EC proposals leave alternative investors up in arms

The European Council (EC) is tightening its grip on alternative investment funds and industry experts say it will squeeze them dry.

Regulators have targeted hedge funds and private equity funds for some months, but a new proposal ­covers all funds not regulated under Ucits. Following a meeting in Brussels, the European Council is reaching out to grasp the regulation of alternative investment funds, the role and res­ponsibilities of depositories, and the transparency and stability of the derivatives markets.

“The financial crisis has demonstrated the need to improve regulation and supervision of financial insti­tutions, both in Europe and globally,” it says in a report entitled Presidency Conclusions of the Brussels European Council.

It has drafted a set of rules for managers of alternative investment funds in an effort to increase regulation and oversight of sectors, and activities it considers risky. Under this new ­regu­lation, most non-Ucits funds, including investment trusts, would be classified as “alternative investment funds”.

Industry experts say it would be difficult and expensive, especially for in­vestment trusts in Britain, to comply with these rules. In many cases, the design of new rules is not suitable.

If enacted in their current form, the Association of Investment Companies (AIC) says, these proposals are likely to have significant and damaging implications for investment companies.

Managers will be restricted by extra regulatory burdens and ­­com­pliance costs as a result of new auth­orisation requirements, reporting obligations, and marketing limit­a­tions, the AIC says. For example, the proposed rules imply that investment trusts need an authorised fund manager who is responsible for management and administration of the fund alike.

The AIC says the rules do not take account of the board’s role and fail to recognise that many investment firms choose to separate port­folio management and administrative activities.

Another point implies that assets must be independently valued at least once a year and each time shares
are issued or redeemed. But the AIC says, this will be particularly onerous and costly. Since shares in investment trusts would be labelled “complex financial instruments”, it could be harder for retail investors to buy them.

The AIC adds that fund managers would face restrictions on delegating fund management and administration to non-EU firms, even for the management of assets outside the EU.

Jarkko Syyrilä, the director of international relations at the Investment Management Association (IMA) says the fact that non-European funds would need regulatory equi­valents ­resembles a protectionist approach by the EU. Third-country funds will only get a “passport” to enter the European market three years after the directive is in place.

James Budden, the director for global wealth management at Baillie Gifford, says the debate really centres around the hedge fund industry “post Madoff and pals”. But the new ­regulation could “catch a lot of innocent victims in its net”.

He adds: “The EC tends to pre­suppose that the absence of blanket ­uniform regulation means the market is a casino, which is far from the truth.”

Simon White, the head of investment trusts at Allianz Global In­vestors, says under the new rules, the directive does not accommodate particular ­structures and characteristics of investment trusts.

“They are lumping all non-Ucits in the same category,” he says. White says the regulation needs to be adapted and changed, adding that investment trusts in Britain have a long history and that their regulation has evolved over time.

At the International Fund Forum in Monaco, Dan Waters, the asset management sector leader of the Financial Services Authority (FSA), said it supported much of the direc­tive.
“We have long thought that a pan-European regime for private placement was desirable, replacing the current patchwork of regulation across the EU, which is complex and inefficient.”

Waters said capital markets and the wider economy would benefit from sensible, proportionate harmon­isation of standards. Regulators could benefit from a more harmonised ­framework and mitigating risks to financial stability.

Daniel Godfrey, the AIC director general, says the AIC favours appropriate regulation, but sees nothing positive” in the proposal.

“They can’t go ahead with the current directory,” he says. Instead, he suggests, investment trusts traded on regulated markets should be removed from the scope of the directory.

“One should ask whether the new regulation is appropriate, proportionate, whether it is achieving its ­reg­ula­tory objective and whether there is a regulatory gap to be filled. Our view is that [the directory proposed by the EC] fails all of these questions.”

Syyrilä expects a decision by early spring 2010, which leaves them with “a huge amount of work to be done
in a really short time”. Syyrilä says they are talking to the FSA, the British government and policymakers across Europe.

Guy Foster, a portfolio strategist at Brewin Dolphin, says tighter regulation for Ucits may follow. “We would be quite keen to see more regulation on Ucits. We are surprised how much freedom investment companies are given,” he says.

Waters says: “You should be in no doubt that the EU regulatory landscape for the fund management sector is going to be the subject of con­siderable change over the next few years.”

The Alternative Investment Management Association, the hedge fund industry’s trade association, was unavailable for comment.


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