FACTBOX-How will new EU rules control hedge funds?

October 11, 2010

FACTBOX-How will new EU rules control hedge funds?

BRUSSELS, Oct 11 (Reuters) – France is ready to drop objections to a key part of a law to tighten rules on hedge funds in exchange for concessions from Britain, a senior diplomat has said, moving to end a row that threatened to harm relations with Washington.

Following are some key points about the proposed legislation.

* The draft law does not lay down a rigid code of rules, such as a cap on hedge-fund borrowing or pay, but sets up a framework for watchdogs to police hedge funds and private equity firms.

* Most significantly, the law would put hedge funds under the supervision of a pan-EU regulator, one of three new watchdogs the European Union will set up from January next year.

The watchdog would have the power to demand tightly held information about how funds invest or borrow money. It could also intervene with curbs on trading, such as a ban on short-selling.

* Think tanks and finance experts are sceptical about whether the regulator, with only as many staff as the financial supervisor on the small island of Jersey, will have sufficient clout to make powerful hedge funds adhere to the rules.

* At the heart of the row about how the rules should look is a passport scheme or licence for foreign hedge funds to do business throughout Europe.

Governments and lawmakers in the pan-EU parliament are divided over the issue, with many in favour of keeping the current system, which requires foreign funds to apply for permission to sell to investors on a country-by-country basis.

The United States says refusing a passport unfairly blocks foreign funds from Europe.

* Under the draft being considered, EU countries want hedge funds to inform authorities of how and why they have borrowed money to invest. The information could 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. EU parliamentarians are pushing for even more stringent borrowing limits.

* The law would extend the range of 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.

For example, a fund could be told to reveal its short- selling positions, something most would be reluctant to do in case the information were to fall into the hands of rivals.

The information would be shared among watchdogs around Europe as well as a new market-risks supervisor, to be based in Frankfurt under the wing of the European Central Bank.

* The authorities would be given powers to demand documents from hedge funds, to quiz managers, and to probe telephone or data records as well as launch surprise on-site checks.

* The law will set up a system of guardians 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 prevent sham investment schemes like that run by Bernard Madoff, who paid dividends to investors using their own money.

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

Forty percent of bonuses should be staggered over a number of 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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