28/04/2010 Author: Tony Griffiths

What difference does it make?

With the UK General Election virtually upon us, and the polls pointing towards a genuine three-horse race, HFMWeek speaks to representatives from each of the prospective Governments to assess what impact their policies will have on Britain's hedge fund industry, both nationally and, crucially, in addressing the challenges of impending European regulation

On 6 May the UK will go to the polls for one of the most closely fought general elections in recent times. The Liberal Democrats recent surge in popularity – thanks in no small part to leader Nick Clegg’s performance in the inaugural TV debates – has made a mockery of the UK’s so-called 2.5 party status, and, for the first time in years, the balance of power is split, very much, three ways. Clegg’s Liberals, David Cameron’s Conservatives, and the ruling Labour Party under Prime Minister Gordon Brown all harbour realistic hopes of success – outright or otherwise.   
 
Much has been made of the implications of a potential Labour, Conservative or Liberal Democrat Government for the UK’s wider financial markets, not to mention sterling’s prospects under the very real possibility of the country’s first hung parliament since 1974, but the impact each would have on Britain’s hedge fund industry is another matter entirely. Certainly, the awkward nature of the political animal means any negative, financials-focused political grandstanding – to a recession-hit electorate – should be taken with a pinch of salt.

Speaking at last month’s HFM European Performance awards, former Lib Dem leader Charles Kennedy addressed the political community’s quandary – balancing public mood with the greater gain. “As all of us are out in the electoral marketplace for votes and support in the coming weeks, we do need to remember that we are tremendously constrained in our aspirations and ambitions by the simple fact that we’ve got to have a wealth-creating capacity in this country which enables good social objectives to be pursued and to be realised,” Kennedy said. “We are very dependent on you being good at your job, in the way that you need to be dependent, whoever’s in power, on us being good at our job.”

Christopher Miller, CEO at industry consultant Investment Quotient, believes Kennedy’s assessment is shared by the majority of the politician’s peers. “There might be some horse-trading and grand-standing,” he says, “but, in general terms, all three parties agree that hedge funds are beneficial.”

In the UK, at least, hedge funds are not a political target. However, with the financial services sector such a major part of the UK’s economy, change – the buzzword of modern political rhetoric – will be forthcoming. Under a Tory government, for example, national regulation could be in for a potentially significant transformation, though, ironically, with negotiations on the Alternative Investment Fund Managers (AIFM) Directive at a critical point, it could be the three parties’ individual approaches to Europe that has the most lasting impact.

THE NATIONAL EFFECT
An outright victory for the Conservative Party – the most likely outcome before the recent surge in Liberal Democrat popularity pointed to a hung parliament – would result in the most dramatic post-election change in national regulation, as shadow financial secretary Mark Hoban explains. “A Conservative Government would replace the failed tripartite system with a new regulatory regime to restore confidence in the City,” he says. “It is in no one's interests to go back to business as usual.”

The Liberal Democrats, under market liberal Nick Clegg, have made no such commitment to wholesale regulatory overhaul. The party’s Treasury representative, Vince Cable, like Clegg, an advocate of the benefits of a free market economy, told HFMWeek that a Liberal Democrat government would “work with” the FSA “to ensure that “hedge fund regulation is proportionate and places no unnecessary burdens on the industry”.

paul Myners, the financial services secretary, says that Labour would ensure the maintenance of the current framework. “In the recent budget we took a number of steps to enhance the attraction of the UK as a fund domicile,” he notes, referring to Chancellor Alistair Darling’s commitment to a series of small-scale initiatives likely to benefit FoHFs and onshore start-ups.

Some regulatory commentators, however, have pointed to Labour’s new company takeover provisions – the so-called ‘Cadbury’s Rule’ – as a potential problem. Aimed at short-term investors, the rule would prevent an investor who had bought shares during a bid from voting on the transaction. “It won’t help activists, who may buy shares during the bid to get more influence, but it could be the death-knell for doing merger arbitrage in UK listed companies,” warns Andrew Shrimpton, a regulatory expert with investment consultants Kinetic Partners.

Bankers bonuses are the focal point for the Liberal Democrats, Shrimpton adds. “Though it’s not very clear whether it will spread across to hedge funds or not.”

If successful, the Conservative Party plans to carve up the FSA and reinstate the Bank of England (BoE) as the primary regulatory force in the UK financial sector. Larger hedge fund managers would then fall under the remit of the BoE. “I think bigger hedge funds would be comfortable with it,” says Shrimpton. “For hedge funds, the FSA has already started changing what they’re doing to be the way the BoE would be interested in supervising anyway.”

Earlier this year the FSA published its first survey of larger hedge funds. The poll was part of a wider move into improved data collection and focus as laid out by the G20. The BoE has always had a focus on systemic issues, says Shrimpton, and the FSA’s shift towards thinking about systemic issues fits more comfortably with a potential Conservative recalibration.

Not everyone is convinced. “There will be winners and losers within the FSA,” notes Christopher Miller of Investment Quotient. “[the Conservatives] will decrease the amount of red tape as far as they can in regard to Europe.”

THE EUROPEAN EFFECT
“The biggest issue is the EU directive,” says Investment Quotient's Miller. “Whoever gets into power will have about two weeks before a crucial Ecofin vote to get their act together, which is a really tall order. I think all the parties are aware of that.”

In March, Gordon Brown’s personal intervention helped postpone a vote on the Alternative Investment Fund Managers (AIFM) Directive in the EU Council (at the Ecofin meeting of EU finance ministers), pushing it back to the likely date of 18 May. As the European hub for hedge funds, the UK is charged with upholding the fund industry’s interests, and it will be up to the next Government to continue to fight where Labour and Gordon Brown left off.   
“We have worked hard with our partners in Europe to secure significant improvements,” says Paul Myners, adding that “there are still a number of areas where we are fighting to secure further improvements”.

A Liberal Democrat Government would “build on the work already done,” regarding the AIFM Directive, and “continue to press for a workable solution”, says Vince Cable. When contributing to this article, the vast majority of Cable’s comments concentrated on the Directive, highlighting specific examples of the document’s potential for harm, including third-country restrictions and strict liability for depositories. As Cable notes, Sharon Bowles, the chairwoman of the Econ committee – where crucial, final Directive-related negotiations will play out – is a Liberal Democrat.

“A change in Government to the Liberal Democrats would certainly not have a negative effect; it is a Conservative Government that is much more likely to find itself on the outside and therefore ineffectual in persuading other countries to side with them.” Cable refers, of course, to the Conservatives'     highly publicised withdrawal from key EU group the EPP, choosing, instead, to align with a smaller, less influential group. Unlike the Liberal Democrats, who support the enlargement of the UK’s role in Europe, the Conservatives are considered to seek the return of certain EU powers.

Mark Hoban, however, claims that, going forward, a Conservative Government would be “much more active” in Europe. “We will give a single senior Treasury minister specific responsibility for European financial regulation,” he says. “That minister will spend as much time as necessary in Brussels to ensure that the Government is fully engaged in the legislative process and able to shape the agenda.” According to Hoban, the Tories would enhance the UK Treasury team dealing with European issues, and begin a new programme of secondments for UK civil servants in the European Commission.

Contemporary British politics is often criticised for an apparent lack of difference between parties. Indeed, when it comes to hedge funds, Labour, the Conservatives and the Lib Dems have much in common, from their
acceptance of the industry’s benefits and contribution to the UK economy, to the general acknowledgement, in these straitened times, of a likely tax hike for top-bracket earners.

That said, though no manifesto mentions hedge funds explicitly, there is enough variation in the three
parties' policies and approaches – both home and abroad – to warrant a comparison. Labour’s company takeover provisions will impact merger arbitrage hedge funds in particular, the Conservatives’ more sceptical attitude to both the EU and the FSA could prompt dramatic change, while the pro-Europe Liberal Democrats role in a likely hung parliament could be decisive. Wherever the balance of power lies on 7 May, the UK’s hedge fund industry will need to be aware of the small-print.