Effectively US hedge funds will find it next to impossible to market into the European Union.
When two Bear Stearns hedge funds collapsed in June and July of 2007, the resulting questioning of the safety of investing in hedge funds created an initial political motivation for regulating the industry, especially the issue of hedge fund marketing.
By the time that Lehman Brothers collapsed and the 2008 financial meltdown was in full momentum, political temperature for regulation had hit fever pitch and it was all but decided that hedge funds, this unregulated and uncontrolled beast, were to blame.
OTC derivative trades, illiquid markets and dark pools, leveraging and short selling were all touted as instrumental in attacking the financial stability of the global economy.
A Mis-Directive?
The initial political response to regulating hedge funds was nothing short of irrational and illogical and no research has ever been provided to support the position that hedge funds caused or magnified any financial instability (it must be remembered that stock markets fell further and faster after the global bans were introduced on short selling in 2008).
However, when the first draft Alternative Investment Managers Directive (AIFM Directive) was published by the European Commission in 2009 it was viewed as nothing short of an attack on the UK hedge fund industry and an EU protectionist measure designed to prevent US hedge fund managers from selling funds into the EU.
What had initially began as an issue of hedge fund trading techniques, such as leveraging and shorting, had turned into the most controversial financial services directive in EU financial services history with a marketing war of epic proportions at the core.
The Hedge Fund Marketing Issue
The initial European Commission draft text for the AIFM Directive was followed up by successive new proposals as the 6 monthly presidency of the EU changed hands. Each presidency was expressing different views and each European body (European Commission, European Parliament, European Council) was also forming separate and distinct proposals.
This process of altering versions of the draft directive continued until May 2010 when a series of votes took place resulting in the European Parliament formally adopting one version of the directive and the European Council formally adopting another version.
Both versions would be debated as part of the June/July trialogue discussion between the European Commission, European Parliament and European Council in order to vote and accept one text that would be implemented across the European Union.
However, on the third country provisions concerning the marketing of non-European Union funds by EU fund managers and the marketing of EU funds by non-EU fund managers the European Parliament proposed more stringent restrictions than the European Council in relation to passporting and national private placement regimes.
The European Parliament’s rapporteur, Jean-Paul Gauzès, came under immense industry and political pressure from other MEPs to soften his hard-line approach to the third country marketing rules proposed for non-EU hedge funds selling into the EU. A more palatable text would favour the European Council stance of allowing national discretion. However Gauzès appears to have even dismissed a possible highbred regulation that merges a passporting regime with a national private placement regime.
The Bottom Line to Hedge Fund Marketers
This means that all EU marketing teams selling non-EU funds, and all non-EU marketing teams selling funds will have to become familiar with new regulation affecting their ability to access the European Union.
The breaching of these rules will have serious implications and therefore it will become even more important going forward that marketing departments make themselves aware of EU licensing rules and private placement regime rules.
The Current Dilemma
On the June 24, talks between the European bodies collapsed as the parliamentarian leading the negotiation efforts to agree a common proposal announced it was disbanding for the duration of the summer and that renegotiation would not commence until September at the earliest.
At the core of the problem remain the third country marketing rules which neither side is willing to concede on. Only if non-EU funds meet EU standards can they be marketed within the EU but this has especially angered the US who will feel that the EU are attempting to place an embargo on US funds in the EU.
The US Equivalency Test
The UK appears to have been fighting a loosing battle with the AIFM Directive as more powerful French and German voices within Europe ring out. However, the US has joined forces with the UK to argue that protectionist measures will only hurt the European Union hedge fund industry, admittedly more so in the UK where all the hedge fund managers are based.
Effectively US investment funds will find it next to impossible to market into the EU. Equivalency requirement placed on US funds under current European Parliament proposals would be difficult for US funds to comply with.
Conclusion
This directive continues to threaten Brussels’ plans to overhaul European financial regulation, whilst coincidentally Obama continues with effective overhaul in the US. With third country marketing rules threatening to divide Europe internally, and spark an adverse reaction from the US externally, there has never been a more needy time in the history of EU financial services regulation for a mutually agreeable position to be found.
About the Author
Thomas Bullman is the founder of The Hedge Fund Society and the Hedge Fund College and a noted resource regarding regulatory concepts, implications, and current developments within the hedge fund industry in both the European Union and United States.
