UK: Hedge Fund Groups Attack Proposed EC Directive For Alternative Investment Managers

Last Updated: 11 June 2009
Article by Philip Rubens
  • New framework for European hedge fund industry including regulatory, governance and disclosure standards, plus minimum capital requirements
  • Directive applies to funds with more than €100 million in assets
  • AIMA calls Directive "ill-considered" and "punitive"
  • Directive could cost industry £3 billion, says Kinetic Partners

Groups representing the UK hedge fund community have criticised the European Commission's proposals to regulate alternative investment fund managers. The draft Directive, published last month, which also covers private equity funds, would create a new European-wide regulatory framework with all hedge fund managers having to meet regulatory, governance and disclosure standards as well as minimum capital requirements.

Announcing the proposed framework, EU Internal Market Commissioner Charlie McCreevy said there was a "global consensus" on the need for tighter regulation and that the recent economic crisis had "underscored the importance of robust risk and liquidity management systems and the need for reliable investor information." According to the Commission, hedge funds and private equity funds in the EU manage around €2 trillion of assets.

However, the Alternative Investment Management Association (AIMA) described the Directive as "ill-considered" and "punitive" and said it would put thousands of job at threat and could even slow down economic recovery. In a statement, Florence Lombard, AIMA Executive Director, said it would also disadvantage European hedge fund managers against those outside Europe and could give them an incentive to move their business elsewhere.

Antonio Borges, chairman of the Hedge Fund Standards Board, was equally critical. Borges said he was "particularly concerned" that the draft Directive opts for "prescriptive" rules rather than adopting a principles-based approach to regulation that has been developed in the UK. He also criticised the Commission for "ignoring" the efforts being taken to develop global proposals, as agreed recently at the G20 meeting.

A "de minimis" exemption in the Directive means that funds with total assets of less than €100 million will be exempt. With this threshold, the Commission estimates that approximately 30% of hedge funds - representing 90% of assets of EU domiciled funds - would be covered by the Directive.

Taken together, critics believe the proposals will place a disproportionately high regulatory burden on hedge funds. Hedge fund regulatory consultancy Kinetic Partners described the planned Directive as "disastrous," and claims it could cost the UK industry up to £3 billion to implement because of the additional costs of holding additional capital, implementing new fund reporting systems, and retaining independent valuation teams, legal advisers and other professional service providers.

For a typical hedge fund manager, Kinetic estimates the costs will be "several million pounds" each year. In addition, it says funds will have to spend heavily to get up to speed on the new directive.

Julian Korek of Kinetic also observed that the hedge funds had invested heavily to comply with the recent EU Markets in Financial Instruments Directive, which the new Directive would be likely to supersede. "The Directive amounts to a huge waste of time for those affected...It's tragic," he said.

Key requirements for hedge fund managers in the Directive will include:

Authorisation: All managers will have to obtain authorisation from the competent authority and demonstrate they are suitability qualified and provide detailed information on their planned activities. This will include: identity and characteristics of the fund, governance of the fund, arrangements for valuation and safe-keeping assets, and systems of regulatory reporting. They will also be required to hold a minimum level of capital.

In addition, managers will also be required to satisfy regulators on the "robustness of their internal arrangements" with regard to risk management, in particular liquidity and counterparty risks associated with short selling, management and disclosure of conflicts of interest, fair valuation of assets, and security of depositary/custodial arrangements.

The precise requirements will be tailored to the investment strategy deployed by the fund.

Treatment of investors: Managers will have to provide to investors a clear description of their investment policy, including the type of assets and leverage, redemption policy, valuation, custody, administration and risk management procedures, and fees, charges and expenses.

Disclosure to regulators: Managers will have to report to the competent authority on a regular basis the principal markets in which a fund trades, its principal exposures, performance data and concentrations of risk.

Leverage: Managers who employ leverage on a "systematic" basis above a defined threshold will be required to disclose aggregate leverage data and the main sources of leverage.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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