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U.S. Enters Europe's Fund Debate

Date: Monday, July 27, 2009
Author: Alistair MacDonald, The Wall Street Journal

Washington Joins U.K. in Lobbying EU for Less-Stringent Regulations

As its hedge-fund and private-equity industries worry about new rules, the U.S. is quietly lobbying Europe to change the terms of proposed financial regulation that could place strict new rules on any U.S. hedge- or private-equity fund doing business in the region, according to a senior Treasury official.

The move wades the U.S. into a fierce battle between the U.K. and other parts of Europe over how tough regulation should be. Some nations, led by Germany and France, are calling for wholesale regulation of financial services in the wake of last fall's crisis, but the U.K. says that overly stringent rules would damage its large financial sector and close off U.S. and other funds to European investors.

The U.S. and U.K. are lining up to change the European Union's proposed Alternative Investment Funds Directive, a sweeping bid to overhaul regulation of hedge funds, private equity and other alternative investment funds. In its current form, the directive would, among other things, place limits on how much debt funds can take on; require them to hold capital to cover potential losses and redemptions; and place strict disclosure requirements on private-equity portfolios.

The directive would effectively apply to all funds and financial firms, including those based in the U.S., if they want to raise cash or provide services in Europe. This so-called equivalence test may block some U.S. companies from operating in Europe, given that the European directive goes much further than proposed increases in U.S. fund regulation. The U.S government wants hedge funds to register and provide more information but isn't looking at rules such as leverage caps.

The U.S. signaled its position in a little-noticed speech late last month by Mark Sobel, the U.S. Acting Secretary for International Affairs. "In a world of mobile capital...we cannot go our own ways, deviating significantly from international standards," Mr. Sobel told the Federation Bancaire Francaise, a Paris-based banking association. "Nor should we impose standards on one another if we are not identical."

U.S. Treasury officials have made their presence felt in the debate by talking with both their counterparts in European governments and European Commission officials in Brussels. The U.S. is also pushing its agenda on regulation in international forums such as meetings of the Group of Seven industrialized nations. Funds have told the Treasury of their concern and are doing their own lobbying in Brussels, and in capitals like London through industry bodies such as the Managed Funds Association, according to a person familiar with the matter.

The U.K., which already regulates hedge-fund managers, believes the European rules go too far and will drive funds out of Europe in what was described as a "weak form of protectionism" by Paul Myners, a U.K. government minister responsible for London's financial center. The stakes are high for Britain, where 80% of Europe's hedge funds are managed and which has a large private-equity industry.

"It is perhaps easy for other European countries to make political capital out of demanding intrusive regulation of an industry of which they have little or no direct experience," Mr. Myners said in a recent speech to the fund industry.

The funds themselves say the financial crisis was caused by banks, not them, and that the new regulation is the fulfillment of a long-held desire of countries like Germany, who dislike their boardroom interventions, to control them. Acknowledging hedge funds played little role in the financial crisis, a spokesman for the Commission said that these rules are to prevent future risks to the system, which these funds could pose.

The directive has been controversial even within Continental Europe. Sweden and Finland, for example, believe that private equity, which has proved a big investor in their countries, shouldn't be subjected to the same rules as hedge funds; Ireland wants to change the strict rules on hedge-fund custodians, a big sector in Dublin.

But few are seeking the sort of large-scale overhaul the British want -- and to succeed the U.K. will need to win over a majority of the EU's 27 states. Even countries advocating more flexibility within the directive, like Finland, Sweden, Hungary and the Netherlands, aren't calling for a revamp.

"The U.K. will need to do a lot of foot work to get the majority supporting their criticisms," said Ilkka Harju, a senior Finance Ministry official in Finland.

Any politician challenging the directive would be swimming against public opinion, which blames the financial sector as a whole for the deep recession the region is currently suffering.

Critics of the E.U.'s plans also say that political horse trading is to blame for the strict nature of the directive's rules. The heads of socialist parties in the European Parliament told Jose Manuel Barroso, the president of the EU's executive arm, the Commission, that unless he helped push through stricter regulation they wouldn't back him in his bid to be re-elected to this post, people familiar with the matter say. Having been endorsed by EU governments, Mr. Barroso now needs his re-election to be sanctioned by the European Parliament.

A spokesman for the Commission said that while Mr. Barroso did have input on this directive, the idea this was part of a deal to get him re-elected "is absurd and completely without substance."

The directive is currently being discussed in a series of working groups, and countries want to get a version ready before the September G20 meeting in Pittsburgh, where regulatory reform will be high on the agenda. It will be discussed by the European Parliament and European finance ministers in the autumn. Ahead of this U.K. Treasury officials are embarking on a tour of European capitals to put their case forward.

"We are confident that we will get the changes we need, but it will take time," a U.K. Treasury spokesman said.

Write to Alistair MacDonald at alistair.macdonald@wsj.com