EU Proposes New Rules for Hedge Funds, Private Equity While Debate on "Too-big-to-fail" Continues
The EC Commission on Wednesday proposed new binding legislation on “Alternative Investment Fund Managers” (AIFM), which includes the managers of hedge funds and private equity funds. This is, according to the Commission, the first attempt in any jurisdiction to create a comprehensive framework for the direct regulation and supervision in the alternative fund industry. The proposal now passes to the European Parliament and Council for consideration.
The proposed AIFM Directive would:
- Adopt an 'all encompassing' approach so as to ensure that no significant AIFM escapes effective regulation and oversight. The Directive will only apply to those AIFM managing a portfolio of more than 100 million euros. A higher threshold of 500 million euros applies to AIFM not using leverage (and having a five year lock-in period for their investors) as they are not regarded as posing systemic risks. A threshold of 100 million euros implies that roughly 30 percent of hedge fund managers, managing almost 90 percent of EU-domiciled hedge fund assets, would be covered by the Directive.
- Regulate all major sources of risks in the alternative investment value chain by ensuring that AIFM are authorized and subject to ongoing regulation and that key service providers, including depositaries and administrators, are subject to robust regulatory standards.
- Enhance the transparency of AIFM and the funds they manage for supervisors, investors, and other key stakeholders.
- Ensure that all regulated entities are subject to appropriate governance standards and have robust systems in place for the management of risks, liquidity, and conflicts of interest.
- Permit AIFM to market funds to professional investors throughout the EU subject to compliance with demanding regulatory standards.
- Grant access to the European market to third country funds after a transitional period of three years. This should allow the EU to determine whether the necessary guarantees are in place in the countries where the funds are domiciled (e.g. the equivalence of regulatory and supervisory standards and the exchange of information on tax matters).
Meanwhile, the chairman of the UK Financial Services Authority, Lord Turner, gave a speech in New York on Monday in which he expanded on his recent review of UK banking regulation. Turner conceded that,
“We simply have to accept that there is a ‘too-big-to-fail’ and ‘too-connected-to-fail’ category, and accept that the primary discipline on excessive risk-taking by this category comes through regulation rather than market discipline.”
Capitals in Europe are now re-assessing the fundamentals of banking legislation, which, according to Turner, should ensure that taxpayers are properly protected if “too-big-to-fail” banks are a fact of life.
There is some pushback on the notion of “too big to fail” in the United States, where the Federal Deposit Insurance Corporation Chair (FDIC), Sheila Bair, continues to press for a resolution mechanism to deal with large, failing financial institutions. In remarks before the Economic Club of New York earlier this week, Bair said, “The sooner we modernize our resolution structure, the sooner we can end too-big-to-fail.” She added that bankruptcy would not work for “large, systemically important financial institutions” and stressed that the FDIC “is up to the task” of disassembling institutions in a way that “can preserve stability and avoid disruptions in the financial system.”
On the matter of regulating hedge funds, the Obama administration and Congress are still working through the policies, but House Financial Services Committee Chairman Barney Frank (D-MA) said earlier this week that Congress will give the Securities and Exchange Commission (SEC) the explicit authority to register hedge funds. SEC Chair Mary Schapiro said the agency is seeking increased rulemaking authority along with the registration in order to inspect, examine, and compel the maintenance of necessary records. U.S. Treasury Secretary Tim Geithner also supports requiring large hedge fund, private equity fund, and venture capital fund managers to register with the SEC. Additionally, Geithner has called for counterparty disclosure and information needed to assess a fund’s potential systemic risk.
