Ecofin Agrees Stance On Hedge Fund Regulation

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

22 October 2010

The European Council (EC) has announced that it has agreed its position with a view to concluding negotiations with the European Parliament (EP) on a draft directive introducing harmonized European Union (EU) rules for entities engaged in the management of hedge funds and other alternative investment funds.

After a meeting of finance ministers from the member states, it was stated that the draft directive is aimed at establishing a “harmonized framework for monitoring and supervising the risks that alternative investment fund managers (AIFMs) pose to their investors, to counterparties, to other market participants and to the stability of the financial system.”

It is intended to fulfil commitments made by the EU at the G-20, as well as the EC's pledge to regulate all market operators whose activities might pose a risk to financial stability. According to the EC, the recent financial crisis underlined how the activities of large hedge funds may "serve to spread or amplify risks through the financial system."

Under the draft text, when the directive enters into force, a European AIFM with a portfolio of more than EUR100m (USD137m) 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.

Fund managers would 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, which also establishes a number of requirements in other areas, such as leverage, governance standards and transparency.

They would also have to abide by EU directives on remuneration in the financial industry, for example, by deferring performance related pay; although the UK’s Financial Services Authority (FSA) has said that it does not “propose a rigid approach to those elements of the remuneration principles that are relevant in the design of remuneration structures for asset managers.” Instead, it proposes to apply them “proportionately”.

The most controversial proposal in the draft directive has been that AIFMs from 'third countries' would be able to obtain an EU permit to sell their funds within the EU, a planned regulation that is widely awaited, for instance, by US funds wanting to continue to operate in Europe.

The possible allowance of non-EU hedge funds to obtain EU-wide permission, however, has caused long-standing divisions on hedge funds between various EU countries to resurface. Those divisions range, 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 permit for hedge funds from countries outside the EU remains within the text of the draft directive now agreed by the EC. However, a compromise has been reached under which, while the permit will still be approved by national regulators (particularly the FSA), more powers have been granted to the European Securities and Markets Authority to oversee funds operating in the EU and instigate inquiries where it may deem necessary.

It is said that permits could be available for EU AIFMs by 2013, and for non-EU AIFMs by 2015, although member states could maintain their own rules for hedge funds until 2018.

In a statement, the European Commissioner for Internal Markets and Securities, Michel Barnier, said that the “member states took a fundamental step towards an agreement on this important directive. The text takes into account the numerous and legitimate requests of the EP, with whom we must now finalize this agreement.”

He added that the negotiations with the EP are intended to enable adoption of the directive at its first reading. It is expected that such a vote could now be taken early next month.

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