EU Agrees Final Version Of Hedge Funds Directive

by Ulrika Lomas, LawAndNews-Tax.com, Brussels

28 October 2010

The European Parliament (EP) and the European Council have announced that they have reached an agreement on the AIFM directive which will introduce, for the first time, European regulation for alternative investment fund managers, including hedge funds and private equity.

The directive will impose registration, reporting and initial capital requirements on a financial industry sector which until now has been subject only to "light touch" regulation. It is hoped that, following its introduction, the enhanced regulatory oversight over AIFM will enhance investor protection and financial stability.

Under the directive, a European AIFM with a portfolio of more than EUR100m (USD140m) will be required to obtain an authorization from national authorities to operate. This permit will entitle them to market funds throughout the EU single market.

The most controversial proposal in the directive has been that AIFMs from 'third countries' would be able to obtain that EU permit, or ‘passport’, to sell their funds within the EU without first having to seek permission from each member state and comply with different national laws - a planned regulation the terms of which have been widely awaited, for instance, by US funds wanting to continue to operate in Europe.

The possible allowance of non-EU hedge funds to obtain such a EU-wide passport caused long-standing divisions on hedge funds between various EU countries to resurface. Those divisions ranged, for example, from the United Kingdom, in which most European hedge funds reside and which is against too-stringent regulation, to France, supported by Germany, which has expressed a wish for the strongest rules and is against allowing non-EU funds into the European market at all.

The passport for AIFM from countries outside the EU remains, however, within the text of the agreed directive, but such AIFMs will obtain passports only if the non-EU country they are located in meets minimum regulatory standards and has agreements in place with member states to allow information sharing. The latter stipulation is important because many of the US and UK hedge funds, themselves, are invested out of other countries, such as, for example, the Cayman Islands.

Initially, only EU AIFMs will be able to obtain a passport, with those based outside the EU having to market through the current national private placement regimes. After an opinion from the European Securities and Markets Authority (ESMA), and the adoption of implementing legislation by the European Commission (EC), the passport will then also become available to non-EU AIFMs.

The EP has also insisted on the insertion into the directive of rules to deal with asset stripping, and the agreement now includes a number of provisions to this end, relating primarily to limits on the distribution of capital within the first years that a company is taken over by a private equity investor. This, it was said, is intended to deter private equity investors from attempting to take control of a company solely in order to make a quick profit.

The EP has also introduced information and disclosure requirements to be imposed on private equity investors, particularly regarding the information to be provided to employees and their representatives on the planned strategy for the company. The intention is to oblige investors to develop longer-term strategies for the companies that they take over.

In a statement after the agreement was reached, Michel Barnier, the European Commissioner for Internal Markets and Services, said: “Thanks to the agreement reached today, the alternative funds management – which according to recent estimates, currently manage around EUR2 trillion in assets and more than half the financial market transactions on some days – will henceforth be subject to targeted regulation and supervision.”

He added that he was “particularly pleased by the truly European character of this directive. By guaranteeing a high level of transparency and protection throughout the industry, it will allow us to create a passport for all fund managers, even those established outside the European Union. Based on strict controls and an enforced role for ESMA, this system constitutes a sound and effective regulatory foundation for this sector, which has an important role to play in the economic recovery.”

It remains to be seen how AIFMs react to the final version of the directive, after they have been able to digest its detail. Some parties, obviously, begrudge any involvement of European institutions in the regulation of their markets, particularly the fledgling ESMA, believing that financial markets are best overseen by national regulators, such as the UK’s FSA. Others, accepting that some European rules were inevitable, will hope that the final outcome can be made to work.

The agreed text of the directive will now be put to a vote of approval at the EP's plenary session on the November 11. Following the directive's entry into force, member states will have two years in which to incorporate its rules in their national laws. The ESMA and the EC are to have the considerable task of fleshing out the details of how the directive works, through guidelines and implementing legislation.

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