11/05/2011 Author: Tony Griffiths

Regulation Round-up

EU
SHORT-SELLING REGULATION
Commission draft directive published Sep 2010
Status Parliament text finalised in March, Council text yet to be finalised
Expected to be voted into law Jul 2011

Probably the most pressing legislative matter affecting European hedge funds, short selling is a key topic for the incumbent EU presidency, Hungary. However, the informal deadline for agreement, June, already looks unlikely, with July, the first month of the Polish presidency, now seen as the earliest date for the regulation to be passed into law. “The Hungarians would like to see it voted through in their presidency, but that’s becoming more and more unlikely,” one Brussels lobbyist told HFMWeek.

Unsurprisingly, the time-sapping divisions are politically rooted. Last year’s Greek debt crisis is still fresh in the memory, compounded by recent aftershocks in Ireland and Portugal, and remains the biggest influence on proceedings. Both the EU Parliament and Council are divided along these lines.

Parliament’s version of the Directive was voted through in March, but faced unsuccessful protests led by UK MEPs due to the inclusion of an effective ban on the shorting of uncovered sovereign credit default swaps (CDS). “A ban on sovereign CDS would hurt liquidity and make it more expensive for governments to raise debt – not a smart option when EU debt markets already face difficulties,” UK MEP Syed Kamall, told HFMWeek.

The EU council – yet to finalise its text – isn’t trying anything quite as radical, but is divided over sovereign debt shorting, with a coalition led by the UK and Italy trying to avoid restrictions in this area. Kamall is confident however that the Council will provide a “more balanced and less knee-jerk proposal”.   
 
HFMWeek’s Brussels source suggests that if there is no text from the Council following the May Ecofin meeting, then Parliament’s rapporteur, French MEP Pascal Canfin, who approved the ban on sovereign CDS, will attempt to vote through the Parliament version at the June plenary session. While success is unlikely without Council’s backing,
a no vote would take proceedings to a second reading, prolonging the process.   

EUROPEAN MARKET INFRASTRUCTURE REGULATION (EMIR)
Commission draft directive published Sep 2010
Status Parliament and Council texts yet to be finalised
Expected to be voted into law Oct 2011

Less politically charged than AIFMD was, or short-selling is, the EU’s derivatives regulation, or EMIR, has so far proved a relatively smooth ride. The reduced politicking has allowed technical issues to take precedent. Conversely, it also means the procedure lacks the urgency of earlier initiatives.

Neither the EU Parliament nor Council have finalised their versions of the text as yet, although expectations are that Parliament will vote through its version on schedule on 24 May, with Council following in early June. September is a potential date for a final vote in plenary, but October is widely considered more likely.  

The full scope of EMIR has been up for discussion, as have exemptions for pension funds and the FX space – the latter prompting debate following the publication last week of an equivalent rule in the US. Backing for a single, global clearing house – a one-time political hot potato – fell out of favour early in proceedings.

In general, the process has been “very collegiate,” one Brussels insider said, with the only contentious issues likely to be those relating to equivalence regimes and global harmony; a possibility acknowledged by UK MEP Kay Swinburne. “The most crucial aspect is that they stay on the same path internationally,” she told HFMWeek. “Both the EU and the US need to be careful not to erect barriers that hinder investment flows between their two jurisdictions – let alone in Asia and the wider world.”

AIFM DIRECTIVE
Voted into law November 2010
Status Level 2 – rule writing stage
Likely level 2 completion Jan 2012

Approved by the EU last November, the Alternative Investment Fund Managers Directive (AIFMD) has taken a somewhat peaceful turn, easing itself away from the political storm and moving onto the technical issue of rule writing.  

Since December, new European super regulator Esma has been busy crafting this technical framework with the help of regulators and policy-makers around Europe. With the official final wording of the level 1 text now delayed until June, Esma is likely to receive more time. Level 2 work, therefore, should finish in November of this year, with a further two months granted to polish off.   

Esma has formed four working groups to concentrate on the key areas: Depositaries, chaired by French regulator AMF; Scope, under the stewardship of the Central Bank of Ireland; Authorisation, delegation and organisational requirements, as overseen by BaFin of Germany; and issues of transparency, leverage, risk and liquidity, through the UK’s FSA.

Each sub group has its own autonomy and has been proceeding at a fairly fast pace, with each already having held a workshop – most recently organisational issues on 4 May.

“Everyone is trying to work out what the issues are, rather than how to solve them,” says one Brussels source privvy to discussions. “Some proposals are being floated, but it’s too early to tell where all the fault lines are.” If there is one area destined for conflict however, it looks set to be the depositories.

One topic noted for its absence, of course, is third countries. This has been pushed back, pending progress made by extra-territorial co-operation agreements.

US
DODD-FRANK REGISTRATION
Voted into law Jul 2010
Status Final rule-writing stage
Registration rules expected July 2011
Final derivatives rules expected Uncertain

Like AIFMD in Europe, the Dodd-Frank Act has been voted through and is at the second, law-making stage in proceedings. Here, the technical aspects of each law have been outlined by the agencies to which they are relevant. Draft rules have been and gone, as have the 60-day public comment periods that follow them. In most cases, the industry is now waiting for the final versions of the Act’s rules to be published. 

Registration rules – largely under the eye of the SEC – remain of particular concern and have made headlines of late, with rumours of an extension for managers to adhere to mandatory registration; originally slated for 21 July 2011. 

Confusion had arisen back in April when the prospect of Congress shutting down over the budget stalemate had threatened to cut short the SEC’s opportunity to finalise its rules. Panicked, the regulator sent a letter to concerned parties informing them that, because of the potential time constraints, the deadline would be extended to the end of the first quarter of 2012.

Final rules on registration from the SEC are now expected by 21 July and hedge fund managers remain on tenterhooks, waiting for the final wording.  

According to George Mazin, of legal consultants Dechert, there are three elements to registration that are of concern. Firstly the act of registration and the compliance burden and disruption that comes with it. The potential for an SEC examination is the “wildcard” that scares managers the most, Mazin says.

Form PF is the second big worry. “For the larger managers, it’s a potential headache,” Mazin explains. An annual form for smaller managers, the document is expected quarterly of managers with more than $1bn in AuM and are given only ten days from the end of the quarter to comply.

The biggest potential problem, however, could be in the Commodity Futures Trading Commision (CFTC)’s patch. Previous commodity trading advisor exemptions – rules 4.13(a)(3) and 4.13(a)(4) – ensuring that hedge funds could avoid the CFTC’s jurisdiction look set to be removed.  “If the CFTC goes forward with this, it will have major problems that will ripple through the industry,” Mazin says. 

DODD-FRANK DERIVATIVES
As with almost all Dodd-Frank rules, derivatives law is still in the rule-making process, awaiting final drafts from the two agencies involved: the CFTC and the SEC. Once again, there remains uncertainty as to when the final rules will appear. There is a bill in congress, proposed by a Republican-led financial committee, that would slow the process of implementation down, but expectations are that this won’t get any further than the House of Representatives.

There has been considerable discussion as to whether the increased cost will make such products less attractive, while a new type of entity – a Swap Execution Facility – has been created which has benefits, such as transparency, but also the potential downside of providing proprietary information to the market.

Equivalency regimes, designed to aid global harmonisation, appear to be led by the US, determined to see the Fed take charge. This may prove a stumbling block for the EU. 

On the plus side, the thorny issue of defining a Major Swap Participant (MSP) appears to have been resolved. MSPs are subject to much more stringent regulation by the CFTC, and some hedge funds were concerned that they would be caught. However, with a threshold of $5bn of current exposure to swaps/derivatives and $8bn of current and future exposure, the number of funds applicable will be miniscule.

OTHER LEGISLATION
Away from the current heavy-hitters, there are a number of other regulations, laws and directives affecting hedge funds on the horizon.

Once again, Europe is leading the way. Included within the EU’s heaving in-tray is a second drafting of the Markets in Financial Instruments Directive (MiFID). Expected to begin in July, the review will look to address perceived weaknesses, such as pre- and post-trade transparency.

The next iteration of the Ucits legislation, Ucits V, focusing on investor protection and depository liability, is also scheduled to be drafted in 2011 – likely in Q4. Ucits IV will itself only have been adopted this July. 

The Investor Compensation Scheme Directive (ICSD), meanwhile, has been seeking to incorporate Ucits since proposals were drawn up in 2010. Concerns that this will make such vehicles unnecessarily expensive and reduce their global appeal means it remains one to watch.   

Elsewhere, fresh changes to the EU’s Capital Requirements Directive (CRD) will come into force later in the year, as will Packaged Retail Investment Products (PRIP) regulation.    

Dodd-Frank’s all-encompassing reach means that other hedge fund-relevant changes in the US will come in the form of tax laws – most pertinently Fatca. While in Hong Kong, minor changes to short-selling are believed to be on the cards.

KEY DATES
2011-2013

EU
May 2011
EU Council to finalise its version of the short selling directive. EU Parliament to do likewise with its version of EMIR.

EU
Jun 2011
EU Council to finalise its version of EMIR. Review of MiFID expected to begin.

EU
Jul 2011
Short-selling directive likely to be voted through the EU plenary, beginning implementation process (level 2). Ucits IV passed

US
Jul 2011
Likely deadline for the SEC’s Dodd-Frank registration rules to be finalised

EU
Oct 2011
EMIR likely to be voted through the EU plenary, beginning implementation process (level 2).

EU
Nov 2011
Initial deadline for Esma to complete AIFMD level 2. Potential first draft of Ucits V.

EU
Jan 2012
Ultimate deadline for Esma to finalise its technical advice on AIFMD level 2.

US
Mar 2012
SEC registration under Dodd-Frank expected to come into force

US
Jan 2013
The Foreign Account Tax Compliance Act (FATCA) comes into effect

EU
Jun 2013
Expected date for AIFM Directive to become law and for hedge funds to begin complying