There’s a lot riding on the outcome of negotiations surrounding the European Union’s Directive on Alternative Investment Fund Managers (AIFM). Its controversial “third country” rules, for example, could dictate how and where fund managers do business with European investors. Another clause tacked on in recent months could prevent AIFM-compliant firms from doing leveraged buyouts.
A definitive document is expected by the end of July that would reconcile two versions of the AIFM voted on in May by the EU Parliament’s Economic and Monetary Affairs Committee (ECON) and the Council of Ministers, which has representatives from each member state.
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There are significant differences between each group’s versions. The Council of Ministers’ version allows for national private placement regimes to continue, provided that there are cooperation agreements in place between the particular EU country’s regulator and the regulator of the third country where the fund is domiciled. If the fund manager wins the seal of approval from that particular EU country, the manager could then freely market throughout the EU.
The ECON committee’s version, however, adopts the third country rules as previously written, prohibiting foreign fund managers from marketing within the EU unless they can demonstrate that they are subject to a regulatory regime of equivalent rigour in their home country. Should this version pass, the outcome would be dire for the private equity industry as the manager must gain approval from each EU nation to get the needed passport.
Currently, many major EU trading partners, including the US, Russia, China, India and Brazil, do not meet the required standard, and therefore would be denied a “passport” to market within the EU. The UK and the US have both publicly opposed the third country rules.
“If you’re a US fund manager, then you would, under the Parliament text, need to go through a number of requirements and the outcome might not be the same for you in each country in the EU. Some countries’ regulators might recognise equivalence, whereas others may not so willingly,” says Elizabeth Ward, counsel at law firm Linklaters, who adds the AIFM could result in cutting Europe off from access to external funds.
US and European finance officials have expressed strong opposition to the third country rules.
In a Wall Street Journal editorial, Christine Lagarde and Wolfgang Schauble, respective foreign ministers of France and Germany, said: “All hedge funds marketed in Europe should certainly provide information to European authorities so that they can monitor systemic risk. But besides such rules agreed by the G-20, qualified investors should be free to invest in funds from all around the globe irrespective of quality standards set for state-of-the-art European hedge funds.”
The AIFM directive could not only limit how and where fund managers do business, but it could also negatively impact limited partners.
It “could have a significant impact on the ability of institutional investors, such as pension funds, to source and invest in the best private equity and hedge funds worldwide,” says Andrew Bradshaw, partner at London-based law firm Sacker & Partners. “Whilst there may be a transition period of say, three years, many pension funds are already invested in private equity and infrastructure funds where they are effectively locked in for 10 to 15 years.”
Many, including this publication, have argued the directive was borne out of a politicised attempt, post-financial crisis, to increase transparency in the alternative investment industry and bring greater protection for European investors. But Brussels has surely misfired in terms of choosing an industry to target if it truly wants to safeguard investors and bolster market confidence.
“Whilst I recognise the EU’s good intentions, large sophisticated institutional investors are big boys and don’t really need Brussels holding their hands when it comes to making investment decisions,” agrees Bradshaw.
We will have to wait until next month to find out just how firmly those hands will be held.