Yellen Signals Scrutinizing Hedge Funds a Renewed FSOC Focus

President Joe Biden’s council of financial regulators signaled a sharpened focus on hedge funds and whether their trading poses dangers to markets.

Treasury Secretary Janet Yellen, speaking at a Wednesday meeting of the Financial Stability Oversight Council, said the group has revived a task force on hedge funds so agencies can better “share data, identify risks and work to strengthen our financial system.” The council was briefed in a separate private meeting on how the funds performed during the Covid-19 crisis, she said, adding that their use of borrowed money added to instability last year.

“The pandemic showed that leverage of some hedge funds can amplify stresses,” said Yellen, who leads FSOC.

The power of lightly regulated investment firms to roil markets was on full display in recent days. While not technically a hedge fund, the blowup of Bill Hwang’s Archegos Capital Management has sent shock waves through Wall Street, triggering billions of dollars of losses for banks and scrutiny from the Securities and Exchange Commission.

The closed portion of the FSOC meeting included a presentation about hedge funds cutting their leverage during the pandemic-fueled turmoil in March 2020 and how that might have triggered “price declines in certain financial markets,” Treasury said in a statement. The council also discussed more recent hedge fund activity, according to the statement, without offering specifics or naming any firms.

Wild Trading

In addition to Archegos, another high-profile development involving private funds that captured Wall Street’s attention this year was wild trading in GameStop Corp. and other so-called meme stocks. Some hedge funds, including Gabe Plotkin’s Melvin Capital Management, that had bet against the companies got slammed with losses in January after retail investors drove the shares to astronomical levels.

The Treasury statement noted that Yellen personally requested the revival of the panel’s hedge fund working group, which hasn’t been in operation since 2016.

FSOC, holding its first meeting since Democrats took the White House, is working to reinvigorate financial oversight after it fell into a lull during the Trump administration. Yellen said the council was also studying new rules for money-market mutual funds and would delve deeply into climate-related issues.

Global warming “is an existential threat to our environment, and it poses a tremendous risk to our country’s financial stability,” Yellen said, adding that the increasing frequency and intensity of storms could lead to severe disruptions in food and water supplies and cause increased unrest around the world.

Over the first few months of Biden’s presidency, several financial agencies have moved to increase their focus on how a warming planet could threaten the economy. Allison Herren Lee, the SEC’s acting chair, has set up an enforcement task force to focus on environmental-related issues and signaled that corporations may soon have to disclose more to shareholders about business risks. Meanwhile, Rostin Behnam, the Commodity Futures Trading Commission acting chief, said this month that he was establishing a unit to examine how derivatives can be used to address climate change.

‘More Resilient’

In her remarks, Yellen called on FSOC to review the critical role that open-end mutual funds play in financing the economy. She also said the council must explore “vulnerabilities” in the U.S. Treasury market that were exposed by the pandemic.

“We also must strengthen the Treasury market itself and make it more resilient to future disruptions,” Yellen said.

FSOC, created in response to the 2008 financial crisis, is tasked with spotting risks that could cause another crash. Set up under the Dodd-Frank Act in 2010, it has the authority to call out firms and industry practices as “systemically important” -- a label that brings stricter rules and heightened oversight by the Federal Reserve.

The council’s members include the heads of the Fed, SEC and CFTC, making it a forum for regulators to coordinate their supervision of banks, asset managers, hedge funds and other finance companies.

While FSOC is expected to be much tougher during the Biden administration, Yellen hasn’t always sided with Democratic lawmakers eager for a clampdown on Wall Street. Last week, she sparred with Massachusetts Senator Elizabeth Warren over whether BlackRock Inc., the world’s biggest asset manager, should face designation by the council. And when Yellen led the Fed in 2017, she voted along with other panel members to remove insurer American International Group Inc.’s risk label.

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