New Alternative Investments Directive Ruffles Feathers in the EU and Abroad
By Elizabeth Harrin (London)
Since the economic downturn started, people have been calling for more regulation of the financial markets. And in Europe, we’re about to get some. The European Parliament’s Committee on Economic and Monetary Affairs (ECON) voted this month in favour of the proposed rules that will form the basis of the Alternative Investment Fund Managers Directive.
While it isn’t yet law – the exact details are still to be worked out – the Directive is already unpopular, especially in the UK. ‘Alternative’ funds are those that are not already covered by extensive EU legislation and include hedge funds, real estate funds, commodity funds and private equity. The Directive agrees to tighten up the rules on hedge funds, and as most of Europe’s hedge funds are head-quartered out of the UK, British commentators believe there is a risk that London’s financial centre will suffer as firms move out.
In addition, the new rules will prevent a non-EU fund from marketing itself to Europe as a whole. Just because your hedge fund is cleared to do business in one country, doesn’t mean it will have an automatic right to be traded in any of the other EU states. This is the clause that many in the UK find most restrictive, and there is a genuine worry that trading with the US will be affected because of the tighter rules.
However, it’s not all bad news. “In several areas we have secured significant improvements, including greater proportionality for small funds, greater clarity and flexibility in depositary liability requirements, and the removal of the more burdensome private equity requirements,” says Sharon Bowles, Liberal Democrat MEP and Committee Chair. “I welcome the several workable and sensible changes introduced in this report and think that when these are merged with the [European] Council’s report we will be 90% of the way towards a very good text. My liberal colleagues and I have worked very hard to improve the proposed AIFM Directive and ensure that it finds the right balance between regulating the fund industry and ensuring that it can still be successful.”
Establishing a Harmonised Framework
The Directive is trying to establish a harmonised framework for monitoring and supervising the risks that alternative investment funds pose to their investors, other market participants and to financial stability in general. The European Council has pledged to regulate every part of the financial market that could cause the markets to be exposed to unacceptable risk. At the moment, these alternative funds are regulated by a mix of national regulations and general provisions of EU law. There are also industry standards in place and professional bodies that contribute to keeping the markets – and those who operate within them – in check. However, those proposing the new rules believe that the global financial crisis showed that having a mix of ways to regulate the industry results in an uncoordinated mash-up of national responses. A European-wide approach will arguably make managing risks easier.
Under the new rules, fund managers would have to register with regulators in their home state before they could market their products. They would have to justify their approach to risk management and hold reserve funds just in case. Fund managers would also have to release information on their assets, use of leverage, principal exposures and other factors.
Ruffling Feathers
While no one would argue that financial stability is a bad thing, the way in which the Directive is proposing to achieve it has ruffled some feathers. On her website, Bowles describes the new AIFM legislation as “probably the biggest and most controversial item to cross my desk since I became ECON Chair.” The decision to even discuss and vote on the idea that this Directive will become law was delayed due to the general election in the UK, which saw Labour lose power to a Conservative and Liberal Democrat coalition. The change in personnel at the Treasury may have an impact on how the UK debates the passage of the new legislation, but for now it looks as if George Osborne shares the concerns of his Labour predecessor. Another factor that held up this month’s vote was that several EU other countries including Ireland, Austria and Malta, had reservations on bits of the document and ministers wanted more time to negotiation concessions and come to an agreement.
It doesn’t seem as if the agreement has been satisfactorily reached yet. “I am disappointed that the rules are not sufficiently flexible for EU investors in non-EU funds, which risks creating ‘prison Europe’,” says Bowles. “I fear these restrictions could severely hamper the ability of pension funds and other investors to make those vital returns which are necessary to provide for our ageing population.”
It’s not just US asset managers who will be affected should this clause stay in the final versions of the documentation. “I am also concerned that some funds and fund managers in developing countries will no longer have access to finance from EU investors since the barriers for so called ‘passive marketing’ are too high,” explains Bowles. “Given the ever increasing presence of China in Africa and elsewhere, I feel the EU is losing its strategic advantage by restricting itself through such measures.”
However, there is still time for this piece of the legislation to be ironed out before it comes into force. The negotiators will no doubt be busy between now and July, when the final Directive is expected to be taken to vote.
