FACTBOX-How European rules will curb hedge funds

May 19, 2010

May 19 (Reuters) – The European Union’s 27 countries and the bloc’s parliament agreed to tighten controls of hedge funds and private equity this week.

Negotiations will now begin between the two to hammer out a final version of the law to regulate the secretive industries by 2012.

Although some issues remain contentious, such as how the new law will treat foreign funds, both parliament and European countries have committed to set up broad controls on a sector many suspect exacerbated the financial crisis.

Here are the highlights from the new law:

* The directive does not lay down a rigid code of rules with caps on borrowing or pay but sets up a “regulatory and supervisory framework” for watchdogs to police hedge funds and private equity.

* It will put hedge funds under the eye of what one senior industry figure dubbed ueber-watchdogs, giving those authorities the power to demand closely-guarded information about how the fund invests or borrows as well as to intervene with curbs.

* Many are sceptical the new pan-European supervisors will have the teeth to enforce order on this financial-services elite. Britain is pushing to water down the power of these new enforcers, while parliament is arguing to give them more clout.

* European countries want hedge funds to inform the authorities why and how they have borrowed to invest. This information can be shared with other watchdogs.

* They also want to give supervisors the power to limit borrowing at a hedge fund if they see a threat to the financial system. Parliamentarians are pushing for more stringent borrowing limits.

* The law would extend what information hedge funds are required to hand over, such as what products and on which markets they are trading as well as outlining key exposures.

A hedge fund would be told to reveal its short-selling positions, something most would be reluctant to do in case the information falls into the hands of market rivals.

The information will typically be widely shared among watchdogs around Europe as well as a new market-risks supervisor, which will be based in Frankurt under the wing of the European Central Bank.

* The authorities will be given power to demand documents from hedge funds, quiz managers, probe telephone or data records as well as launching surprise on-site checks.

* The area where parliament and countries disagree most is on the issue of how to treat foreign fund managers.

Parliamentarians want to give them a passport or licence to do business across Europe if they meet the new standards. But EU countries want to hand out the so-called European passport to local funds.

* The draft law agreed by European ministers on Tuesday would set up a depositary to monitor what is happening to investor money at a hedge fund as well as safeguarding the investments it has made.

* Lawmakers hope this would make it harder to set up sham investment schemes like that of Bernard Madoff, who paid dividends to investors using their own money.

* “The depositary should be responsible for ensuring that investor money is booked correctly in segregated accounts, for the safe-keeping of financial instruments … and the verification of whether the Alternative Investment Fund … has obtained ownership of all other assets,” officials write.

* The law will also impose a loose pay code on hedge fund managers, asking that they stagger earnings over a number of years.

40 percent of bonuses should be delayed over years, for example, to reduce the incentive for managers to take big risks for bumper one-off windfalls.

(Reporting by John O’Donnell; editing by Stephen Nisbet) ((+32 2 287 6817 or +32 473 92 48 90; john.odonnell@thomsonreuters.com))

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