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.

Rasmussen v. Lord Myners (and the rest of the City)

In case you missed it, Open Europe last week organised a debate on the EU's proposed new rules for hedge funds, private equity firms, and various other funds currently not regulated by EU law. In good-old Brussels fashion the proposal goes under the acronym AIFMD (Alternative Investment Fund Managers Directive), and has been recieved with some scepticism in the City of London - to put it mildly.

In a Guildhall filled to the brink with angry pin-striped suited City people, the AIFM Directive's key proponent, Poul Nuryp Rasmussen, fearlessly explained why he didn't think the proposal goes far enough. The arguments aside, you have to give Rasmussen credit for his dedication, courage and willingness to walk into what can only be described as a lion's den. And he certainly stood his ground. During the course of the debate, it became evident that Rasmussen knows more about the alternative investment industry than the industry itself perhaps feels comfortable admitting. It would be a mistake to underestimate him, particularly as he still - despite no longer being an MEP - has much input into what kind of amendments the socialists in the EP will put down on the draft Directive.

Rasmussen carries a lot of respect around Europe. During the 90s he took on the unions in Denmark in a bid to get the Danish economy up and running again - a point he was keen to make at the end of the debate. This, he said, highlights that he's a "pragmatic Scandinavian" and a "pro-growth guy" (in addition to being an economist). He's not out to get the City of London. A Scandianvian economist with pragmatist credentials is the nightmare opponent for the alternative investment industry, insofar as he'll draw a lot of sympathy from around Europe (and hedge fund managers aren't exactly the most popular kids on the block). However, notwithstanding his courage and the rest of it, the arguments are against Rasmussen on this issue - as we've outlined here.

The main counter-blast to Rasmussen's arguments did not come from any of the industry representatives, but from City Minister Lord Myners, who used surprisingly strong rethoric - no doubt mindful of his audience. In particular Lord Myners hit out at "the lamentable lack of consultation" which preceded the Directive, and said that the proposal amounted to "protectionism hiding as if it were protection".

One of the most interesting admissions from Rasmussen was that the Directive was designed to keep fund managers from the rest of the world out of the single market, unless they "pay a price". "No one can have my Danish passport", Rasmussen said. As we've argued many times before, this type of protectionist thinking remains one of the EU's greatest flaws. Whether it's raising barriers to global capital flows and investment, or free trade in products and agricultural commodities, this kind of approach leaves everyone worse off.

This flaw is more than enough reason to oppose the draft Directive in its current form.

Showdown over alternative investment

In HFM Week, we're today setting out our thoughts on one of this year's most contentious EU proposals: the Directive on Alternative Investment Fund Managers (i.e. stricter rules for hedge fund and private equity managers and various other more or less obscure managers with alternative investment styles). The proposal is up for discussion and amendment in the European Parliament and the Council this autumn.

It's clear that there will be a Directive, but exactly what it will look like is a completely different story. In a nutshell: The Directive will - quite literally - force more transparency on fund managers, while giving them the opportunity to market their products across the EU once they've been authorisied to do so. Within reason and market practice, these are no bad things.

However, overall, the Directive is in danger of becoming a prime example of bad business law - especially when viewed through the prism of the Commission's own 'better regulation' principles. As we argue in the article, the Directive's objectives and benefits are unclear, it is riddled with legal uncertainty, and it is inconsistent with both existing regulations and prevailing market practices. Perhaps most critically, the Directive is protectionist to its very core.

The battle will primarily take place over the Directive's protectionism and the provisions which seek to overturn how managers are stuctured and how they go about their business (which could seriously harm the industry, restrict investor choice, etc.).

In the absence of a proper Impact Assessment on the proposal from the UK Government, Open Europe will soon publish a report on the possible impact of the Directive on the industry, investors and the wider economy. Watch this space.