For years, the comprehensive regulation of hedge funds and private equity funds had topped the list of demands of the European Parliament and labour representatives. Following years, during which the Commissioner in charge Charlie McCreevy, had bowed to the pressure of the finance lobby and prevented any form of European regulation, a respective initiative of the Commission came at last within reach during the course of the financial crisis. In Brussels, the time had finally come this week. The proposal presented by the Commission, however, seems to partially confirm the worries of some, who were concerned that the Commission would once again only produce a cosmetic draft, which leaves too many open loopholes.
The European Social Democrats and the Commission already clashed over the Draft in the run-up to its publication. The Social Democrats pulled the text of the Commission, which had already been leaked before the official resolution, to pieces and made Commission President Barroso personally responsible for the fact that in spite of having paid lip service in favour of an effective regulation, a weak proposal of his controversial Irish Commissioner McCreevy had been accepted.

A detailed analysis of the unofficial Commission’s Draft, which was presented in Brussels by the leader of the European Social Democrats, Poul Nyrup Rasmussen at the beginning of the week had, however, also limited praise for the proposal of the Commission. Hence, the approach not only to subject hedge funds and private equity funds to regulations, but also all other market participants, should be welcomed as much as the fact that the Commission will at last move away from the long-term practiced approach of self-regulating the industry by voluntary codes of conduct.

However, from the point of view of the Social Democrats, this already sums up the advantages of the Commission proposal. One of the main points of criticism of the Social Democrats is reserved for the registration system, which is slightly similar to the country of origin principle, which was included in the original Draft of the Commission on the EU Services Directive: once a fund manager has been registered in a Member State, he is free to market his products in all other Member States. National provisions, which go beyond the ones provided for by the Commission’s Draft, are then no longer possible, unless the funds turn to small investors.

It is exactly this background, against which the Social Democrats demand a strict regulation regime. The fact that the registration applies to the entire Union makes it even more important to guarantee a high standard of regulation. And that is where the Social Democrats see significant weaknesses. The Commission in fact proposes that only fund managers should be regulated and not the funds themselves - a regulation modelled on the British concept. After all, 80 % of the EU hedge funds are managed in Great Britain and at the financial centre London, whilst the majority of funds themselves - for tax and legal reasons - are held in offshore centres such as the Cayman Islands. Following the proposal of the Commission, any access to these funds would still remain almost impossible. Obviously, the British have asserted their influence in the Commission to please the London City, which has allegedly invited a lot of criticism by other Member States such as Germany and France.

In the opinion of the Social Democrats, European investors too - which frequently include important institutional investors such as pension funds, which manage workers’ savings - are not sufficiently protected by this model. The Directive only provides for regulating fund managers, who are located within the EU, not, however, fund managers, who are not located within the EU, who, however, work for funds, in which European depositors have invested. In addition, the Socialists criticised the investment limit, from which onwards the Directive will be effective. In a first draft, the Commission had specified that only funds exceeding an investment volume of over EUR 250 million should be subject to the Directive. This, in accordance with calculations made by the Social Democrats, would only concern 15 % of all funds. One had to be worried that this would result in regulatory arbitrage, where large funds are simply divided into smaller ones to escape the regulator.

Further fundamental points of Rasmussen et al of the Draft: no sufficient duty to furnish information for fund managers; no sufficient right to information for workers and their representatives if their company, for example, is swallowed by a private equity fund; insufficient provisions with regard to the admissible extent of indebtedness and the necessary equity capital of hedge funds; no consideration of tax-related aspects.

The pressure of the Social Democrats on the Commission has at least partially come to fruition. Hence, the Commission has in its final Draft lowered the investment threshold, from which fund managers are subject to the provisions of the Directive, from EUR 250 million to 100 million. And fund managers, who want to market funds from third countries within the EU, shall in future also be subject to EU regulations - however, only 3 years after the now introduced Directive has come into force.

The Directive itself has now been forwarded by the Commission to the co-decision makers for further consideration, hence to the European Parliament and the Member States. The Commission braces itself for difficult “political” negotiations, which, however, can only take place after the EP elections at the earliest. The final Directive must then be converted by each of the Member States into national law. The Commission therefore expects the Directive to come into force in 2011 at the earliest.

Further information:

Presse Release of the European Commission

Questions and answers from the point of view of the European Commission