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Comment: Regulate in haste, repent at leisure


When a piece of legislation is so roundly criticised on all sides as the European Commission’s proposed Directive on Alternative Investment Fund Managers, attacked by the alternative fund

When a piece of legislation is so roundly criticised on all sides as the European Commission’s proposed Directive on Alternative Investment Fund Managers, attacked by the alternative fund industry as bureaucratic and punitive and by Europe’s socialists, as well as the French government, as toothless and ineffective, one might assume that its draftsmen have got the balance right. Alas, that may well not be the case.

The first thing to remember about the draft directive is that internal market commissioner Charlie McCreevy has been coerced into producing it. McCreevy has made amply clear over the past year that he does not believe the pan-European regulation of alternative funds is necessary either from the perspective of reducing systemic risk or to protect professional and institutional investors who are supposed to be know what they are doing, and who should be fired if they don’t. Yet here is a blueprint for pan-European regulation of the industry.

It is popularly believed that the European hedge fund industry is unregulated. It is not. Managers accounting for up to 80 per cent of industry assets are based in and around London and regulated by the Financial Services Authority in the same way as other kinds of asset managers. Managers based in other European Union countries, France for instance, are regulated too. So where is the problem?

The problem is that many European politicians, a depressing number of them in a position to wield government power, have been looking for an opportunity to punish what they see as the rapacious greed of the hedge fund and private equity industries, and the global credit crisis and economic downturn has provided it.

Never mind that hedge funds did little if anything to exacerbate the crisis and that they and their private equity colleagues are implicated mainly as victims who have lost a lot of their investors’ money and their own personal wealth. The opportunity to clamp down on a sector that has few friends in high places (and paid insufficient attention to making any, until it was too late) was irresistible.

The very smallest alternative managers will not be caught by the directive, and the largest may grin and bear it, unless they decide that life would be easier outside the EU’s purview (Switzerland may not be far enough – it adopts a wide swathe of EU directives into its national legislation and has been bullied into adopting international tax transparency standards with, in the end, considerable ease).

Those in the middle are likely to find the regulatory burden difficult. Hopefully by the time it comes into force in 2011 or later the industry will have recovered from its current slump, otherwise it could well prove the coup de grâce for managers struggling to operate profitably.

The draft directive sets out a framework that the Commission seems to hope will encourage the development of a thriving, well-regulated pan-European market for alternative investments, with a common set of rules for public placements (which would be a good thing) and, from 2014, an avenue for funds based in other (read offshore) jurisdictions to be marketed within the EU, as long as those domiciles toe the line on regulation and tax transparency.

That may as be. However, funds currently domiciled in centres such as the Cayman Islands and British Virgin Islands can continue to be sold to European investors under the current national regulatory arrangements. At the moment it’s hard to see what incentive exists for managers to conduct all their operations under the EU regulatory umbrella – which rather defeats the stated aim of increasing systemic stability, if that is what the new legislation will deliver.

Again, the draft directive is misconceived because Europe does not have a regulatory problem with alternative asset managers. The US does, but is moving to address it. Not everything in the EU proposals is daft, pointless or counterproductive, but enough of it is to make the industry and its investors (led by ordinary people’s pension funds, let’s not forget) weep with frustration. And the idea that some EU member states and the European Parliament might succeed in toughening up the supposed weaknesses of the legislation doesn’t bear thinking about.

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