07/10/2009 Author: Tony Griffiths

Building bridges

Last month’s G20 summit in Pittsburgh reiterated the resolve for hedge fund regulation in both the US and across Europe. HFMWeek takes a look at how the industry is engaging with the current proposals on the table 

With one sentence in April’s G20 communiqué, the wheels of sweeping, regulatory change were set in motion. Tucked away in the body text, world leaders confirmed the inevitable, that the regulatory overhaul of the financial machine would “include, for the first time, systematically important hedge funds”.  

September’s follow-up summit in Pittsburgh may have been, in hedge fund terms at least, more an exercise in reiteration than development – leaders noting only that the sector was one of number receiving enhanced “oversight” and poised for “tougher” measures – but, if its corresponding leaders’ statement gave an impression of relative inertia, then nothing could be further from the truth.

The last six months have been some of the most eventful in the industry’s history, with little room to breathe for the emerging reams of red tape. Whether it’s been the European Commission’s draft AIFM Directive or the myriad of hedge fund transparency bills in the US, the legislative proposals to have stemmed from April’s pledge have given the entire sector food for thought – not to mention cause for confusion and concern.

The current regulatory climate is well summarised by the following: Speaking at a hedge fund regulation conference in London last week, Nathan Greene, a US-based partner with global law firm Sherman & Sterling, reported an exchange he’d had with a European client. “These proposals are far-reaching, containing some of the biggest changes for decades,” Greene had said of the US situation. “That’s interesting,” his European counterpart replied. “But we have much bigger problems over here.”

No doubt the American story is one of significance (a point addressed later), but it’s in Europe where developments continue to provoke the loudest reaction. It’s now accepted that legislation, in some form, is inevitable. As is the fact that the current document requires substantial changes: “I don’t deny that there are areas that need to be improved,” Claus Tollmann, a member of the European Commission’s own AIFM team, conceded last week.  
So where is the Brussels process presently? A little further from its destination following the EU’s August recess, it would seem.   

Reconvening on 2 September, the EU Parliament’s Economic and Monetary Affairs Committee (Econ) pushed the date for its vote on the Directive back from December 2009 to April 2010. Some lobbyists had held forlorn hopes that the legislation could be pushed through during the Swedish EU Council presidency – deemed more sympathetic to the hedge fund industry than Spain, who take the chair in January 2010. However, with the appointment of French lawyer Jean-Paul Gauzès as rapporteur – the key figure in the Directive’s parliamentary life – not announced until the end of August, it has proved an impossible timeframe.

As rapporteur, it is up to Gauzès – widely considered a willing listener – to produce a report on the Directive to present to Econ. His latest update was given during a committee meeting on Tuesday. According to an HFMWeek source close to the action, November is the likely date for the report's completion (the same month a public hearing is expected). Unsurprisingly, the August confirmation signalled a clamour, on both sides of the Directive fence, to secure an audience. The Alternative Investment Management Association (Aima), it is rumoured, was one of the lucky few. HFMWeek has, so far, not been so fortunate, as Gauzès refused to comment.  

In parallel to efforts made by Econ to agree on Parliament’s position, the Council of Member States, the other half of the EU's bicameral legislative system, is establishing its own stance (both parliament and the Council have to agree on an identical text before the Directive can become law). Having received all the recommended amendments from national member states – in the form of an eye-watering 200-page document, containing, according to Brussels gossip, over 1,000 suggestions – it is up to the Swedish chair to produce a revised, comprise text for the council to consider.

“We’re trying to move fast on this, but there are a lot of technical questions, with a lot of concerns,” says Raana Farooqi-Lind, the civil servant and economist heading the six-man Swedish team, who hopes to have the council’s revised text finished by the end of the month. “We’ve had a lot of technical input from the alternatives industry which has been very helpful because it’s really important to understand the different kinds of fund structures.”

Though admittedly tired, Farooqi-Lind remains both cheerful and optimistic. “There’s a lot of agreement on some of the basic principles which take into account that this has to be balanced and proportional, so in that sense we’re feeling very positive,” she says, noting that there is a lot of pragmatism in the council’s AIFM working group, due to meet next 16 October.

While Farooqi-Lind is unable to provide any specific detail on the current redrafting, a number of recent quotes, statements and papers from member states have allowed a picture of likely amendments to crystallise.  
Last month, Sweden provided delegates with an issues paper, since made public, collating every member state’s gripe (the rumoured 1,000), and every suggested means of improvement. This was circulated in time for the working group’s first meeting after the August break on 8 September.  

According to the paper, “a number of delegations” have “expressed concerns” about the proposed articles on supervision and leverage. A number, also, were “not satisfied” with those regarding valuation. This last issue appears a prime contender for drastic change following last week’s comments made by Patrice Bergé-Vincent of French
regulator, Autorité des marchés financiers (AMF).  

“I can say that an external valuator won’t work,” he said, speaking on the regulators panel discussion at last week’s regulation conference in London. “There is a strong opposition to this provision from almost all delegations. This is an example of something that will be redrafted.”  

The French position was backed by the panel’s Financial Services Authority (FSA) representative, Giles Swann, but contested by Claus Tollmann, who argued that the Directive’s valuation provision was aligned with the recommendations of the industry's own Hedge Fund Standards Board.

However, if there is one area that has caused the most uproar, it is that which includes marketing and third-country issues. The Swedish issues paper acknowledges this, declaring that an “overwhelming majority of member states” have expressed concerns on these topics. Even the marketing passport, largely considered a benefit, is proving contentious.

It is now clear that France is vehemently opposed to the possibility of offshore funds being allowed improved access to French investors. “We oppose the passport for offshore funds because it would be contrary to the G20,” says Bergé-Vincent, re-affirming the position of AMF chairman Jean-Pierre Jouyet expressed at the FSA’s annual conference in September. “We want to remain on the current framework.”

One of HFMWeek’s Brussels sources believes that this is not only becoming a “red line” for France, but also for Germany. Behind-the-scenes talk is rife that a two-tier marketing system will be drafted into the Directive, allowing both the original private placement rules and the passport to co-exist. How exactly, is a very different matter.

Though solid opposition to the current draft has materialised, disagreement on the details remains endemic.

Suggestions have been that negotiations are nearing the point of stalemate, and that politics has become a deciding factor. Martin Cornish, partner at Katten Law, explains: “Proceedings are being dealt with purely on a political level, and the regulators in each country, who probably would speak a lot more sense, are not involved directly in the process.” For European managers, at least, everything is still up in the air.

While the hubbub in Europe has been audible since April, in the US hedge fund regulation is only just beginning to find itself in the spotlight. A speech last month by Barack Obama, which name-checked hedge funds, provided a clear indication of regulatory intentions. “We’ve got to close the loopholes that were at the heart of the crisis,” said the US president.

Manager registration – which the Services and Exchange Commission (SEC) failed to push through in 2006, but, as AIFM lobbyists have been keen to stress, has long been mandatory for UK managers – and heightened disclosure are now as good as guaranteed in the US, and the net is being spread as wide as possible.

As such, third-county issues are now proving one of the few controversial elements of US regulatory developments – controversial for European managers, that is. If the Obama administration’s recent proposal – the most likely of the four main US bills to succeed – becomes law, then any non-US manager with a sizeable US interest will have to register with the SEC as well as adhering to their own national regulations.

“The proposed bill is going to have very significant extra-territorial implications because, effectively, it will apply to any foreign investment advisor who advises a fund where more than 10% of the outstanding securities are owned by limited partners through a US person,” says PwC’s James Greig.

If, for example, a fund is 89% owned by UK persons and 11% by US persons, the UK manager will have to register with both the SEC and the FSA. And once swept into dual-registration, said manager will then be subjected to the new, increased US reporting regime the bill also proposes, as well as the UK equivalent. Says Greig: “It’s basically a compliance burden.”  

The US Managed Funds Association may have endorsed the Obama bill, but, tellingly, Aima has yet to comment.
Jack Governale, a US-based partner with Katten Law, believes the Obama administration approved route of adviser registration, as opposed to investment company registration (see sidebar), is probably the simplest approach to implement.

“If the paramount policy goal is obtaining greater transparency, this is arguably better achieved, or at least as well achieved, by regulating the investment advisers to funds rather than the funds themselves, and adviser registration is potentially less intrusive,” he says. The SEC already has significant experience with hedge fund managers registering as investment advisers.

New reporting provisions – also known in the US as ‘registration plus’ – will be upheld by the SEC and, possibly, further counterparties. The SEC is also likely to receive enhanced authority, which, according to Nathan Greene, may include a federal fiduciary duty. Clients of Greene’s have confessed concerns over this, likening the potential SEC to a “teenager with muscles”. Hopes are that said adolescent will grow into its new powers quickly.

Though current US proposals have been largely accepted, with little of the furor found across the Atlantic, Greene remains weary. “The [US] industry kids itself if it doesn’t think this reporting is not a prelude to further registration,” he warns. “The SEC can’t take all this information without making use of it.”

If the G20’s original terse statement has unleashed panic in Europe, it appears US managers must not be seduced into complacency. While the controversy engendered by EC tinkering has at least united Europe’s hedge fund
sector – for possibly the first time ever – US managers, asleep at the switch, could be set for future regulatory tribulations. The next six months remain crucial for both sets of managers