For those of us with children who made a long car journey to the continent over the summer, ‘Are we there yet’, will be a familiar chorus. One of the truly wonderful benefits of working in Jersey is that France is just an hour away by ferry and many Islanders, myself included, have struck south from St Malo where we can reach warmer climes quite easily. The Cook family headed for La Baule, and I can heartily recommend it to any UK colleagues who have been a bit short changed in the sunshine stakes this summer. However, as we return to work, refreshed after the summer break, we are finding that the same chorus has followed us home. Everyone is asking repeatedly of the financial crisis and the global slowdown;
'Are we there yet?'
Are the first signs of recovery underway?
Its probably too early to call, but nervous talk of green shoots, anaemic recovery and fragile GDP growth has emerged in the US, France and Germany, with Alastair Darling assuring us that the UK won’t be far behind.
But something else has been going on over the summer on the continent, this time in Brussels, where the EU Alternative Investment Fund Managers Directive (AIFM) has caused quite a stir. Proposals are being progressed which will, if passed in their current form, provide for regulation of hedge funds and private equity firms who will be subject to greater disclosure and capital requirements, and will also face restrictions on leveraging.
With a global market in excess of $1.3trn and with around one fifth of this value being managed in Europe (most of it in London), it is not too difficult to see why the London Funds community has become exercised about the Directive.
“Our aim is a framework which allows efficient, well run and well regulated fund managers to compete for business without restriction across the EU and to make the EU a base from which to compete in global markets. The draft directive needs major surgery before this can be delivered.”
Lord Myners, Financial Secretary to the Treasury, 7th July 2009
Given the recession we are experiencing is the worst since the Great Depression of the 1930s, it should come as no surprise that regulatory authorities around the world are looking at all forms of risk, especially financial activity, on a scale that could pose systemic risk. Given its size, it is understandable that the alternatives sector has come under the microscope, but it should be remembered that leading respected figures in the regulatory world such as de Larosiére and Turner have concluded that hedge and private equity were not central to the crisis. The fact is they have held up remarkably well through the associated financial disruption.
So is it all bad news, more rules for rules sake, more shutting the stable door after the event?
In fact, an objective review of the Directive reveals some worthwhile and commendable aims. The concept of passporting is especially welcome, allowing those who meet the standard to promote their funds throughout the EU. Greater flexibility and improved market access should improve customer choice and enhance the prospects of increased savings in a demographically challenged continent where private provision for the future becomes increasingly important, as the pressured budgets of the EU states fail to maintain the real value of state pensions.
The private equity and hedge fund industries justifiably feel misunderstood, and to a degree, scapegoated as a result of the crisis. The Directive will give them the chance to step up to the bar and demonstrate they are already well regulated and in tune with the public mood. They are supportive of sound regulation, provided it is well structured, proportionate and relevant.
It is in the area of proportionality that most concerns have been expressed. The restricted access proposed for all non EU providers through effectively insisting all functions are carried out in the EU, combined with an equivalence proving period of three years before non EU funds could hope to achieve full access to the European market would certainly have the effect of restricting choice and is clearly protectionist, whether intended or not.
The end users of these funds, almost exclusively institutional investors, have voiced their concerns. The Chief Executive of Standard Life and Chief Investment Officer of Eumedion, a Dutch institutional investor group, have jointly addressed the EU Commission in a balanced and helpful way.
They make the point that any form of market access restriction will reduce investor choice, and that the compliance burden implied by the directive is likely to make the European Funds industry uncompetitive. They go on to note that hedge funds provide liquidity and improve price information, and that private equity firms have the capacity to invest in business in ways that should support the economic recovery we are all working for.
The EU Commission have cited the G20 imperatives as the primary driver behind the aims of the directive; with the EU putting its best regulatory foot forward in the role of responsible steward of a significant proportion of the global financial architecture.
This is a reasonable stance to take, but with hasty action we may get less workable and ineffective regulation combined with other unintended consequences which are not in the EU’s interest, nor aligned with the fundamentals underpinning the G20 communiqué.
It is true that the April G20 focused on the need for enhanced regulation at the London Summit:-
‘We will take action to build a stronger, more globally consistent, supervisory and regulatory framework for the future financial sector, which will support sustainable global growth and serve the needs of business and citizens.’
However, the April communiqué also addressed the overriding need to ensure free markets can function effectively and that protectionist tendencies must be avoided at all costs:-
‘World trade growth has underpinned rising prosperity for half a century. But it is now falling for the first time in 25 years. Falling demand is exacerbated by growing protectionist pressures and a withdrawal of trade credit. Reinvigorating world trade and investment is essential for restoring global growth. We will not repeat the historic mistakes of protectionism of previous eras.’
It is apparent therefore that one of the consequences of a directive which effectively locks out non EU private equity and hedge funds would be a reduction in the flow of investment funds and capital mobility. This could starve the EU of international capital they would otherwise have benefited from. Given the commitment to free trade in the April communiqué, this aspect of the AIFM Directive does seem to be at odds with the spirit of the G20 meeting.