FSA Official Seeks Revision of Draft Directive on Hedge Fund Regulation

A senior official of UK Financial Services Authority urged the European Commission to recast the proposed Directive on Alternative Investment Fund Management to recognize of the global nature of the hedge fund industry and not impose unjustifiable geographical restrictions on firms' business models that would significantly restrict investor choice. At a recent seminar on asset management, Sally Dewar, Director of Wholesale Markets, emphasized that proposed restrictions on non-European management firms are misplaced; as are blanket prohibitions on the marketing of non-European funds to professional investors.

The Director also urged the Commission to differentiate between types of alternative investment fund management. Given the diversity of the alternative investment fund sectors, she noted, a single, standardized approach will not work. The issues around a hedge fund prime brokerage business model, for example, are quite different from those around the management of a private equity fund.

In addition, some fundamental concepts that are relevant to one type of fund may not be equally applicable to others. For example, leverage and liquidity issues, and capital risks, are different for closed-ended funds, she observed, and the additional investor protection afforded by requiring independent custody is quite different for private equity investments than for funds which invest in financial securities or derivative contracts.

The Director also called for a more risk-based approach to hedge fund regulation. The draft Directive’s scope and thresholds are too low to adequately focus on those alternative funds and managers posing significant risks to financial stability and market efficiency, she averred. The draft does not strike the correct balance between imposing additional costs and enabling regulators to identify and therefore mitigate systemic risks.

Further, the official cautioned against leading regulators into prescriptive product regulation of alternative investment funds. Thus, the FSA believes that the hard limits on leverage proposed in the Directive are both inappropriate and unworkable; and could result in considerable unintended consequences for European hedge funds.

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