In the continuing battle between protectionism and open markets, the European Union Council has set forth a new draft of legislation regulating hedge funds and private equity funds in an effort to find consensus on the marketing of US hedge funds in the EU. The issue of under what circumstances US and other non-EU hedge funds could be marketed in the EU has been disputed most of this year as legislation implementing the European Commission’s proposed Alternative Investment Fund Manager Directive moves towards final passage.
The conditions under which US hedge funds could be marketed in the EU has been the one of the most hotly contested issues as the EU attempts to pass legislation regulating hedge funds in 2010. In an earlier letter to EU Commissioner for the Internal Market Michel Barnier, Treasury Secretary Tim Geithner expressed concern over provisions in the proposed Alternative Investment Funds Management Directive that would discriminate against US hedge funds and deny them the access to the EU market that they currently enjoy. More broadly, he said that it was essential to fulfill the G-20 commitment to avoid discrimination and maintain a level playing field in regulating the alternative investment fund management industry.
The UK’s position has consistently been that the legislation should not restrict EU institutional investors from taking advantage of valid investment opportunities in US and other third-country hedge funds. Earlier, Dan Waters, FSA Director of Asset Management, emphasized that the legislation should not be seen as an attempt to protect European funds from competition from legitimate US and other third-country funds. In today’s fragile international economic environment, he noted, introducing damaging constraints on international investment flows is not a sensible policy.
Article 35 of the new draft legislation sets forth conditions for an EU hedge fund manager with an EU passport to market shares in a US hedge to professional investors in the European Union. Note that EU Member States must require that the US funds managed and marketed by the fund manager are only marketed to professional investors. Article 36 provides for a transitional regime allowing EU fund managers to market US hedge funds in the EU without a passport. This transitional regime may or may not be extended depending on the results of a study by the European Securities and Markets Authority of the experience of the passport regime.
In order to market a US fund in the EU with a passport, the draft requires that appropriate cooperation arrangements be in place between the authorities of the fund manager’s country, those member states hosting the fund manager, and the supervisory authorities of the US or other third country where the non-EU hedge fund is established in order to ensure an efficient exchange of information allowing the authorities to carry out their duties according to the Directive. The draft legislation directs the European Securities and Markets Authority to develop guidelines to determine the conditions of application of the measures adopted by the Commission regarding these cooperation arrangements in order to ensure their uniform application.
In addition, the US or other the third country where the fund is established must sign an agreement with the home Member State of the authorized fund managers and with each Member State in which the shares of the fund are proposed to be marketed, which fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention and ensures an effective exchange of information in tax matters, including multilateral tax agreements. Also, the third country where the non-EU hedge fund is established must not be listed as a Non-Cooperative Country and Territory by the Financial Action Task Force on anti-money laundering and terrorist financing.
Under Article 36, EU Members may, without a passport, allow authorized EU fund managers to market to professional investors, on their territory only, shares of US and other non-EU funds that they manage. The marketing of the US fund in the EU is conditioned on the existence of cooperation arrangements for the purpose of systemic risk oversight between the authorities of the fund manager’s home jurisdiction and US authorities in order to ensure an efficient exchange of information that allows the authorities of the fund manager’s jurisdiction to carry out their duties according to the Directive. Another condition is that the fund manager cannot perform depositary functions. Rather, the fund manager must ensure that another entity is appointed to carry out the depositary functions and inform its regulator of the identity of the appointed entity.
The legislation would allow EU jurisdictions to impose stricter rules on the hedge fund manager in respect of the marketing of fund shares on their territory for the purpose of this Article.
The legislation commands ESMA to conduct a review three years after the legislation’s enactment of the managing and marketing of US and other non-EU hedge funds under the passport regime with an eye to seeing if the transitional non-passport regime can be terminated. If the ESMA review concludes that the Article 35 passport regime has no negative effects on investor protection, market disruption, competition and the supervision of systemic risk, it must advise the Commission to terminate the non-passport marketing of US hedge funds. Within three months of receiving this advice, the Commission must specify a date when the Article 36 non-passport regime will terminate and the passport regime will become the sole and mandatory vehicle for marketing US and other non-EU hedge funds in the EU.