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Representatives of alternative investment managers have been lining up to complain about draft European legislation to be published this week. Private equity and hedge fund trade bodies have expressed concern, respectively, about the inclusion of relatively small funds – more than €250m (£226m, $332m) – within the ambit of the proposed rules, and the extent to which the directive has been shaped by political considerations rather than practical ones.
Coming from the other direction, some European parliamentarians criticised the draft proposals as “almost worthless” because they were insufficiently stringent.
It is no surprise to see the debate shaping up this way. Alternative investment managers based in the UK, where most European hedge and private equity fund managers congregate, are used to the light touch of the Financial Services Authority. Becoming subject to the heavy hand of the Brussels bureaucracy is horrifying for them.
There is the suspicion too that those pushing for more controls are motivated by protectionism: countries such as France and Germany that have not sought or attracted significant numbers of alternative investment managers do not want their own financial services sectors threatened by competition from London-based managers.
So what is all the fuss about? Leaked copies of the draft directive have been flying about like confetti. Ignites Europe, a sister publication, provided a link to the copy it had received in a story published online last Friday.
Going on what I have seen, the new directive will cover alternative investment managers running funds with total assets (including leverage) of more than €250m. This covers commodity, real estate and infrastructure fund managers, as well as the more controversial hedge and private equity funds.
To manage funds in the European Union, they will have to be authorised and adhere to the new rules. Authorised managers will be able to sell funds to professional investors across the EU, but will not be allowed to market to retail investors. Distribution to the retail market will remain governed by domestic regulation.
There is no proposal to regulate the funds run by alternative investment managers. And in theory funds can remain offshore, although the conditions laid down for funds domiciled in third countries are demanding. But they are not demanding enough for some tastes, and the decision not to regulate funds, or order them onshore, is one of the objections being raised by politicians.
Managers will be subject to capital requirements and will have to provide detailed information about their operations. They will also have to report regularly on the markets and instruments they are trading in, their main exposures, their performance and their risk concentration. Those using leverage above a certain threshold will have to make additional disclosures, as will those acquiring a controlling interest in companies.
Unsurprisingly, there are requirements to segregate investor assets and appoint independent depositaries and valuators. The latter must have a registered office in an EU country but the former can be outside the EU.
In a sense, the details are by-the-by. What has infuriated some in the alternative investment industry is the powers that Brussels is aggregating to itself with this proposed directive. It is assuming the mantle of a European regulator, leaving little to the discretion of national regulators. This is particularly galling for the hedge fund industry, which is concentrated in the US and UK.
The need for a single European regulator, and international co-ordination, has been discussed post crisis, but this directive appears to be pre-empting any move.
It has plenty of hurdles to clear before becoming binding, and may get watered down considerably. But it is indicative of the views currently prevailing within the European Commission: in short that the activities of hedge funds and other alternative investment managers pose potential systemic risks that the current nationally organised regulatory framework cannot adequately pick up.
Hedge funds deny the systemic risk charge: they say it only arises when banks have the same positions as hedge funds. Restricting banks is the way to go, they maintain, not hobbling hedge funds and other risk-takers.
Perhaps they still fail to appreciate how much the climate has changed. Free-wheeling capitalism and the opportunity to make money any which way will have to take a back seat for a while.