More hedge fund regulation is on its way.
In the wake of the Group of 20 meetings in London in early April, French and German politicians swiftly seized the opportunity to roll out a broad set of regulatory proposals for the alternative asset management industry. Given the antipathy that French President Nicolas Sarkozy and German Chancellor Angela Merkel have expressed toward private equity and hedge fund managers, the results are hardly surprising.
The European Commission in late April put forth an ambitious proposal informed by political distaste for hedge funds and designed to curtail the activities of almost every conceivable type of alternative-investment manager in the European Union. It applies not only to hedge funds but also to commodity traders, private equity firms and infrastructure and real estate funds. If approved — and that could happen within the next year — the directive would override existing national regulations and create pan-European rules requiring every firm based in the EU to register in its country (something U.K.-based hedge fund firms already have to do with the Financial Services Authority) and to provide regulators with details on holdings, leverage, risk controls, valuation metrics, custodial arrangements and reporting systems.
The boldest element in the proposed directive is the power it would convey to EU regulators in Brussels to create a pan-European supervisory framework and set the regulatory agenda for all national authorities, including the FSA. Firms would have to seek permission from these authorities to do business, and any change in their investment strategy would have to be approved. Leverage would also be subject to greater control. Asset valuations on funds would have to be conducted by independent custodians, and firms would be required to maintain a minimum level of capital. The most striking part of the proposal is that no foreign firm seeking to market its funds to investors in the EU would be exempt.
“Does this mean that the FSA can now start telling U.S. hedge fund managers what they are meant to invest in?” wonders Andrew Shrimpton, a member of London-based investment advisory group Kinetic Partners and a veteran of the FSA, where he helped monitor the U.K.’s largest alternative-investment funds.
Skeptics of the initiative see it as being more about micromanaging hedge fund firms than advancing worthy goals like improving the assessment of aggregate risk posed by what the EU calls systemically important hedge funds. There’s nothing wrong with that aim, they say, but the EU defines such a fund as one that oversees more than €100 million ($136 million), a tiny sum in the hedge fund world, even if leveraged to the roof.
The EC asserts that its directive will protect investors — never mind that hedge funds aren’t intended for retail distribution, says John Godden, founder of IGS Group, a London-based advisory firm, and that qualified investors are capable of due diligence (and wealthy enough to absorb losses). The proposal is also promoted as a way to improve transparency and accountability across “a single market.”
What seems to have been discounted is the possibility that, by going its own regulatory way, Europe will inspire others to do the same, and that managers may begin to vote with their feet. “If conditions here become unfavorable for them, they will take their business outside the European community,” Godden predicts. “If that happens, the biggest net beneficiary of the proposed regulation may well be Switzerland.”
