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European Parliament Critical Of Hedge Fund Proposals

by Ulrika Lomas,, Brussels

11 December 2009

An Impact Assessment commissioned by the European Parliament and prepared by Europe Economics has estimated one-off costs of up to EUR22bn and almost EUR4bn of ongoing annual costs associated with the so-called “AIFM Directive”.

The estimate of one-off compliance costs ranged from approximately EUR1.1bn to EUR22bn for the non-UCITS (Undertaking for Collective Investment in Transferable Securities) sector as a whole. Transactions costs were expected to rise between 30 and 45 basis points.

According to the Assessment, the annual growth rate of European Union GDP would fall by around 0.1-0.2%, but booms and busts would be evened out by around 0.8% of GDP.

The Assessment stated that, with the regulation proposals, the EU "playing field would be more level," but at the expense of competition and innovation in the hedge fund sector, driven particularly by de-globalization, and leading to materially higher costs for investors, reduced efficiency in financial markets, less investment to innovative businesses, and less efficient restructuring of businesses in financial distress.

The Assessment pointed out that the new regulatory regime would further promote the existing trend towards re-packaging non-UCITS funds as UCITS funds – increasing the access of retail investors to such products. However it was thought likely that some fund managers would exit the EU market as result of limitations on the use of leverage, constraints on the use of certain strategies and the additional costs of complying with the Directive.

The Assessment balanced this against the EU investors who would be more inclined to move capital from offshore funds to onshore funds to reduce perceived risk and EU fund managers possibly bringing their funds increasingly onshore where domestic investors are clearer on the regulatory regime in place.

The Assessment deemed the potential for non-EU domiciled investors to withdraw their funds in the short-term, and EU investors to move their capital to compliant non-EU domiciled fund managers to be only modest.

As a result of the proposed threshold to regulate hedge fund managers with more than EUR100m assets under management, or EUR500m when no leverage is used, the assessment indicated that of the 80% of hedge funds domiciled outside the EU, only between 5% and 25% would still be allowed to market their funds to EU investors, and of the estimated 66% of private equity firms outside the EU only about 20% would be able to market their funds.

The Assessment considered the following alternative options to the proposed regulatory framework:

  • Regulation of the dealings of banks and/or prime brokers with hedge managers.
  • Extention of existing regulation, such as the Transparency Directive or Prospectus Directive.
  • Introduction of a change in merger guidelines to prevent hedge managers from merging to create systemically significant organizations.
  • Regulation of systemically significant hedge fund managers by national monetary authorities, including the power to restrict certain practices, such as leverage, risk-taking and remuneration.
  • Varying the application of the “all encompassing” and “asset class by asset class” approaches, applying the “all encompassing” approach only to those provisions which have a general applicability and relevance, and to deploy the “asset class by asset class” approach elsewhere.
  • An opt-out clause for hedge fund managers not engaging in cross border activity (although, they would remain subject to supervisions at the national level as they currently stand).
  • Reduce the liability standard for depositaries in line with the UCITS Directive.

The Assessment concluded that:

  • Hedge funds vary significantly, including the strategies they employ and types of products they invest in, the amount of leverage they use and their liquidity.
  • They make a very important contribution to the functioning of a market economy, for example by providing financing, enhancing market efficiency and promoting financial innovation.
  • They are, however, key participants in economic volatility, though such volatility might simply reflect new information or new interpretation of the information.
  • Leverage per se does not increase risk.

Europe Economics described the AIFM Directive proposals as "premature" and "misguided". The proposals need to be approved by states and the European parliament.

As Sweden will be handing over the EU presidency and responsibility for the matter to Spain at the end of the year, it is unlikely that there will be any speedy compromises made in the immediate future, and most commentators expect negotiations on amendments to continue into the middle of next year.

A comprehensive report in our Intelligence Report series giving a country-by-country analysis of offshore investment funds, stock exchanges and trusts, with an analysis of the US QI regime, is available in the Lowtax Library at and a description of the report can be seen at

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