E.U. Hedge Fund Reform Stalled For Now
Tuesday’s meeting of the European finance chiefs in Brussels resulted in an unsurprising stalemate over proposed Alternative Investment Fund Manager legislation to place restrictions on hedge fund activity in the E.U., an E.U. official said. The AIFM legislation was set to be vote upon by the Economic and Financial Affairs Council (Ecofin), but the item was deleted from the agenda by Spain, which holds the rotating E.U. presidency, shortly before the start of the meeting. E.U. leaders agreed to postpone talks about the legislation until May or June, by which time they hope to gotten the lone dissenter, Britain, on board with a compromise deal.
Unfortunately for the rest of Europe, any attempt to regulate hedge funds in continental Europe depends on one thing the continental Europeans cannot control or require–the cooperation of Britain. As over 70 per cent of Europe’s hedge funds and alternative investment companies are based in Britain, the decision to take a couple more months to try to reach consensus was likely a wise one, as any legislation not endorsed by Britain would probably end up being ineffective. Spanish Finance Minister Elena Salgado said in an Associated Press article that her country was in talks to broker a deal with “as many concessions as possible” to get the full agreement of all 27 finance ministers by the time they come together again this the summer.
“It’s a good outcome for U.K.,” an official from the British Treasury was quoted as saying in the New York Times, who added that the British government was focused on “getting a deal that makes the system stronger without sacrificing competitiveness.” Chancellor Alistair Darling, who has been seeking more concessions to prevent the blocking of international firms from the European market, believes that the passage of the legislation as is would have been considerably damaging to the hedge fund and private equity industries as well as to returns made by pension funds. In an article on The Independent UK, the Chancellor was quoted as saying the ministers must not put Europe and its primary financial center, London, “at a competitive disadvantage”. Mr. Darling went on to say,
That would only drive more funds to less well-regulated offshore centers. That’s why we agreed today that further discussions are needed. There is no free pass for hedge funds. Tougher regulation is necessary. But nor can there be a deal at any price. Europe must get this right.
The legislation, proposed last year by the commission, had been intended to limit hedge fund speculation, monitor risk taking at the expense of the European financial system, and create greater transparency in a secretive industry that many politicians blamed for exacerbating fiscal problems in Greece through betting on its debt. In order to market themselves to investors within the E.U., funds based outside the E.U. would be required to comply with the rules outlined in the new legislation, which include restrictions on bonuses and leverage. It remains unclear if foreign-based hedge funds would be allowed to operate in the E.U. under the new legislation and, if so, to what extent and in what capacity.
Finance ministers were unable to resolve a dispute between Britain — which, like the U.S., opposes the restrictions of an industry important for London’s financial center–and France and Germany, which support the restrictions. The new legislation, if passed, could potentially block foreign funds from Europe if they aren’t subject to tight oversight at home. The legislation is meant to target funds in tax havens like the Cayman Islands where supervisors might not be closely monitoring their risk exposure.
The shake-up of the E.U.’s financial services sector is led by the E.U.’s financial markets chief, Frenchman Michel Barnier. Barnier, irked by unwelcome opinions from all sides, said in the AP article that he was “not amenable at all to pressure” and would not take instructions “from Paris or London and certainly not from Washington. We need to work together without there being any pressure on either side, that’s my state of mind in dealing with the Americans.”
The U.S. and Barnier also disagree on how to handle large banks that pose a risk to the wider economy. While President Obama has spoken about banning banks from trading on their own account in addition to demanding they abandon stakes in hedge funds and private equity, Europe has a more lenient view. According to Reuters, this “tug-of-war” will put pressure on the Group of 20 as they continue their regulatory crackdown on banking and the hedge fund industry.
Ominously, a Bloomberg report just out today is quoted as saying:
Nearly two-thirds of institutional investors polled by the Brussels-based European Private Equity and Venture Capital Association said yesterday they would “substantially” reduce their holdings in European venture capital if the proposals go through, according to a survey of investors with 560 billion euros ($766 billion) under management.
The article goes on to speculate that the protectionist aspect of the legislation could spark a trade war if it is passed. Earlier this month, Geithner warned Barnier that the U.S. would hit back with regulation of its own if the E.U. passed with the proposed AIFM legislation. With any luck, however, compromise will be reached and the more offensive terms of the legislation will be watered down to be more palatable to investors and hedge fund managers alike.
“We believe that the vast majority of European officials agree with the G-20 goals of achieving a regulatory framework that is global and avoids any kind of protectionism,” London- based Alternative Investment Management Association Chairman Todd Groome said in a Bloomberg article. Let us hope so.
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