In the sweeping proposal to overhaul the regulatory structure of the financial markets, where is the plan for oversight of hedge funds and private equity?

The answer is nowhere.  

Treasury Secretary Hank Paulson delivered remarks about his blueprint for regulatory change during a press conference this morning, and the subject never came up. In the 212-page plan the Treasury Department released today, the term hedge fund appears only twice and private equity just once. In the Q&A with Paulson published by the Wall Street Journal this weekend, there is no mention of how the new regulatory regime would impact the use of alternative investment vehicles.

Paulson spoke about the great changes that our financial system has undergone since the current regulatory structure was implemented. And yet one of the biggest agents of change—the emergence of hedge funds and private equity funds—gets little attention. Although there has been a lot of discussion in Washington over the regulation of them, hedge funds and private equity funds remain lightly regulated.

And judging by the language in the blueprint, Paulson's plan would essentially keep it that way. According to the executive summary, the funds would fall under the purview of a new regulator to oversee business conduct across all financial firms. They would also be subject to information-reporting requirements from the Federal Reserve, but that information would only be used broadly when systemic risks in the market emerge.

Indeed, in a footnote, the Treasury Department seems to fall back on its existing statements on regulation of the investment funds. It cites the set of principles and guidelines for hedge funds and other private pools of capital released by the President's Working Group in February 2007 as evidence that "market discipline is the most effective tool to limit systemic risk."

In terms of disclosure and transparency, then, the new regulatory proposal seems to say that status quo in the world of private pools of capital is sufficient.

The business-conduct regulator would essentially be the consumer advocate in the financial services industry, which would include hedge funds and private equity. The agency would set standards, license firms, and ensure that compliance needs are being met.

But considering that hedge funds and private equity firms don't currently market their products to consumers, it's unclear what role this would play for them. Also, the plan clearly calls for continued enforcement functions by their self-regulatory organizations. Because the hedge fund and private equity industries do not operate in an S.R.O. model, it's unclear where the enforcement of them would fall.  

Of course, the timing of Paulson's announcement is a curiosity in and of itself. If November's election results in a Democratic president and Congress, we may look back at this sweeping plan as little more than a last-ditch effort by an outgoing administration to leave a favorable legacy.

In the New York Times' news analysis of the plans yesterday, Nelson Schwartz and Floyd Norris mention the "light touch" the regulation would have on hedge funds, but they didn't delve deeper into the outcome of that. However, they do end the piece with a quote from Richard Baker, the former Republican head of the House Financial Services Committee, who is now the hedge fund industry's chief lobbyist: “The general tone is positive, and moving toward a consolidated regulatory structure is reasonable,” he said.