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The two drafts differ in some areas, for example the Econ version requires non-EU based fund managers to comply with various standards in order to market their funds to EU investors, whereas Ecofin suggests that national regulations should apply. Both Econ and Ecofin have softened their stance on leverage controls, and managers would be able to set their own leverage limits as long as they report to national regulators. The Directive has also been softened in relation to portfolio company disclosure requirements as now firms with fewer than 50 employees would be exempt from disclosure rules.

The most recent versions of the Directive by both Econ and Ecofin include new measures concerned with remuneration, which have been taken directly from the banking directive and have been deemed by many as inappropriate when applied to hedge funds. The funds that are significant in terms of their size will be required to have a remuneration committee chaired by a non-executive member of the management body.

The AIFM Directive will introduce powers and duties for a new centralised European regulatory authority called the European Securities and Markets Authority (ESMA), which will start work on 1 January 2011. The creation of the new body was agreed on 23 September 2009 and ESMA will be able to issue guidelines to national regulators on how to monitor conformity with the Directive, hence transforming the financial markets legislation to a supranational level! This will probably add a layer of interpretation which will not be welcomed by managers unless it is seamless.

Laven Partners recently met with Conservative MEP Syed Kamall to discuss the ongoing developments in the negotiations between Ecofin and the European Parliament. Mr. Kamall who is showing a strong understanding of the issues and has the interest of London and its service industry at heart, stressed that Ecofin is well equipped to carry out technical discussions based on facts and practicalities as some members are seconded from the national regulators, and we remain hopeful for a final AIFM Directive text soon.

At the recent Hedge Fund Operations Conference attended by Laven Partners a number of speakers suggested the industry might end up in the “Fortress Europe” and “Prison Europe” situation, where the non-EU based alternative managers will not be able to market their funds in the EU and likewise EU residents will not be able to buy offshore funds. The majority view remains that the Directive would serve as a vehicle to force hedge funds to sign up to UCITS III structures. It appears that the patience of some of the industry lobbyists has been exhausted. Javier Echarri, the secretary general at the European Private Equity and Venture Capital Association (EVCA), will leave the organisation at the end of the year, or sooner if the AIFM Directive is voted through before that. Although the Directive was not cited as the reason for his departure, some may say it marks an end of an era for EVCA.

The move towards more UCITS III structures is certainly not the solution, as it is simply not compatible for some strategies and will lead to more correlation between investment styles which no doubt kills off any idea of being an ‘alternative’ fund. One might also consider whether tighter regulation is needed to protect investors from themselves. A recent survey by the European School of Management and Technology together with the Rotterdam School of Management has produced evidence that investors systematically allocate money to hedge fund investment styles that have performed well over the previous three quarters without regard for any change in the level of risk. This implies that investors are still simply chasing the best past performance rather than assessing the risks of different investment strategies.

Eurozone’s fiscal deficit crisis affecting the AIFM?
Germany has recently emerged as the world’s financial reformer and introduced a number of measures to curb the misbehavior of financial institutions. The decision on 19 May to ban naked short-selling in Germany sent a strong message of tougher regulation and was reiterated with an enigmatic quote by the country’s finance minister Wolfgang Schäuble: “If you want to drain a swamp, you don’t ask the frogs for an objective assessment of the situation”.

This contradicts with the notion that Europe should be regulated as one market, further highlighting that one Directive equally regulating the overall European market is virtually impossible. The view that the new rules should be defined on a European level and not by nation states was reflected by the EU Competition Commissioner Joaquin Almunia, who encouraged governments “to adopt such decision at a European level, not on unilateral basis”.

In the past month Germany also announced plans for a levy on banks, which would be paid into a fund to cover the costs of future financial crises. There were also further calls for a potential global regulation tax. German Chancellor Angela Merkel is hoping to achieve mutual regulatory objectives at the G20 summit in Canada on 26-27 June: “We will campaign for a tax on financial transactions. It is clear that this is something that will not be agreed at our first dinner. But I don't think it would ruin the financial markets if we found agreement on a global tax”.

Nevertheless, as the Economist suggested, these events shaded into the background, and instead of worrying about the Eurozone crisis, the Econ and Ecofin “thought their time would be well spent agreeing on tough new rules for an industry that has had remarkably little to do with the financial crisis.”

Laven Partners is a global consulting group focused on the alternative investment industry that offers structuring, regulatory compliance, legal and tax services to asset managers. www.lavenpartners.com

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