Two early draft versions of AIFMD both ruffle feathers in the City.
If the unprecedented scale and scope of the financial crisis has created something of a war between financiers and politicians, then the key battleground is to be found in the realm of financial services regulation.
And the gulf between the two sides’ positions can be seen as clearly as anywhere in the European Union’s ongoing fight to increase the regulation of the alternative funds industry.
Last month, during his first week in the job, chancellor George Osborne was one of the EU finance ministers who passed a draft version of the Alternative Investment Fund Managers Directive (AIFMD). A marginally more fund-friendly draft of the directive was passed by the European Parliament the previous day, but neither version has been well received by the City.
The problem facing fund managers and their advisers is not only the likelihood of swingeing measures, but the fact that haggling around the scope of the regulation is likely to continue all summer.
“Without a shadow of a doubt this has been the most politically controversial piece of financial regulation in Europe in the last two to three years,” says Ashurst financial institutions partner James Perry. “They’ve really started a fire. Some politicians see this directive as a vehicle to air their prejudices about what has happened.”
The two central pillars of the proposed directive are the restrictions on non-EU funds from marketing themselves in Europe and the imposition of freshly tightened disclosure rules on any entity that is more than 10 per cent fund-owned.
The former, which revolves around the issue of ’third-country passports’, would restrict the right of US funds in particular to operate in Europe unless they submit to a strict set of criteria.
The consensus says that such an imposition would invite retaliatory legislation in Washington. The current parliamentary version of the directive would force US
fund managers to be regulated by the EU.
“The parliamentary draft is completely barking,” says Perry. “The ESMA [European Securities and Market Authority] would call up the SEC [Securities and Exchange Commission] to ask how they’re regulating US managers on European law. Everyone expects that to be negotiated out in due course.”
The issue of disclosure is one around which there is even more fear among fund managers. Portfolio companies would have to apply a different set of disclosure rules than they would if they were not owned by an investment vehicle. In a market where private equity acquisitions are already hard to get away, the directive could be a disaster for both the houses and their legal advisers.
SJ Berwin private equity partner and European Venture Capital Association (EVCA) member Simon Witney is one of a number of lawyers who sees the regulations as a draconian squeeze on every aspect of the EU funds business.
“If it’s not good for European funds, it’s not good for European advisers,” he says. “I don’t disagree with the need to regulate, but the UK private equity market has been regulated by the FSA for many years. In fact, many see that regulation as helpful in their marketing of funds to investors.
“I’m not against regulation but I am against bad regulation and many parts of the current draft of the directive are bad regulation. It would make it more difficult for the funds to do business and many of its provisions would not protect anyone from any identified risks.”
However, there are optimistic noises that rules on disclosure will be eased when an agreement is finally reached later in the year.
“It was very unfair originally but has been watered down,” says Perry. “The consensus is that there should be a level playing field between private equity and other buyers.
“The level playing field idea is something people want to achieve so we can expect there’ll be some commitment to that.”
Of course, for European private equity it makes sense to read UK private equity, given the size of the UK market. Some see the rush to impose new restrictions on the industry as a swipe at the power of London as a financial capital.
“There’s a feeling that this is a smash and grab against the City by other financial centres,” explains Norton Rose corporate finance partner Jonathan Herbst, a member of the Alternative Investment Management Association’s (AIMA) legal committee.
“The fund management community thinks that the crisis is a banking crisis but [the AIFMD] is being used to have a go at the funds business.”
The continuing uncertainty about the ultimate form of the directive and what its impact might be is keeping managers on edge while their advisers try to make sense of the proposals. But Herbst dismisses the suggestion, as some have previously made, that work might start to flow for funds lawyers.
“It’s true that more regulation creates more work but that’s a very glib way of looking at it,” he says. “We have to have a thriving industry to have a thriving set of advisers. For a short period of time it might mean an increase [in work], but a bad result for London is a bad result for all of us.”
The real sticking point is that no one knows either how long it will take to reach a consensus nor what that consensus will look like.
“The drafts are different in almost every respect,” adds Witney, “so it’s very hard to assess what the ultimate impact will be.
“We’re going to see big changes in all areas covered by the directive.”
At the moment, uncertainty is the order of the day. And while that’s bad news for the alternative funds market, the coming regulations could be even worse.