Hedge funds hit in EU manager directive

The European Union (EU) directive governing the marketing efforts of hedge funds was passed on Tuesday, and gives offshore managers little wriggle-room to claim further distribution powers within the political bloc.

On Tuesday, EU finance ministers finally passed the draft directive – called the Alternative Investment Fund Managers (AIFM) – although the new British and Czech representatives lodged reservations which must now be considered by the Spanish presidency.

The motion came a day after the European Parliament adopted a parallel position – which was friendlier to hedge funds and, by extension, the UK, which contains the greatest concentration of hedge fund managers in the EU.

Now the parliamentary proposal and the AIFM must be reconciled by July – an ambitious target, according to The Economist, given that the EU directive was first proposed in April 2009 and has been intensely revised ever since.

The AIFM states that negotiations on “third country provisions” – the terms dictating which funds and managers based outside the EU can market products to pension funds, insurers and other professional investors, within the bloc – should be taken into account.

While the parliamentary version offers a ‘passport’ for managers to market funds throughout the EU, provided they satisfy strict provisions, the AIFM aims to give national authorities a voice in deciding which non-EU based managers and funds can market products within their jurisdictions, and does not provide managers with the chance to gain EU-wide marketing rights.

It follows that US managers, and many London managers which domicile funds in offshore jurisdictions, could see many sales pipelines shut down if the AIFM does not get watered down in the imminent months of negotiations.

But even if the parliamentary version wins out, managers must still clear a series of hurdles before qualifying for an EU-wide passport. They must convince the bloc that their home jurisdiction sets tough operational and compliance standards, including anti-money laundering and tax regulation, and also ensure their funds comply with EU rules.

This extensive regulatory reach will not be received well in the US. It could also displease EU investors because they will not be allowed to invest in offshore funds that do not meet the bloc’s standards.

This regulatory caution around offshore investing – spurred by the big losses that European investors took as they were defrauded by Bernie Madoff – could create greater liabilities for custodians safeguarding client assets. This could lift the prices custodians charge for their services, and make them less willing to entrust assets to sub-custodians offshore, potentially limiting the allocations European pension funds can make to emerging markets, The Economist notes.