Reg Rage: EU to cut hedge funds down to size

What is it?

The European Commission (EC) has proposed a directive to curb the growth of hedge fund and private equity fund managers. Fund managers have reacted furiously. They argue that this threatens the viability of the alternative investment fund industry. They say it has been hastily prepared without proper consultation, contains many ill-considered provisions and is biased and punitive.

Who dreamed it up?

The Internal Market and Services Directorate-General of the EC. It published the draft Directive on Alternative Investment Fund Managers (AIFMs) at the end of April. It is the first attempt in any jurisdiction to control the management of alternative investment funds, the directive's definition of which also includes commodity, real estate and infrastructure funds. The proposal is being considered by the European Parliament and Council and could be in force by 2011.

What are the main provisions?

The directive would require all fund managers within its scope to be authorised and subject to a wide range of harmonised regulatory standards. It would also force them to be more transparent about their activities.

It would apply to AIFMs with assets under management of more than €100m, or €500m for unleveraged funds which have a five-year lock-in period for investors. The €100m threshold would capture 30% of hedge fund managers, managing nearly 90% of assets in EU-domiciled funds. The €500m threshold is designed to exempt smaller private equity and venture capital fund managers, which do not pose risks to financial stability.

What's in the small print?

AIFMs would need to hold a minimum level of capital of €125,000 and have a liquidity risk management system.

What does the industry say?

The Alternative Investment Management Association (AIMA), which has 1100 hedge fund industry members in 40 countries, is apoplectic. "This directive is not a proportionate regulatory response to any of the identified causes of the current crisis. All of the major reports which analysed the crisis in depth concluded that hedge funds neither caused nor played a significant role in the crisis. This directive undermines their findings and the vast amount of work that is currently being undertaken by the G-20, IOSCO and the Financial Stability Board," says Florence Lombard, AIMA's executive-director.

Jonathan Russell, chairman of the European Private Equity and Venture Capital Association (EVCA), adds: "While we welcome the Commission's distinction between hedge funds and private equity, we are deeply concerned that the thresholds set out today punish [private equity-backed] middle market companies, which lie at the heart of corporate Europe."

How much will it cost?

Hundreds of millions of euros in administration and lost business. The EVCA, for example, says that the proposals "heap unwarranted costs on value-creating parts of the economy at a time when these businesses are dealing with the effects of a severe economic downturn".

What do the legislators say?

Internal market and services commissioner Charlie McCreevy argues that AIFMs, which managed about €2000bn in assets at the end of last year, "have had a significant impact on the markets and companies in which they invest" and "there is now a global consensus - as expressed by the G-20 leaders - over the need for closer regulatory engagement with this sector".

The law of unintended consequences

"These measures may put thousands of jobs in several major European industries under threat and slow down any economic recovery," says AIMA's Ms Lombard. London - where most of Europe's hedge fund managers are based, with most of their funds being offshore - would be hardest hit. The directive would allow only EU-domiciled funds to be marketed in the EU.

Could we live without it?

Yes - hence, the industry is fighting a rearguard action to convince member states and the European Parliament to water down the most objectionable aspects.

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