Hedge fund associations in the UK continue to mount pressure against the European Commission’s Alternative Investment Fund Managers (AIFM) draft directive set for adoption as early as this autumn. On July 7, Paul Myners, the UK Financial Services Secretary to the Treasury, who was speaking at an Alternative Investment Management Association (AIMA) event, noted that the draft needs major surgery before being approved. Lord Myners expressed concern about the protectionist impact of the directive, stating that the UK government was reaching out bilaterally to leverage natural alliances and win over others in Europe to rework some of the provisions in the directive.

The reaction of other industry associations, most of them in the UK, but also in Sweden, has been equally negative and reflects their perception that only limited consultation has taken place. The European Private Equity and Venture Capital Industry wrote in a recent executive summary: “While the explanatory memorandum of the draft directive recognises the differences between different types of funds and associated risks, the legislative proposal does not take these differences into account. As a consequence, it would impose undifferentiated provisions, which are mainly directed at hedge fund strategies, an area where there are concerns about systemic risk to the financial markets, upon all alternative investment managers. This would result in private equity and venture capital firms being burdened by inappropriate, irrelevant or disproportionate regulations.”

Scope wider than expected

Not only was the scope of the directive released in late April much broader than expected, but also, the provisions in the draft were much more extensive than originally believed, according to a new report by accounting firm Price Waterhouse Coopers (PWC) on the regulation of hedge funds around the world. While the draft will be subject to much lobbying and negotiation in the coming weeks before it is considered by the European Parliament, most observers believe the basic thrust of the directive will remain intact. Compliance with the requirements would be sufficient to permit AIF managers to market their funds to professional investors in other member states.

 The AIFM directive aims to cover EU-based managers of alternative investment funds such as hedge funds, or all non-UCITS investments, of over €100m and private equity funds of €500m. The draft proposes that EU hedge fund managers with assets under management of €100m or more will be subject to a minimum level of capital of €125,000 plus a further 2bps of the value of assets under management in excess of €250m. In addition, managers will have to register with regulators in their home country, adhere to minimum capital requirements and leverage limits. Approved managers will receive a passport to market their investments across the 27 member states. “The first impact will be higher costs for fund managers resulting in higher fees for investors. The second will be to put pressure on UK-domiciled hedge funds to change jurisdiction, directly impacting the UK economy where 85% of European hedge fund managers are domiciled,” warns one industry source who is particularly troubled by articles 22-25 of the directive.

These articles address the issue of high levels of leverage used by alternative hedge fund managers, requiring them to disclose their exposure on a systematic basis to competent authorities. Article 25 of the guidelines goes further, setting limits on the use of leverage. “In order to ensure the stability and integrity of the financial system, the Commission shall adopt implementing measures setting limits to the level of leverage alternative investment managers  can employ… measures taken by the competent authorities of the home member states shall have a temporary nature,” according to the Directive.

“What is clear is that the financial environment in which hedge funds operate has changed fundamentally. The regulators are rewriting the rules,” notes the PWC report. “Hedge fund managers need to get up to speed quickly with the proposed new rules.” The Directive is the first attempt in any jurisdiction to create a comprehensive framework for the direct regulation and supervision in the alternative fund industry. A similar process is underway in North America, though the US is moving at a slower pace and with a much narrower scope and a lower appetite for a root and branch rewriting of the rules, which could lead to serious competitive disadvantages for EU managers, warns the PWC report. The US House Sub-committee has finished a hearing on “Perspectives on Hedge Fund registration.” There is a bill proposing an amendment to the Investment Advisors Act of 1940 which would lead to a mandatory registration regime for all US investment advisors and non-US investment advisors if they have US clients.

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