Hedge funds face uncertain future after EU votes

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After the European Parliament approved tighter controls on hedge funds and private equity firms yesterday (17 May), the EU's finance ministers today gave their blessing to a very different proposal, leaving the European Commission with the job of forging a "dynamic compromise" by June.

Finance ministers meeting in Brussels today secured an agreement on the contested Alternative Investment Fund Managers Directive (AIFMD), after a vote in the European Parliament yesterday on the issue.

But the two camps sit on different sides of the fence, leaving the European Commission to pick up the pieces.

The crux of the issue comes down to whether foreign funds can gain access to all EU countries once they have a European "passport", or whether these funds would have to establish themselves in each individual member state.

The European Parliament is in favour of an EU passport, while the EU's finance ministers are against it, allocating some of the blame for systemic risk in the financial crisis to hedge funds and other such vehicles.

Though MEPs voting in the Parliament's economics committee (ECON) largely agreed on a draft version of a law creating an EU passport, there is still some resistance from liberal (ALDE) and conservative (ECR) camps, who argue the passport will be difficult to enforce in jurisdictions, which do not subscribe to OECD rules on tax and money laundering.

Early reports this morning quoted the German Finance Minister Wolfgang Schaeuble as saying the UK was no longer resisting AIFMD, despite having openly deemed it protectionist. 

Tensions to persist until June

Diplomats insist that tensions will still emerge in talks in June, when the EU's three institutions – the Parliament, the Commission and the Council – lock heads to reconcile their opposing positions.

"We are going to work on trying to find a dynamic compromise which ensures the equal treatment of third country fund managers," Internal Market Commissioner Michel Barnier said ahead of ministerial and parliamentary talks yesterday.

Negotiations are now expected to take place between MEPs, the European Commission and the Council of Ministers ahead of a first-reading vote by the full European Parliament, scheduled for July.

"There are going to be differences," Barnier told members of the press yesterday.

"To be frank, it will come as no surprise to you that the original text from the European Commission is much closer to [French centre-right MEP Jean-Paul Gauzès'] report [a parliamentary draft] than to the Spanish Presidency [of the European Council]," he added.

Commissioner Barnier indicated yesterday that he would try to convince EU finance ministers of the merits of the Parliament's draft proposal, which would see non-EU funds meet certain conditions – like OECD tax rules – to get an EU passport.

This will likely please British observers, who say they are happier with the Commission's thinking on third country funds than that of their European partners.

Home to the majority of the EU's alternative investment funds sector, Britain is in favour of a single passport, while France and Germany are not.

Plot against Britain

Brussels diplomats foresee "some flexibility" in the French and German camps but this will probably only emerge once the EU's three institutions, the Council, the Parliament and the Commission, lock heads in June 'trialogue' talks to clinch a compromise.

In British quarters, the directive has been interpreted as a political ploy to clamp down on London's City as a sensible thing to do after a financial crisis or as a way to lessen the UK's dominance of the sector.

"This is an overarching political message to Britain's financial sector driven by the EU's member states," said sources who did not wish to be named.

"And others just don't have a dog in the fight," the source added.

However, sources at the European Commission tried to sideline any hint of a political plot against Britain, insisting that hedge funds regulation was a priority that was set at the G20 talks of world leaders and not just an EU initiative.

"This position will ensure better transparency and better investor protection while at the same time being on the side of the financial industry when it is working for the real economy," the European Parliament's rapporteur Jean-Paul Gauzès (EPP, FR) said minutes after the vote.

London Conservative MEP Syed Kamall said the Parliament's vote was supported by "an alliance of the Communist, Green, Socialist and EPP groups," creating "a heavily protectionist" directive which will make it "difficult or impossible for investors in the EU to invest in non-EU funds".

"To single out alternative fund managers in this way when they had no direct involvement in the financial crisis is unwarranted and ill-timed when the flows of investment into research companies are so dependent on non-EU funds into venture capital. These entrepreneurs are the future European growth engine. To starve them of funds now would be a mistake," said MEP and ECR (European Conservatives and Reformists' group) coordinator on the Parliament's economic and monetary affairs committee, Kay Swinburne.

"It is never too late to act. The euro crisis reminds us of the urgent need to regulate speculative funds. Yesterday's ECON vote paves the way for regulating all European speculative funds. The majority of ECON MEPs have translated into action the G20 commitment not to leave any financial actor outside the scope of regulation," said Green MEP Pascal Canfin, welcoming the ECON committee vote.

Javer Echarri, secretary-general of the European Venture Capital Association (EVCA), said: "We have fresh hope of constructive debate on the flow of funds between the EU and third countries. A solution that balances cross-border transparency and cooperation with the need for investor choice and finance for European business is an absolute priority.

“A path to tame the damages caused by the worst excesses of hedge fund activity has been identified by the European Parliament. It is now time for the EU Finance Ministers to recognize this route”, said Poul Nyrup Rasmussen, President of the Party of European Socialists (PES) and the initiator of the EU legislation on hedge funds and private equity.

In April 2009, the European Commission proposed a new set of rules for hedge funds and private equity firms, requiring mandatory registration and disclosure of their activities to regulators, while at the same time easing their access to European markets in the long term (EURACTIV 30/04/09). 

The main regulatory component of the proposed legislation is an obligation for EU-based managers of so-called 'alternative investment funds' to register and disclose their activities, in order to improve supervision and avoid systemic risks. 

The obligations are not applied to the funds themselves, but only to their managers, who are considered responsible for key decisions. However, critics said that the exemption of funds from the proposed new regulation would leave hedge funds and private equity free to develop their investment policies, despite the fact that their risk-prone attitudes were strongly criticised during the financial crisis.

  • June: Council, Parliament and Commission begin trialogue to find compromise on AIFMD regulation.

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