The impact assessment, written by consultants Europe Economics, has given the funds lobby renewed strength as it says that EU GDP could decline by up to 0.2% if the draft Directive on Alternative Investment Fund Managers (AIFM) becomes law.
However, the paper's authors say the decline in GDP would be offset by the AIFM's greater contribution to financial stability.
The law reduces the chances of another recession by 0.8%, because investment funds will have less room to make risky investments, said one of the report's authors, Andrew Lilico.
Brussels investment fund lobbyists have long argued that they were not the cause of the crash in financial markets, but this report establishes a clear link between hedge funds, in particular, and unstable markets.
Much work has already been done to water down the European Commission's original proposals and the latest parliamentary draft of the AIFMD, authored by MEP Jean-Paul Gauzès, has already made significant concessions to the funds lobby, say MEPs and industry representatives (EurActiv 27/11/09).
Weighing up the costs
The financial sector will have to weigh up the risks on whether the 0.2% drop in output is a fair deal for a more secure financial future in Europe, added Andrew Lilico, one of the report's authors.
Not only do investment funds depend on leverage – using debt to supplement investments – they are also trend-setters in the industry: funds will follow investments made by other funds.
Alternative investment funds therefore not only contribute to market volatility, say Lilico, but can create a domino effect, maximising the potential costs of a crash.
As the report points out, this argument is old and previous crashes have been linked to leveraged funds.
The near-collapse of Long Term Capital Management (LTCM) in the US in 1998 raised concerns over the systemic risks posed by highly leveraged institutions, and hedge funds were blamed for the financial instability in Hong Kong during the East Asia crisis.
Interest groups argue that the lack of venture capital will overburden a suffering SME sector already worried by the lack of credit resulting from higher capital requirements at banks (EurActiv 09/10/09).
Private equity wants exemption from AIFMD
Private equity groups, which are nominally the smallest kind of fund, do not consider themselves to be "systemically relevant" enough to fall under the EU's regulation.
By far the most vocal protestors against the Commission's draft law, private equity lobbyists have argued for an exemption from the outset and the Parliament's impact assessment has provided the industry lobby with fresh evidence.
The European Venture Capital Association (EVCA) argues that systemically relevant funds should fall under existing EU regulation on marketing inside the EU. The Commission's proposal would limit all non-EU funds' ability to market within the EU.
Private equity and venture capital activity in the EU would drop off by up to 44% if the law came into force and total compliance costs would reach 22 billion euro, according to the report.
The impact assessment estimates that of the roughly 66% of private equity funds domiciled outside the EU, only about 20% would still be able to market in the EU under the AIFMD.
