Hedge funds may still escape EU pay crackdown

July 7, 2010

Hedge funds should stop panicking. It is true that some have been lumped in with banks on tough new European Union rules regulating pay. But there are a number of factors that should defuse the threat.

Managers have understandably looked askance at the new rules, which were passed by the European Parliament today. They feel that interfering with their pay is unjustified, given that the sector was not the prime driver of the financial crisis, and did not receive taxpayer bailouts.

Moreover, methods that should work well for banks — such as requiring 70 percent of the upfront award to be paid in shares or other non-cash instruments — are not relevant to hedge funds, which are mostly privately owned.

At first glance, the rules might prompt some of London’s leading hedge funds to dust off their plans to relocate to Geneva. But they are insulated in two ways.

First, not all are actually affected by the remuneration reforms, which were tacked onto the latest version of the EU Capital Requirements Directive that sets rules for bank capital. Larger funds that manage pots of cash separate from their main funds have been lumped in with the banks. But smaller-scale hedge funds will be covered by another set of rules: the much-maligned Hedge Funds Directive, which is still being thrashed out.

More fundamentally, the proposals appear to give plenty of leeway to national regulators. The directive explicitly states that supervisors can apply the reforms “in different ways according to [the institution's] size, internal organisation and the nature, scope and complexity of their activities”.

That would suggest the Financial Services Authority can restrict the new reforms to banks, while leaving hedge funds alone. Given that the FSA has already internally concluded that only bank pay should be regulated, it would presumably exercise that right.

Hedge funds cannot afford to be complacent. Their own directive due in the autumn has less onerous guidelines on pay, though EU policymakers eager to give the City of London a bloody nose could still change the game. But as things stand the pain from the EU’s new bonus rules looks likely to be felt only by the bankers.

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