Bank of England panel condemns draft EU hedge fund legislation

Date: Monday, February 8, 2010
Author: Suzy Jagger, Times Online

Draft European Union legislation designed to regulate the hedge fund industry would trigger “systemic failure and widespread market disruption” if it became law.

Those are the findings of the Financial Markets Law Committee (FMLC), which was established by the Bank of England, on the eve of a critical week for the EU hedge fund directive in Brussels.

The Times has learnt that European lawmakers will be presented today with about 2,000 amendments to the draft legislation, each of which must be debated.

Lawmakers in Brussels — led by the French — believe that the trading behaviour of hedge funds exacerbated the severity of the global credit crisis and played a key role in the collapse of a number of lenders.

The French and the Germans have long argued that hedge funds behaved like “locusts” on the financial system. Three quarters of Europe’s hedge funds are based in London and they contribute about £3.5 billion a year in tax revenues to the UK Treasury.

Using the European Commission’s Directive on Alternative Investment Fund Managers, a number of politicians in Brussels want to impose regulations on hedge funds that would limit the amount of debt they assume, force them to hoard more capital, disclose more data about their trading practices and clients and effectively block EU and non-EU hedge funds from taking stakes in one another.

Lord Myners, the City Minister, and Lord Mandelson, the Business Secretary, have sought to persuade Europe to tone down the draft legislation. The report from the FMLC, which was set up to monitor the draft legislation, has concluded that it is unworkable and would “create significant legal uncertainty” if implemented in its present form.

The committee said that it had spoken to a number of representatives of the fund management industry, who raised “an infinite number of legal uncertainty issues”. The report found that one of the biggest worries about the proposed legislation was that Brussels had no idea how to define a hedge fund or its activities. It also indicated that a number of conflicts existed between present legislation and the draft regulations.

The FMLC wrote of “the inconsistencies and inherent conflicts between the Commission’s proposal and existing financial services directives which create legal uncertainty as to the general application of Community legislation”.

The committee indicated that it was “aware that a number of other ambiguities and uncertainties have been identified in submissions by other parties”.

Andrew Baker, chief executive of the Alternative Investment Management Association, said: “There are still very important areas that need to be discussed, where agreement has not been reached. Measures governing leverage, depositaries, valuation and remuneration all have question marks over them. A number of the amendments will be boiled down, but it’s only after that that we will see what shape the directive will take.”

Mr Baker welcomed the FMLC report. He said: “What the report highlights is that no one [in Brussels] has sat down and thought: ‘How are we going to implement this?’ ”