The AIFM Directive: It's back!

Some of you may recall the AIFM Directive, tabled by the European Commission in 2009. The proposal was aimed at striking down on hedge fund managers, private equity firms, investment trusts and other so-called “alternative investment” funds (i.e. those that do not invest in stock, bonds or cash), in the wake of the financial crisis. That there was absolutely no evidence that these funds had much to do with the crash in the first place seems to have been a secondary concern. That Commission President Jose Manuel Barroso was seeking support from socialist MEPs for his re-appointment was likewise just a coincidence...

Now, as we argued in the first comprehensive impact assessment of the proposal, the industry does need more transparency and accountability, so in that sense, the Commission was correct in looking at new regulation for this sector. But the Commission’s original proposal was fundamentally flawed. Leaving aside the huge number of technical details involved (for a wider discussion see here and here), the original proposal would have paved the way for a world in which investors in these funds, the managers of them, their custodians (that hold the assets of the funds) and the funds themselves were all confined to a life either within the EU’s borders, or a life outside them. This was clearly contrary to best industry practice (for example by increasing concentration risk), the nature of modern finance (which is inherently mobile, global and cross-border) and would have also contradicted the 2009 April G-20 summit conclusions, which instructed world leaders to

“promote global trade and investment and reject protectionism, to underpin prosperity.”

To their credit, MEPs and national ministers, following 18-20 months of negotiations, adopted a far more sensible version of the proposal which kept many of the Directive’s transparency provisions while aligning most of the other rules with global economic realities and the need for inward investment into Europe.

But, as we also argued in 2009,

“The Commission is the dark horse in all of this. The way the Directive is written leaves the EU executive unusually large room for manoeuvre in deciding key aspects of the legislation – including leverage levels, valuation standards and restrictions on short-selling – either in the implementation phase or further down the road.”

This is because, in the so-called Comitology stage, the Commission has the power to lay down ‘technical’ or ‘supplementary’ standards when these are specified in the proposal, with limited involvement from MEPs and member states (for a background see here).

As reported by the FT this morning, this is precisely what the Commission is now seeking to do, in several ways, including

• Tougher liability rules for custodians (which would be liable for the safekeeping of assets, even if the custodian decided to delegate the responsibility to a third party). This could make EU-based banks far more hesitant to operate with partners in emerging economies, in turn undermining investment in those parts of the world.

• Stricter rules on leverage, i.e. how much money a fund manager is allowed to borrow. Interestingly, a recommendation for a more discretionary model of calculating leverage, put forth by ESMA – the EU’s markets supervisor – was rejected by the Commission.

• Fund managers based outside the EU, would face more obstacles before they could market their products to investors based in the EU. As Andrew Baker of AIMA put it,

  “This would be extremely problematic if not impossible to conclude if the regulation prescribes that the co-operation agreements ensure that third-country regulators enforce EU law in their territories.”

Now beyond the boring technical details, this is politically interesting for at least two reasons:

• The Commission is ignoring ESMA, begging the question, what exactly is Commission's relationship with ESMA and the other EU financial supervisors (ESAs), set up in 2010, meant to be. Specifically, whether “technical details” will be allowed to remain technical or become politicised with the ESAs being colonised by the Commission’s agenda.

• Via the Lisbon Treaty, the Commission has increased its powers in the so-called comitology procedure (for the full story, see here). This is an interesting test case for how far the Commission dares to push its luck.

This will go on for some time and we should not jump to conclusions – and clearly, the industry has its own agenda as well. But, the episode is a reminder of one thing: in EU politics, proposals and laws have a curious habit of always coming back.