A group of European state-owned development banks investing billions in the poorest countries has broken ranks with its political masters to criticise the European Union over plans to regulate hedge funds and private equity.

The Association of European Development Finance Institutions (EDFI), a group of 15 government bodies investing in emerging markets, wrote to the EU to warn that the plans could prevent them carrying out their work.

The move highlighted growing opposition to the EU’s planned regulations from private equity groups based in Africa, Asia and Latin America, which are worried about being cut off from European investors, who provide at least a quarter of their funding. Under proposals from the Spanish presidency of the EU, fund managers from outside the EU would gain access to investors in the bloc only if their own countries complied with regulatory standards that were equivalent to a planned directive.

“Africa is hugely reliant on capital from Europe,” said Cora Fernandez, chief executive of Sanlam Private Equity in South Africa. “The people who can least afford it are bearing the brunt of the cost of this directive.”

The campaign by emerging market private equity groups and their investors is part of a wider lobbying effort against the directive. This has ranged from a warning that the plans were discriminatory by Tim Geithner, US Treasury secretary, to claims from venture capital firms that it would choke off investment in start-up companies.

But the opposition from the development finance institutions – including the UK’s CDC, Norway’s Norfund and the Dutch FMO – underlined the difficulty of imposing one-size-fits-all legislation on industries as varied as private equity and hedge funds.

The “third country” restrictions were designed to stop hedge funds and private equity groups being able to move offshore to escape the new rules.

In a twist to the debate, two of the biggest development banks complaining about the directive, Proparco and DEG, are owned respectively by the French and German governments, the two biggest supporters of the “third country” rules.

Europe’s development finance institutions said in a letter to the Spanish presidency of the EU, seen by the Financial Times, that the directive could “restrict the flow of capital to some of the poorest countries in the world, thereby preventing the EDFI members from achieving some of its developmental objectives”.

Richard Laing, chief executive of CDC in the UK, which has £2.5bn (€2.9bn, £3.8bn) of assets, said: “I am not sure what problem the EU is trying to fix here. Why have such a wide net to capture everything from a Kenyan small- and medium-sized enterprise fund to a pan-African infrastructure fund?”

EDFI said its members had committed €5bn (£4.3bn, $6.6bn) to emerging market private equity, mezzanine and debt funds by the end of 2009 with the goal of reducing poverty through investment in private sector businesses.

“I don’t for one moment believe that the EU is really trying to impede its own development agencies from investing in the one of the most effective development tools in these poor countries, which is private equity,” said Sarah Alexander, president of the Emerging Markets Private Equity Association.

Ngalaah Chuphi, a partner at Ethos Private Equity, one of South Africa’s biggest private equity groups, said groups like his would struggle to open EU offices to keep raising money in the region: “There are significant costs of setting up in Europe, which may be too much for a fund in a market of our size.”

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