Tuesday, October 13, 2009

Save the hedge funds?

What do hedge fund managers and bluefin tuna have in common? Both have recently been described by the European Commission as “emblematic”.

Officials drafting support for the endangered tuna reportedly argued for hours over which adjective to use, rejecting “beautiful” and, apparently, “delicious” (see Prospect magazine Oct Brussels diary) as inappropriate.

It seems they had the same adjective problem with hedge funds and private equity firms.
The EC says its controversial Directive on Alternative Investment Fund Managers will be the subject of intense political discussion in view of its “emblematic” subject matter. What seems certain is that, if implemented, the Directive could make hedgies feel about as safe as a tuna in a trawling net.

London Mayor Boris Johnson will on Friday launch a report highlighting threats to the City’s international standing in finance. The AIFM Directive is high on his list of threats, and he’s being backed loudly by the Sunday Telegraph’s “Ditch the Directive” campaign. Expect another flood of ink this weekend.

So what’s the fuss about and should we really be ditching the boldest piece of regulatory reform to be proposed since the financial crisis?

The background to the Directive is nicely laid out in this February 2009 speech by one of its sponsors, Poul Nyrup Rasmussen, president of the Party of European Socialists and former prime minister of Sweden.

Rasmussen doesn’t like alternative investment funds, especially ones that pay big bonuses and disrupt the economy. In his view, financial markets should serve the real economy, rather than be an end in themselves. This is not a line that goes down well in the UK, where we like to believe that financial services are the real economy. Rasmussen says hedge and PE funds undermine society and extract value rather than creating it. This is obviously true for many forms of arbitrage, although rarely admitted in public. Rasmussen says now is the time for the EC to regulate, and warns: “Financiers are not the masters of the universe anymore."

Predictably enough, the industry sees this as routine lefty social capitalism, driven by envy and a failure to see the beauty of the Anglo-Saxon model. It also warns that Rasmussen’s aim is not to regulate the alternative investment industry but to terminate it. In Rasmussen’s world, they say, funds will close or move to Switzerland and Dubai, leaving us short of financial talent and GBP 5bn in tax revenue.

The Directive would require hedge funds, private equity firms, commodity, real estate and infrastructure funds to report their activities so that systemic risks, such as a sudden build-ups in a security, can be monitored and managed, and so investors can be protected from miss-selling, underperformance or fraud.

Hedge funds and prime brokers would face ratcheting capital and liquidity requirements, with the burden increasing when activity gets too complex or opaque.

Detailed implementation would be come through subsequent EU laws but the main principles would be enshrined by the Directive.

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