Investment companies have warned a House of Lords committee that a proposed EU directive is “deeply damaging” for the investment company sector.

The warning came in a letter from the Association of Investment Companies to the House of Lords committee, which is undertaking an inquiry into the Alternative Investment Fund Managers directive.

The controversial EU directive was announced earlier this year and took aim at hedge funds and private equity funds, addressing fears that the sector was not properly regulated.

It proposes stringent new laws on how alternative investment managers can operate, which are due to take effect in mid-2012.

But the AIC says the directive would increase costs and reduce investment companies’ commercial flexibility. It also fails to recognise the role of the independent board in protecting shareholder interests, according to the AIC.

The directive also states that only authorised fund managers should be allowed to issue new shares - but with investment trusts, the board is responsible for new issues.

“A lack of consulation and understanding of investment companies’ unique characteristics mean that profoundly damaging outcomes are a real threat unless the proposals are adjusted,” the letter states.

“In their current form these measures are deeply damaging for the investment company sector,” said Ian Sayers, acting director general of the AIC.

The AIC wants all investment trust companies that already trade on regulated exchanges to be outside the scope of the directive, arguing that they are already subject to European regulation protecting consumers.

The letter from the AIC also criticised the European Commission for failing to consult properly before the directive was published. It said this has caused the directive to be “poorly targeted” and to create “significant unintended consequences”.

The hedge fund industry has also criticised the AIFM directive, warning that it could cause some managers to relocate away from the UK.