FSA warns against heavy-handed EU regulation of hedge funds

Date: Tuesday, February 9, 2010
Author: Phillip Inman, Guardian

The chief City regulator added its weight today to growing concerns that EU plans for regulating the hedge fund industry will prove chaotic and excessively costly to implement.

The Financial Services Authority said a proposed directive still carried "significant risks", even though some stricter rules were toned down during negotiations between member states.

The comments followed warnings by a group of City lawyers that the directive could lead to "systemic failure" in European markets if it were passed in its current form.

In a sustained attack on the directive, the financial markets law committee said the directive would "create significant legal uncertainty leading potentially to systemic failure and widespread market disruption, unless they are appropriately amended".

Ministers are expected to intensify their lobbying efforts in Brussels to head off what are widely seen as heavy-handed rules governing the behaviour of hedge funds, private equity firms and other alternative investment businesses.

The City minister, Lord Myners, recently held talks with his opposite number in the Spanish government, which holds the EU presidency. He is understood to be concerned that hedge funds and private equity firms, many of them based in London, will relocate from the EU if the rules are implemented without reforms.

Dan Waters, sector leader for asset management at the FSA, said at the EDHEC-Risk Summit: "I would not underestimate the significant risks that still exist in this draft directive. It could still go badly wrong in some important areas."

Several reports by the FSA have highlighted concerns that a tight legal framework governing all types of alternative investment businesses will be open to challenge. It has put forward proposals for a principles-based approach to regulation, mimicking the model used by the FSA.

Waters' comments came as members of the European parliament prepared to debate more than 2,000 amendments to the proposed directive on hedge funds and private equity firms. The directive was sponsored by the French and German governments in the wake of the financial crisis.

Sharon Bowles, chair of the European parliament's economic and monetary affairs committee, will oversee the debate, which is expected to start on 22 February before a vote in April.

She is understood to favour a principle-based approach to regulation.

Waters said the parliament's version of the directive contained dangers, despite the huge number of amendments. "The parliamentary text is very far away from an acceptable position from the UK's point of view," he said.

He also said changes put forward last week by the EU's Spanish presidency, which include reintroducing limits on hedge fund marketing, were unjustified. "We are not on safe ground yet. It is incumbent upon regulators and investors to stay very active in this debate."

The directive also covers managers of a wide range of alternative investment funds including private equity and real estate.