19/11/2009 Author: Tony Griffiths

Moving forward

Last week saw the first public debate of the divisive draft AIFM Directive legislation. Members of the Econ committee joined industry representatives to thrash out the many issues with the legislation and take the first steps on the long road to a consensus

One step into the cold, functional surroundings of Room 3C050 and it was clear this was not your typical parliamentary debate. The spacious, open-plan auditorium – part of the EU’s Brussels-based Paul-Henri Spaak building – hosting last week’s public hearing on the Alternative Investment Fund Managers (AIFM) Directive was packed to the rafters.  

Those present: the 48 members of Parliament’s Economics and Monetary Affairs (Econ) Committee; nine handpicked industry panellists; some 300 invited guests; and a throng of media representatives. HFMWeek was one of the lucky ones. Not everyone got a seat, or, for that matter, the accompanying headphones – an essential component during a multi-lingual debate.

A proficiency in European language, however, wasn’t needed to get a sense of the restlessness that filled the hall. The draft legislation’s inherent controversy, so widely-referenced since its publication, saw to that.    
The run up to the hearing – held to allow public input at a time when Econ members, led by Directive rapporteur Jean-Paul Gauzes, are preparing a Parliament-drafted version of the legislation – had given an already appetizing event some added spice.

Having revealed the hearing’s panel in October, HFMWeek was able to report the hedge fund industry’s concern at its under-representation (only prime broker Deutsche Bank was to provide input from the sell-side), while leaked sections of Council president Sweden’s own redrafting of the AIFM Directive in early November, another HFMWeek exclusive, had hinted at a compromise, fuelling the fires of Europe’s regulation-hardliners.

The findings of two AIFM impact assessment studies had also been published – the FSA-commissioned Charles River Associates report in October, and the Econ-commissioned Europe Economics paper days prior to the hearing itself.  Both criticised the European Commission’s handling of the legislative process, as well as the Directive’s lack of practicality. London-based Europe Economics’ ‘Quick’ report – at this stage only a precursor to its final document – was removed from the Econ website after two days.  

It wouldn’t take long for the hearing’s headliners to recognise the AIFM Directive’s troubled path.  "Nothing can be left out of regulations now, even if hedge funds did not cause the crisis," said Gauzès in his opening remarks. A clear statement of purpose for the day’s proceedings; the address also suggests that Gauzès – widely regarded as a listener – is open to both sides of the debate.

The two-hour hearing’s structure was straightforward. Opening remarks from Gauzès and Econ chairwoman Sharon Bowles would be followed by pre-prepared speeches from a panel of experts. Ten minute time-slots were allocated according to industry sub-area, with, generally, two speakers per slot. The completion of this first hour – kept to schedule by Bowles – would be followed by a one-hour Q&A session, during which Econ MEPs could address panelists.  

There is little doubt which of the panel’s speeches provoked the morning’s biggest reaction. Gerben Everts, head of Dutch pension manager APG’s global regulations and compliance team, set out his stall in no uncertain terms. “If it is indeed the intension of the Directive to increase transparency on the alternative asset management industry, why do you – honourable members – accept the regulatory process to take place in the dark?” he asked.

During the morning’s most animated time-slot, Everts would not only criticise the European Commission, the AIFM Directive and the legislative process, but also called upon Econ to “invite the Commission to temporarily withdraw its proposal in the light of the many amendments called for [in the EU Council]”. He suggested that the Commission should return with a new proposal in the summer – powerful rhetoric from Europe’s largest pensions’ manager.  It would prove the one speech aggressive enough to prompt audible dissent from some MEPs.

Though Everts would word it most strongly, the nine-strong panel shared a similar stance. All acknowledged the need for increased regulation, and, in turn, all acknowledged that the current draft of the Directive was an inadequate tool with which to achieve that goal. The message to Econ was clear –there is still plenty of work to be done.
The range of Directive-based shortcomings touched on would be reflected in the wide  range of queries from
Econ MEPs.

Questions regarding leverage were directed, largely, towards Anthony Byrne, head of Deutsche Bank’s European prime brokerage arm. “A single measure for leverage is not ideal – is this something that could be monitored at the prime brokerage level?” asked British MEP Kay Swinburne.  MEPs also wanted to get a flavour of a prime broker’s role in ensuring that leverage specifications are met.

In the short time Byrne was allocated to respond, he explained that Deutsche Bank has 60-70 staff working specifically to ensure that hedge funds can pay back their loans. He added, however, that he believed targeting leverage was misdirected. “Transparency and by getting data to the regulator is the best way to deal with leverage,” he stated.  

As the hedge fund industry’s sole link to the floor, Byrne was, in part, considered the sector’s representative, but, speaking to HFMWeek after the event, he distanced himself from the suggestion. “Deutsche Bank’s role in this was to educate – to help MEPs understand topics key to prime brokerage such as depositories and leverage,” he said.   
One MEP – who also called for a ban on short-selling – linked the failings of depositories with the Madoff scandal. “Madoff happened when the Ucits negotiations were over,” he said. “There is a problem with Ucits.” A reminder that some MEPs see depository-based problems as deeply ingrained.   

State Street Bank’s Robin Oliver fielded two specific questions on depository requirements. “How many EU credit institutions are large enough to take on the liability required of depositories?” enquired one MEP. “You would see a reduction of custodians,” Oliver responded. This, he added, would have an inverse correlation to risk. For Oliver, the pertinent point was the potential impact on emerging markets.

Econ vice-chair Arlene McCarthy – who would later use Long Term Capital Management’s demise as an example of systemic risk – was eager to learn State Street’s own expectations of sub-custodians.  “We look at whether assets are segregated and whether they are done so properly,” said Oliver. He also outlined the global nature of State Street’s operation, as well as its Ucits-compliant components and extensive legal resources. Recognising time constraints, Oliver offered further post-event details for any MEP that requested them.

The Directive’s impact on pension funds, magnified by Everts’ impassioned address, was of particular interest to MEPs, with the representatives of APG and Mn Services receiving significant attention.

Kay Swinburne cited Charles River Associates’ FSA-commissioned impact assessment study when highlighting the diversification denied European pensioners as a result of the Directive.  Liem Hoang Ngoc, a French MEP with the Socialists and Democrats (the group considered Econ’s main proponent of draconian fund regulation), enquired what losses had been made by pensions in the wake of the financial crisis, while British MEP Vicky Ford took a different tack, asking Everts to estimate the potential Directive-induced loss attributable to each member of his scheme.  

Everts, who said an investor-specific impact assessment was needed, told the floor that the Directive would increase the premiums for each APG member by approximately 15-20%.

In response to Hoang-Ngoc, Kris Douma of Mn Services admitted that the pensions sector did need a better risk management system, but reiterated that diversification was integral to the successful operation of a fund. Mn Services has 20% allocated to alternatives, said Douma. “Transparency on leverage is the main issue. But, as investors, we can always ask for more transparency,” he admitted.

Panellist Eddy Wymeersch of the Committee of European Securities Regulators (Cesr), however, said he was not convinced that institutional investors were able to protect themselves.

The theme of global regulatory alignment – as directed to Wymeersch and his Iosco counterpart, Verena Ross – was introduced by chairwoman Bowles. “How could we join the AIFM Directive more closely with the work being done in the US?” she asked the panel. Bowles, it would transpire, had been in the US discussing the American approach prior to the hearing.

The topic would prove a popular one; a number of MEPs asking the regulators: “How do we do this globally?” Co-operating with the US was an important step, agreed Ross. She also told MEPs that banking regulation should be the main focus. The Parliamentary draft, the debate would suggest, looks set to include increased efforts to bridge the global regulatory gap.  

Though Council president Sweden’s redraft of the AIFM Directive would not be published for another three days, word of its content had made its way to the debating floor on 10 November.   

German MEP Udo Bullmann, of the Socialists and Democrats group, reacted with frustration to the panel’s suggestion that the European Commission’s draft had fallen short of expectations, listing Sweden’s rumoured amendments – including the loss of Commission-imposed leverage caps and capital requirements, and its reduced scope – in terms of missteps. “Why is this proposal any better than the Commission’s?” he asked. “Has there really been progress?”

During a discussion of third-country issues, Swinburne would suggest that it might be “better” to revert to current private placement rules, following the well-documented derision the marketing passport had induced within the council chamber – a change that Sweden has since incorporated into its draft.

Gauzes is due to publish his Directive report on 25 November; after which the proposal will be discussed in Econ on 1-2 December. Parliament, therefore, is currently operating one month behind its legislative counterpart.   

As Bowles drew the hearing to a close – impressively close to the scheduled 12.30pm finish – the post-mortem could begin. This was the alternatives industry’s first, and possibly only, chance to make its case in the public arena – and the diagnosis was positive.     

"I was very pleased with how the debate went,” Anthony Byrne told HFMWeek, as delegates filed out of the auditorium. “All the panellists provide reasoned, rational and unbiased responses to MEPs questions. Comments were very much in line with my expectations, which was good. If you’re getting surprises at this stage, then the right job hasn't been done in getting the appropriate level of consultation done.”  

Most significantly, perhaps, Byrne praised the “work done behind the scenes” by MEPs, and the "familiarity" they displayed with the material. Econ is due to vote on its final version of the Directive in April.  An optimistic timeframe, some have suggested, but if MEPs are taking their time getting to grips with the issues at hand, as this debate would suggest, then this can only be of benefit to hedge funds.