Financial Regulatory Forum

SNAP ANALYSIS-EU states tone down hedge fund rules

By Reuters Staff
October 19, 2010

By Huw Jones

LONDON, Oct 19 (Reuters) – European Union finance ministers have reached a compromise on the bloc’s first set of rules to directly supervise managers of hedge funds, private equity groups and other alternative investment funds from 2013.

Foreign funds will face a two-year delay until 2015 in obtaining a “passport” to operate across the 27-nation bloc.

Negotiations over the new rules have taken months due to a stalemate between Britain, home to the EU’s biggest hedge fund centre who wanted to tone down some elements, and France, which pushed for tougher regulation.

The new rules introduce mandatory authorisation, reporting requirements, stricter rules on use of custodians to protect investors and remuneration safeguards to avert excessive risk-taking.

WIDER CONTEXT

* The European Parliament has joint say with EU states on the new rules and was closely involved in Tuesday’s negotiations. Parliament is expected to formally give the nod next month.

* Currently managers are regulated by national supervisors, with marketing permissions ranging from fairly broad in Britain to very limited in France, Italy and Spain.

* The bulk of Europe’s hedge fund industry is based in Britain where the Financial Services Authority has already introduced registration and reporting requirements on managers of leading funds.

* The EU law enables the bloc to fulfil a pledge it made to the Group of 20 leading countries to introduce authorisation and reporting requirements on managers of hedge funds to increase transparency in a sector that was nevertheless not blamed for the financial crisis.

* The United States approved a reform of Wall Street in July that included only registration and supervision of hedge funds.

* The EU rules go much further than what the EU agreed with the G20 as they include private equity groups and managers of other alternative funds like real estate.

* The rules will also regulate how non-EU fund managers and funds operate in the EU.

* Tuesday’s deal is much less draconian than the original draft law from the European Commission at the height of the financial crisis.

* Hedge fund industry officials say they can live with much of what’s in the final deal now that it has been toned down.

CONTENT

* Injects greater objectivity into how alternative funds are valued, which could bump up costs.

* The new rules introduce curbs on excessive remuneration in the sector, bringing it in line with pay limits introduced in the banking sector. Industry draws comfort after the UK’s FSA said it would apply the curbs in a proportionate way.

* Capital requirement will be imposed.

* Fund managers will need approval from their supervisors on how much risk-taking or leverage they can have though this stops short of earlier industry fears of a fixed leverage cap.

* Offers the possibility for the first time from 2013 of a pan-EU “passport” for a local fund to market itself across the bloc once it has obtained authorisation in a member state.

* From 2015 — later than Britain wanted — non EU managers and funds can obtain a passport to operate in the EU if they meet similar conditions.

* In the meantime, non-EU managers and funds continue to obtain national authorisation to operate on a country-by-country basis. Some new transparency requirements will be set for non-EU managers until passporting is introduced in 2015.

* There will be tighter controls on the custodians that alternative fund managers use to safeguard investors’ assets so that if the fund gets into trouble, investors can retrieve the assets quickly. Costs likely to increase as a result.

* Industry officials expect few non-EU managers will want to comply with the full EU regime to obtain a passport as they tend to target one or two countries only anyway and the costs of full compliance would probably outweigh the benefits.

* Private equity groups will have to disclose what their strategy is as part of wider efforts to stop any “asset stripping” moves.

* As sought by France, the new rules will give a central role to the new European Securities and Markets Authority that will be launched in January in deciding on passports for non-EU managers.

((Reporting by Huw Jones, editing by Hugh Lawson; huw.jones@thomsonreuters.com; + 44 207 542 3326))

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