EU hedge fund law should not ignore microfinance

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.COM Ltd.

The EU's draft directive on Alternative Investment Fund Managers (AIFM) could have direct implications for the booming microfinance sector, whose specific requirements have not been embraced by the current version of the law, writes Axel de Ville, chairman of the European Microfinance Platform, in a commentary for EURACTIV.

The following commentary was sent exclusively to EURACTIV by Axel de Ville, chairman of the European Microfinance Platform. 

"At the end of 2008, microfinance investment vehicles (MIVs) had invested US$ 6.6 billion in the microfinance sector. Although this amount is modest compared to traditional finance, it plays an important role in financing microfinance institutions (MFIs).

MFIs provide financial services to populations excluded from the banking system. Their objective is twofold: breaking even financially and maximising the social impact of their operations. This particularity explains the growing interest of socially-responsible investors, be they individuals or institutions, in microfinance.

From a regulatory perspective, microfinance investment vehicles were, until recently, considered the equivalent of hedge funds or private equity funds. However, the latter have very different motives, management methods and risk profiles to MIVs. In reality, the risks facing MIVs are those inherent to microfinance, and investing in developing countries in general. These risks are systematically assessed by sector experts and give rise to risk mitigation measures (detailed analysis of credit risk, which in turn is offset by strict investment and diversification policies or hedging instruments, for instance). The result is low volatility and negligible default rates in the microfinance sector.

And yet, the initial Alternative Investment Fund Managers (AIFM) directive, which aims to implement new measures and rules for investment fund managers, makes no provisions for microfinance. Disregard of microfinance's specific nature could lead to the sector's deterioration, due to exceedingly restrictive and ill-adapted regulations. For this reason, European microfinance professionals came together to address this issue.

This initiative emerged from the European Microfinance Platform's working group on Microfinance Funds. The working group was formed in April 2009 on the initiative of three banks – BNP Paribas, Crédit Agricole and Crédit Suisse – and three microfinance investment companies—Incofin, BlueOrchard and responsAbility. Together, these players account for nearly one third of worldwide assets under management by MIVs. The goal was to promote a shared European regulatory framework for microfinance funds.

This group of specialists did not seek to exclude microfinance from regulation, but rather draw the attention of European regulators to the risks of adopting a directive that does not account for microfinance's specific nature. The group proposed solutions for a well-adapted regulatory framework, several which were discussed with European parliamentarians and the directive's rapporteurs. An amendment was ultimately proposed.

This amendment has several advantages. Firstly, it clearly defines what is meant by microfinance, in both developing and developed countries. Indeed, microfinance has evolved not only in developing countries, where it was invented, but also in industrialised nations, where the creation of microenterprises may be an answer to rising unemployment. The second advantage of this amendment is that it avoids a regulatory vacuum for microfinance funds.

The amendment combines two solutions: (i) it binds fund microfinance managers to comply with the AIFM Directive, but applies the principle of proportionality (constraints are proportional to the size of assets under management) and (ii) it provides for the introduction of more specific regulation in the next UCITS V directive. It therefore meets the twin objectives of regulation and sector development."

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