May 1, 2009
The European Union (EU) has become the first jurisdiction to propose a comprehensive framework for direct regulation and supervision of the entire investment funds industry – the proposed Directive on Alternative Investment Fund Managers.
The EU already has an established regime for regulating investment funds known as UCITS (Undertakings for Collective Investment in Transferable Securities). UCITS invest in a prescribed range of transferable securities and/or other liquid financial assets and are composed of a collective pool of investments from retail investors.
The draft proposal which was published on 29 April aims to regulate investment funds within Europe which are not already covered by the UCITS regime, referred to in the proposal as alternative investment funds (AIFs). Rather than imposing requirements on the AIFs themselves, the proposals target AIF managers (AIFMs). It was considered that a broad regime focusing on those who manage investment funds rather than a defined set of entities prevalent in the investment fund world (e.g. hedge funds) would be more effective and less easy to circumvent, with enhanced scrutiny on leveraged hedge funds.
Currently, this sector is regulated in the EU through a combination of fragmented national legislation as well as some general provisions of EU law, in addition to voluntary industry standards in certain cases (e.g. the Walker Guidelines in the UK). With investor protection as its fundamental aim, the European Commission’s rationale for the proposals is the introduction of harmonised regulatory standards and enhanced transparency.
Early drafts of the directive had been leaked to the public weeks before and received a barrage of criticism particularly from different interest groups across various member states and not surprisingly, the hedge fund industry. The final draft proposals however have come under even greater attack with the UK Financial Services Secretary and key UK and European industry bodies (in particular the British Private Equity & Venture Capital Association and the European Private Equity & Venture Capital Association) voicing their strong opposition to proposals they consider are "deeply undesirable" and "immensely damaging" to industry.
Some of the main points under the proposed legislation are set out below.
Who Is Regulated?
All EU domiciled AIFMs that meet either of the two threshold tests below will be regulated:
Continuing Reporting and Other Obligations
Pan-EU Marketing Restrictions & Requirements
The increasingly fervent debate around the proposals highlights a long-standing policy divide within different states within the European Union. A number of European member states (led by France and Germany) are of the view that the "locust" like-behaviour of hedge funds, in particular activist hedge funds, has got out of control and needs to be curbed. The latest round of commentary from the French government raises the spectre of hedge fund managers in the form of a "Trojan Horse" attacking the European economies. Other member states, notably the UK, take the view that whilst there is room for greater transparency and guidance on conduct, generally for this part of the industry, self-regulation and a principles-based approach which supports voluntary codes rather than black-letter law requirements will preserve and enhance, over the long-term, market operation and efficiency.
When one looks at the practical impact of the proposals – the context of the debate becomes clearer. The threshold of €100m implies that nearly 30% of hedge fund managers, managing almost 90% of assets of EU domiciled hedge funds, would be covered by the proposed Directive. However, as the UK is home to 80% of European hedge funds, it is likely to bear the brunt of the burden of the proposed new regulation. The other fear of many industry bodies is that the proposed new rules are premature and run the risk of placing the UK and Europe at a significant competitive disadvantage against the US in retaining and attracting the hedge fund industry, where President Barack Obama has recognised that hedge funds are the future, focussing his attentions instead on the banks.
Whilst it is unlikely that the "traditional" UK "comply or explain" voluntary code model for the alternative asset management industry is likely to survive in the wake of the global financial crisis and the public hunt for scapegoats, whether in the form of banks or hedge fund managers, there are serious questions of principle and approach arising from the draft new proposals. Government experts (the Turner Report being one key example) have recognised that hedge fund leverage is typically well below that of banks; the European Commission’s own press release acknowledges that private equity houses are "not regarded as posing systemic risks". If this is the case, how can the breadth of the proposed rules be justified?
The proposed legislation will now be passed to the European Parliament and European Council for further debate and negotiation, with an industry consultation process also expected. Even if final legislation is agreed by the end of this year, a European Directive requiring implementation by EU member states would not be expected to come into force until 2011. Now is the time for lobbying … the debate has just begun.
 Directive 85/611/EEC, as supplemented and amended by Directive 200/1/107/EC and Directive 2001/108/EC, and as further supplemented and amended from time-to-time.
Gibson, Dunn & Crutcher LLP lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work or Selina Sagayam (+44 20 7071 4263, [email protected]) in the firm’s London office.
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