E.U. Moves Ahead with Restrictive Hedge Fund Legislation Despite Opposition
Facing criticism from London and the U.S., the E.U. continues to move ahead with proposed legislation designed to restrict hedge fund speculation in Europe. The proposed law is meant to do three things: protect investors, reduce risks to the financial system and increase the transparency of hedge fund operations.
U.S. Treasury Secretary Timothy Geithner has gone so far as to suggest that the new legislation aimed at regulating hedge funds and other alternative investment vehicles would be discriminatory against U.S. fund managers and banks. In a letter cited in the Wall Street Journal, dated March 1, Mr. Geithner said,
We are concerned with various proposals that would discriminate against U.S. firms and deny them access to E.U. markets that they currently have.
EU representatives maintain, however, that the aim of the proposal was to protect the investors and the people that suffered from the crisis and that the legislation was not discriminatory because once a fund manager had met the European standard, it would have a passport to the whole E.U. In the same WSJ article, E.U. Commission spokesman Amadeu Altafaj fired back at Geithner,
The new hedge fund rules do not discriminate against foreign players and are not protectionist.
One of Mr. Geithner’s central concerns (and surely one of those of many people in the European fund-management industry) are parts of the proposed law that govern access to the E.U. for fund managers and custodian banks based in so-called third countries. The proposal would also affect fund managers, even those based in Europe, that keep their funds in third countries.
British Prime Minister Gordon Brown met with French President Nicholas Sarkozy on Friday to discuss the proposed legislation, as it poses a potential substantial threat to Britain’s economy. According to the WSJ, Britain is home to an estimated 70% of the European hedge fund industry, along with 80% of its private equity funds. The proposed legislation could place serious restraints on British trade. In contrast to the French hedge fund industry, which is largely focused at home, Britain’s is much more global in orientation.
Many London-based fund managers also keep their funds in locations such as the Cayman Islands would be affected by the law, and it would also constrain these funds from marketing services in the U.S. and elsewhere. This would essentially force London managers to choose between the E.U. and the rest of the world, possibly encouraging some to leave London altogether.
Unfortunately, for all of its clout within the E.U., Britain alone lacks the political power to block the passage of the proposed legislation. That’s because the decision among the ministers is made by qualified majority voting and the U.K. mostly likely will not be able to muster enough votes to block it (90 votes are required to block it and the U.K. only has 29). According to the WSJ, there are a few other countries potentially against the legislation (Czech Republic: 12 votes , Hungary: 12 votes, Sweden: 10 votes, Austria: 10 votes, Slovakia: 7 votes, Ireland: 7 votes, Malta: 3 votes, the Netherlands: 13 votes, Slovenia: 4 votes, and Cyprus: 4 votes), but whether there are actually enough votes to block the legislation can’t be predicted.
There’s slim chance of compromise or negotiation. In the wake of so many hedge funds’ speculation (specifically in credit default swaps) being blamed for worsening the economic situation in Greece , France seems determined guarantee that no U.S. fund — or London-based fund with assets held in a tax haven such as the Cayman Islands — gets access to its market. Many London-based funds see the proposed legislation as so restrictive that they may very well be tempted to move elsewhere.
The specifics of the new legislation remain uncertain. The Associated Press speculated that managers of large funds doing business in Europe would most likely be required to register with local market regulators and provide information periodically about their trades and risk exposure to prove they don’t pose a threat to the financial system. In addition, they would probably be required to disclose their overall trading strategy, their risk management system, explain how they value and store assets, and would likely have to possess a minimum level of capital in order to cover any potential losses. Another sticking point for France, in particular, is making depositories liable for losses incurred. Whether or not these rules would allow for the participation of foreign funds, such as those based in the U.S., remains to be seen.
What could be the answer is a so-called equivalence rule, which in effect would seek to grant funds from countries with good regulatory regimes the right to market funds in the E.U. However, it could potentially take years to put the equivalence rule into place.
The WSJ posed the question of whether or not an interim regime could be utilized in the meantime which would, for example, allow a U.S. fund to market in the UK provided it met UK national regulations. But, as mentioned, given attitudes in Paris, such a compromise is unlikely.
Although the final shape of the proposed new laws are far from final, the European Parliament is set to vote upon them in July. If the legislation passes, the new laws could be in effect for E.U. funds as soon as 2011 and for funds outside the E.U. by 2014.
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