EU Approves Hedge Fund Directive

by Ulrika Lomas, for LawAndTax-News.com, Brussels

20 May 2010

European Union finance ministers have reached an agreement on a mandate for the Spanish Presidency of the EU to negotiate with the European Parliament on a directive establishing an EU framework for managers of alternative investment funds, such as hedge or private equity funds.

The aim of the Alternative Investment Fund Manager (AIFM) directive is to overcome gaps and inconsistencies in existing legislation with regards alternative investments funds. However, the proposals are highly contentious and the hedge fund industry has warned that the directive could drive funds to more lightly-regulated jurisdictions offshore. The UK, which has by far the largest slice of Europe's hedge fund business, is also opposed to the legislation, although the new Conservative/Liberal Democrat coalition government has failed in its attempts to force through changes.

According to the European Council, the recent financial crisis has underlined how the activities of large hedge funds "may also serve to spread or amplify risks through the financial system."

"Uncoordinated national responses to the risks make efficient management of them difficult," the Council said following the agreement.

When the directive enters into force, a fund with a portfolio of more than EUR100m will be required to obtain an authorization from national authorities to operate. This permit will also entitle them to work across EU borders. Fund managers would also have to  provide data on risk management, performance data and exposure to risks on a regular basis. They would also be required to deliver a clear description of their investment policies under the directive.

"Information is vital to conducting supervision and ensuring transparency," the Council argued.

The directive also establishes a number of requirements in other areas, such as leverage, governance standards and transparency. But one of the most controversial proposals is that hedge fund managers in 'third countries' would have to obtain a passport to sell their funds within the EU, meaning that they would have to adhere to the same strict standards as EU-based funds, a proposal which could effectively extend the jurisdictional reach of EU regulators.

The global alternative investment funds industry has described the third country rules as unworkable and urged EU lawmakers to devise a more pragmatic solution on non-EU alternative investment funds and fund managers.

Despite the insertion of a compromise amendment in the draft directive, the Alternative Investment Management Association has said that the current proposals "will not provide access for non-EU funds and fund managers, but will instead ban European investors from investing overseas."

"It will reduce choice and drive down returns for pension funds and other investors, as they will no longer be able to select their investments from among the best available products globally,"  states a letter to Members of the European Parliament written on behalf of AIMA, the UK Investment Management Association and the UK National Association of Pension Funds.

"This will undermine Europe’s competitiveness. There is a real risk that it would provoke retaliatory action in non-EU jurisdictions, which would damage the European financial services industry and the whole European economy," the letter warns.

A final vote on the draft directive by the European Parliament has been scheduled for July.

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