14/07/2010 Author: Antonio Borges

Comment: Antonio Borges

Contrary to the expectations of many Eurocrats, the directive on Alternative Investment Fund Managers (AIFM) is not going to be approved in the near future. There is still a serious stumbling block over the degree of market openness, that is, the extent to which investors in Europe should be able to choose between European and non-European fund managers. There is quite a fight going on with proposals from the European Commission, Parliament and Council all contradicting each other. After Sweden failed to achieve agreement on the legislation, the same fate has befallen Spain.

None of this is unexpected and these difficulties were foreseen by the more farsighted regulators. Alternative investments, hedge funds in particular, are complex to regulate both because of the nature of the industry (which relies on constant innovation and is, therefore, not amenable to rigid rules) and also because attitudes differ so much across Europe with respect to the desirability of the industry and the role it plays.

It is interesting, however, that the current controversy is focused on an issue of such importance to investors: freedom of choice and access to global markets. The more heavy-handed politicians want to close the market. If there was no need to worry about competition from outside Europe, it would be easier to control the industry; there would be no competition across regulatory regimes and the rules could be as tough and unreasonable as the most repressive politicians would like them to be.

By contrast, many in the Commission, which has to put the interests of the European market ahead of national preferences, favour free and open markets. So to compensate for some of the most negative aspects of the directive, the Commission staff used the opportunity to push for a more integrated market. The idea of the passport was a major innovation that would vastly increase investor choice within Europe and would force many countries to review their negative attitudes towards hedge funds.

Unfortunately, this was anathema to those very countries that initiated the regulatory drive against hedge funds. As a result we are very likely to end up with the status quo. Hedge funds will continue to be sold throughout Europe on the basis of the private placement regimes, which national authorities insist on.

The European Parliament, which often sides with the Commission, tried to revive the passport concept and open it to non-EU hedge funds by proposing that non-EU regulators commit to enforcing the AIFM directive, in return for the attribution of the passport to their domestic funds. It was always hard to see how this proposal could attract much support, especially as the directive is not viewed with enthusiasm by any non-EU countries.

So there is a good chance we end up back at square one and hedge funds – European or otherwise – will be marketed on the basis of national regimes. This is a great pity as I would have hoped that an initiative as important as this directive would at least contribute to a more open and integrated European market. But at least the attempt to severely limit investors’ rights seems to be failing.

One of the problems highlighted by this sorry tale is that investors are all too rarely consulted by the European authorities. The regulators tend to focus on the fund managers rather than the investors but they would be wise to alter their approach.

More than any other industry, the hedge fund industry is controlled by its clients – the investors who are knowledgeable and professional in the defence of their interests. European regulators should remember that if the regulatory environment is not the right one for this industry, it is the investors not the hedge fund managers who are likely to move outside the EU and conduct their business from other locations.

Apparently, the Swiss authorities are at this very moment happily receiving numerous expressions of interest from large institutional investors who would like to operate from Switzerland. How this can possibly contribute to better capital markets within the EU is hard to understand.

Antonio Borges is the chairman of the Hedge Fund Standards Board