Capco Blog

The AIFM Directive: another European storm?

On May 17th, 2010, after more than a year of industry complaints and disputes, members of the European Parliament’s Economic and Monetary Affairs Committee have approved new stricter rules for Alternative Investment Fund Managers (AIFM). Less than 24 hours later, the E.U. finance ministers endorsed their own version of the proposed text. Although there are no immediate consequences from these votes, reality is that the AIFM Directive has now progressed to its final stage, kicking off the negotiations to forge a compromise that will ultimately be voted on by the entire European Parliament in the summer.

The original AIFM Directive goal was relatively simple: to ensure that all funds operating outside the traditional regulated sector are subject to supervisory oversight – and in particular hedge funds and private equity funds. While appropriate regulation should always be welcomed, the very first draft of the Directive was designed in haste without sufficient industry consultation. It was even described by Europe Economics, commissioned by the Committee on Economic and Monetary Affairs, as “poorly constructed, ill-focused and premature.” After lengthy discussions and thousands of line by line amendments, a compromised form has nevertheless been reached. Unfortunately, the draft Directive as it currently stands is inconsistent with both existing regulations and prevailing market practices. Its benefits are hard to identify while its unintended consequences are numerous. For example, it could seriously scale back E.U. investors choice, result in skyrocketing compliance costs, which will ultimately be charged to investors, and hurt the wider economy through losses of tax revenues and even jobs, particularly in the U.K. More importantly, the Directive is protectionist to its very core.

Should the current proposal or anything that resembles it become law, non-E.U. managers willing to market their funds to E.U. investors will face a range of obstacles, such as demands for reciprocal regulations, information sharing, double taxation agreements, etc. Even with all the boxes ticked, it could take them several years to secure an approval. Some may argue that the parliamentary draft dangles the possibility of a European “passport” that would enable authorized non-E.U. funds to be distributed throughout the E.U. However, the E.U.’s finance ministers are against it and would prefer non-E.U. funds to be forced to seek an approval in each individual member state. Moreover, the passport would require the home supervisors of these funds to ensure that they comply with the E.U. rules, which is tough to accept for some countries.

Worse still, the latest parliamentary draft appears to ban E.U. investors from placing money with offshore funds that do not meet the European rules. This is seriously worrying as more than 84 percent of all hedge funds managed by E.U.-based managers are domiciled outside the E.U., and therefore considered offshore. With such tough barriers, there is a high risk of seeing investors, managers, custodians, and funds themselves confined to a life either within the E.U.’s borders or outside them. Some hedge fund managers may ultimately decide to remain in Britain rather than leave for tax-friendly Switzerland, but others may also simply decide to stop marketing their funds to E.U. investors. They would then have little incentive to remain in the E.U. at all, including for investment and research purposes. Talents and capital would then have to emigrate offshore, thereby again reducing the overall European competitiveness and ability to recover from its current crisis.

The next question at this stage will be the U.S. reaction. The latest draft of the Directive could and should trigger protectionist countermeasures, making it more difficult for European hedge fund managers to access U.S. investors. This would be the sign of death for the European alternative investment fund industry. It would probably achieve the political agenda of some of the member states. However, let us recall that the last G20 summit instructed world leaders to “promote global trade and investment and reject protectionism.” Wishful thinking…

The views expressed in this article are exclusively those of the author.

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