Lords Criticize EU Hedge Fund Directive
Monday, February 15, 2010

Echoing sentiments expressed recently by a senior official from the Financial Services Authority, members of a House of Lords committee have warned that plans for regulating hedge funds at European Union (EU) level are unworkable as they currently stand and could lead to a loss of competitiveness for EU alternative investment funds.

While the House of Lords European Union Committee is of the opinion that the broad thrust of the proposed Alternative Investment Fund Management Directive (AIFM) is correct - that the principle of harmonizing regulation for AIMFs is good for investors and the single markets as a whole - it warned in a report released on February 10 that a 'one size fits all approach' "will not work" in practice.

"We recommend that the government seek to tailor the directive in a way that respects the differences between the types of funds it covers," the report concluded. "A possible solution could be to establish broad principles in the directive."

The report goes on to argue that the retail level of protection offered to investors by the directive as currently drafted is not required by informed and experienced institutional investors and high net worth individuals who are able to carry out their own extensive due diligence. "We recognize that the success of these funds has an impact on those not directly involved in the investments industry, including through pension funds," the report noted.

The committee also urged the UK government to seek changes to the directive to ensure that EU hedge fund are not put at a competitive disadvantage companred to funds domiciled outside the EU: "We believe that the government should not agree the directive unless it is compatible with equivalent legislation with regulatory regimes in third countries and in particular in the United States, in order to avoid a situation in which EU AIFMs lose competitiveness at a global level."

There would appear to be a growing consensus within the UK investment community - which potentially has the most to lose from a badly-drafted alternative investment directive - that the regulations in their current state pose a risk on several fronts.

Speaking at the EDHEC Risk Summit on February 8, Dan Waters, sector leader for asset management at the FSA, warned that "significant risks" still exist in the draft directive. "It could still go badly wrong in some important areas," he said.

The Bank of England has already expressed reservations over the directive in its current form, and a recent paper by the Bank's Financial Markets Law Committee highlighted an number of issues in the proposed law which could lead to legal uncertainty and "widespread market disruption."

Lord Myners, the Treasury minister responsible for financial services in the UK, fears that the directive could lead to an exodus of hedge funds and private equity funds from London, and he recently held talks with the Spanish government, which currently holds the six-month rotating presidency of the EU, in an attempt to press home the need for changes to the draft. But with more than 1,000 amendments to the directive having been tabled in the European Parliament, it is likely to be some time before an agreement on the final text can be hammered out.