaxing the rules to make it easier for hedge fund managers to operate. In October, when other countries were cracking down on short-selling, the Securities and Exchange Board of India eased restrictions on the use of offshore derivative instruments, commonly called “participatory notes,” which hedge funds typically employ to invest in Indian equities, according to Rajeev Baddepudi, a senior analyst at Eurekahedge in Singapore. Of course, short-selling was largely prohibited in India already, so new restrictions would have been unnecessary.
Asia’s largest growth market, China, is opening up slowly to hedge funds. Shanghai allows — and encourages — qualified foreign investors, including private equity, venture capital and hedge funds, to register as local investment firms. Still, most managers follow the example of Value Partners’ Cheah, who is based in Hong Kong and makes frequent trips to the mainland to research companies, while they wait for more regulatory progress in China.
The flap between Mahathir and Soros a decade ago focused public attention in the Asia-Pacific region on hedge funds for the first time. But the calls for greater regulation these days are falling on largely deaf ears among government officials in Asia, who seem more concerned with preserving economic growth and avoiding recession.
