Hedge funds, credit risk transfer and financial stability

Over the past decade, central bankers and financial institution supervisors have sharpened their focus on the increasingly important role that private pools of investment funds play in global financial markets. The growth in these pools has contributed significantly to market efficiency and financial stability by expanding liquidity in many financial markets, improving price discovery, and, ultimately, lowering the costs of capital. Private investment pools and the alternative investment strategies they pursue have contributed to a signifi cant expansion of the global markets and have helped accelerate the evolution in traded credit products such as credit derivatives, collateralized debt obligations, and the securitization of an increasing array of traditionally illiquid assets. However, because of the lack of transparency and an established regime of supervision of these investment vehicles, policymakers and supervisors have become concerned about customer protection and the potential for systemic risk. This paper discusses some of the key issues confronting supervisors in light of the recent growth of private investment pools and the rapid developments in the area of credit risk transfer, with a particular focus on the implications of these trends regarding systemic risk and financial stability.