UK FSA Official Views Amendments to Proposed Hedge Fund Directive as US Officials Voice Protectionist Concerns

Amendments being readied to the proposed EU Alternative Investments Fund Management Directive go some of the way towards ameliorating the protectionist tendencies of the Directive, said Dan Waters, Director of Asset Management at the Financial Services Authority, but there is still concern that the Directive could limit fund choice and damage investor returns. The Director views a protectionist approach to hedge fund regulation as antithetical to fundamental principles of the free movement of capital and contrary to the core G-20 principles of regulatory cooperation. And, indeed, the draft has drawn the criticism of U.S. Treasury Secretary Tim Geithner and a key member of the Senate Banking Committee.

Mr. Waters praised some amendments to third country aspects of the Directive dealing with the treatment of funds and fund managers based outside of Europe. Notably, the amended proposal envisions that, after a transitional period, and subject to certain equivalence criteria being met, a marketing passport would be granted to those fund managers either established outside of Europe or managing funds which are established outside of Europe.

This approach conforms to the FSA’s traditional support of the principle of the marketing passport replacing the current patchwork of national private placement regimes. The FSA accepts that, in order for third country fund managers to obtain such a passport, equivalence criteria should be met. Crucial questions remain, however, as to the content of the standards against which equivalence would be judged and by whom the decision would be made. Given the global nature of the alternative investments market, the FSA’s view remains that the EU must create a proportionate regulatory approach recognizing the reality that alternative investment fund management, including its support services, inevitably involves markets and jurisdictions across the globe and not just in Europe.

The official emphasized the importance of striking the right balance in order to deliver sensible standards and equivalence criteria. There is also the important question about the consequences for a third country failing to make the grade. Unfortunately, proposals put forward could have an adverse effect on future alternative investment flows into and out of Europe.

For example, in instances where third country jurisdictions are not deemed equivalent, fund managers would be prohibited from marketing their funds on a private placement basis. Even more worrying, noted the Director, in instances where the hedge fund and the fund manager are based outside Europe, and the third country jurisdictions are not deemed equivalent, even investment into the fund made at the investor’s own initiative would not be permitted. Calling this a ``draconian prohibition,’’ the senior FSA official noted that it has been strongly objected to by institutional fund managers, who view it as limiting legitimate choice and damaging investor returns.

In a letter to EU Internal Market Commissioner Michel Barnier, Treasury Secretary Tim Geithner expressed concern that the proposed Alternative Investment Funds Management Directive would discriminate against US hedge funds and deny them the access to the EU market that they currently enjoy. The Secretary pointed out that pending U.S. reform legislation will maintain full access to the U.S. market for EU fund managers and custodians. In earlier remarks, Director Waters has stated that the current draft can be seen as an attempt to protect European funds from competition from legitimate U.S. and other third-country funds

Senator Charles Schumer, a key member of the Banking Committee, has expressed deep concern that the Directive would overtly discriminate against U.S. hedge funds. In a letter to Secretary Geithner, Senator Schumer said that, if the EU adopts protectionist rules that discriminate against U.S. firms and activities, he would ask Congress to pass equivalent legislation, including measures prohibiting funds that are not headquartered in the U.S. from marketing and raising money in the U.S. and requiring all funds operating in the U.S. to use only U.S.-headquartered custodian banks.

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