EU Shuns Funds?

by Shane Fitzgerald

Europe is divided over proposals to regulate alternative investment funds.

One of the most controversial elements of the European Commission’s response to the financial crisis has just arrived in the European Parliament, ripe for criticism, debate and amendment. Upcoming sessions of the Parliament and the European Council will grapple with a draft directive, put forward by EU Internal Market Commissioner Charlie McCreevy in April 2009, aimed at regulating the activities of Alternative Investment Fund Managers (AIFM). The AIF Management sector in the EU is substantial, diverse and disproportionately based in a small number of member states (preeminently the UK but also Ireland), so proposals to regulate it were always bound to be politically contested. Indeed, in what looks set to be the latest installment in a long-running feud between the City of London and continental capitals over financial supervision and regulation, protests against the directive have so far been numerous, vocal and sustained.The EU AIF sector managed around €2 trillion in assets at the end of 2008 and includes entities such as hedge funds, private equity funds, commodity funds, real estate funds, feeder funds and infrastructure funds (for the purposes of this legislation, AIFs are defined as as all investment vehicles not covered under existing UCITS rules). Currently, the activities of AIFs are regulated by a combination of national regulations and general provisions of Community law, supplemented in some areas by industry-developed standards. However, as Commissioner McCreevy’s draft directive – building on those arguments of the de Larosière Report concerning the “parallel banking system” – makes clear, the current regulatory environment does not adequately reflect the cross-border nature of risks related to these potentially systemically important market players.

With this in mind, the proposed directive aims to:

  • Establish a secure and harmonised EU framework for monitoring and supervising the risks that AIFM pose to their investors, counterparties, other financial market participants and to financial stability; and 
  • Permit, subject to compliance with strict requirements, AIFM to provide services and market their funds across the internal market.

Industry associations complain that the draft directive was published hastily with little industry consultation and, as it stands, will impose significant costs on sectors that were not directly responsible for the financial crisis. They are supported in their campaign to dilute the new rules by British politicians and diplomats worried about the potential impact on City tax revenues. Mayor of London, Boris Johnson, (in Brussels recently to defend the financial services industry and lobby against this directive)  fears that heavy regulation of the sector will divert investors away from the EU and allow rival jurisdictions to increase their share of the lucrative market. With 85% of EU-based hedge fund assets based in the UK, his is an obvious and legitimate concern, but the broader debate has quickly become politicised along the lines of Anglo-American vs. continental interests.

The UK seems in little doubt that this is a politically instigated initiative, motivated by continental jealousy of the City of London powerhouse. The UK-based Alternative Investment Managers Association (AIMA) argues that the directive makes it so difficult and costly for non-EU funds and managers to access the EU market that it is “protectionist in effect, if not in intent”. This argument was taken up by a delegation of US congressmen who visited the Parliament on September 2nd to protest against provisions that dictate extra-EU funds must endure a three-year waiting period before they are allowed become fully active across the internal market. Criticisms of the draft text have been voiced from other quarters also, with a consortium of eight Dutch pension fund managers the latest to call for significant amendments. This comes after Swedish diplomats, largely in response to British concerns, recommended wholesale changes to the document in an issues note circulated ahead of recent meetings (Sweden currently holds the EU Presidency and has made the implementation of supervisory and regulatory reform a top priority).

Meanwhile, France and Germany continue to emphasise the need for much tougher cross-border rules. While Spain, which takes up the EU presidency next January, has indicated its provisional support for the draft directive, French Finance Minister, Christine Lagarde, has said that France wants much tighter regulation of the funds industry and called the existing proposals “regulation at its minimum”.

The UK would appear to have an influential champion in Sharon Bowles, the British Liberal MEP who is the new chair of the European Parliament’s Economic and Monetary Affairs Committee. Questioned recently on the need for the directive, the holder of one of the most important committee positions in the Parliament said, “Personally, I think I could have lived without it”. Fund managers in London will still be watching nervously as the parliamentary process unfolds, knowing as they do that the British Conservatives, though set to seize power at home in 2010, have ceded much influence over the process by removing their delegation from the EPP-ED grouping, which has been assigned responsibility for the report. The EPP has since appointed French MEP, Jean-Paul Gauzès, as Rapporteur. Mr. Gauzès not only seems set to firmly resist British efforts to dilute its contents but is determined to strengthen its provisions in a number of areas. He has form in shepherding difficult legislation through the EP, having been Rapporteur for the similarly controversial directive on the regulation of credit ratings agencies in the last parliament. Though he faces stiff opposition, he has the support of powerful MEPs such as Poul Nyrup Rasmussen, head of the Party of European Socialists, who argued in London recently for the final directive to include lower thresholds, enhanced capital adequacy provisions and a tougher approach to offshore fund managers – all of which would be anathema to the industry lobby.

While emphasising the political difficulties that he faces, Gauzès promises a draft text by November with adoption of its provisions possible by December. In contrast, Bowles has suggested that the parliamentary process will run well into 2010. The directive is due to be debated formally for the first time in the European Council in November before the Presidency handover from Sweden to Spain on January 1st. Whenever the final legislation emerges, we can be sure that it will look very different to the current draft and that it will have been hotly contested to the last.

This article was first published by the Institute of International and European Affairs. Access the original here.