Europe's hedge funds want to opt out of U.S. rules

European hedge fund managers with investors based in the U.S. bristled at a rule introduced this year that required many of them to register with the Securities and Exchange Commission, even if they're already supervised in their home country and don't have any operations within the U.S.

Many funds had to be restructured to comply with the rule, and some European hedge-fund groups stopped marketing to U.S. investors.

A group set up to study hedge funds for the European Commission on Tuesday called on the European Union and national authorities to lobby for the exclusion of European hedge fund managers from such U.S. oversight. The group argued in a report that Europe's managers already meet rules set by their home regulators, such as U.K.'s Financial Service Authority, and shouldn't have to register with the S.E.C. to place their products with U.S. investors.

"Why should those hedge fund managers who are highly-regulated and who meet the stamp of approval of the FSA have to be re-regulated? If it's the SEC, why not a regulator in another jurisdiction doing it? Then those costs become even more onerous and burdensome," said Gay Huey-Evans, president of Citigroup's (C) Tribeca Global Management hedge fund unit in Europe and a member of the group urging Commission action.

The move is part of a wider debate playing out across the world about how and by whom hedge funds should be regulated to protect investors and maintain financial stability. The S.E.C.'s authority to regulate investment firms and stock exchanges that aren't based in the U.S. but have some activities there is also at question.

A system of dual-regulation "creates significant costs and forces managers to structure their operations to comply with two different regulatory systems," the E.C. group said in its report.

"The European Commission should make appropriate comments and enter into negotiations so that the final regulations that are put in place do not have adverse consequences for the European hedge fund industry," it said.

Europe hosts about 1,250 hedge fund firms controlling more than $325 billion of the world's $1.2 trillion in hedge-fund investments. About two-thirds of the funds are run out of the U.K., where managers must be authorized by the FSA to manage money or advise on a fund's trades, just like any other other asset manager or investment adviser.

From February, the S.E.C. started requiring hedge fund managers both within and outside the U.S. to register if they have more than 14 U.S.-based investors and $30 million or more in assets.

A U.S. appeals court threw out the registration rule for all hedge fund managers June 23, but it remains in effect until August, and is expected either to be revived or replaced with new regulations that also would apply to non-U.S. advisers.

While political pressure is mounting in the U.S. to tighten the reins on hedge fund managers after a series of frauds, European regulators have been known for their light touch toward the industry, which, for the most part, remains the domain of wealthy individuals and institutional investors.

Regardless of whether non-U.S. hedge fund managers are registered with the S.E.C., they must play by the same rules as any investor when they trade in U.S. securities, and are bound by U.S. anti-fraud provisions.

Likewise, in Europe, hedge fund activities are restricted by securities law and a market abuse directive against insider dealing and improper market conduct.

"Hedge funds have gotten to be such major participants in the markets that it's inevitable they're going to be subject to some form of regulation," said Paul Schreiber, a partner at Shearman & Sterling LLP in New York who advises hedge funds. "But one would and should forcefully make the argument for non-U.S. hedge fund managers not to have to be subject to U.S. law."

The E.C. group contended that the lack of any known case of fraud by a Europe-based hedge fund manager is attributable, at least in part, to effective local regulation and the common European practice of having independent firms administer hedge funds.

By contrast, the S.E.C. has brought 96 enforcement cases over the past seven years against investment advisers for defrauding hedge fund investors.

The S.E.C. has come under fire in Europe for extending its reach outside of U.S. borders. In addition to its supervision of some non-U.S. hedge fund advisers, there is concern the body could end up overseeing European stock exchanges that merge with regulated U.S. exchanges.

 

The group reporting its findings to the E.C. includes executives from London-listed hedge-fund group Man Group PLC (EMG.LN), Barclay's PLC's (BCS) Barclays Global Investors and Goldman Sachs Group Inc. (GS), as well as a dozen other representatives from investment houses, prime brokerages and administrators.

It was set up in February to study how hedge funds are marketed, distributed and regulated within the European Union. Other group recommendations include improving retail and small institutional investors' access to funds and allowing hedge-fund groups to market and distribute their products freely throughout the E.U. once they've been approved by a member state.

The Commission will hold an open hearing on July 19 to receive feedback on the Tuesday report before it eventually outlines its own recommendations.