Cicero Policy Briefer

Issue 10, March 2007

Hedge fund legislation in the EU: case closed?

By Michael Cooper

The debate over the regulation of hedge funds has increasingly divided opinion over recent weeks, with high profile figures from around the financial services world setting out their respective stalls on the issue. The increasing number of comments is a reflection of the rapid, unregulated growth of the industry.

Recent figures from Hedge Fund Research value the industry’s assets under management at $1,225 trillion. Earlier this month, G7 finance ministers (Russia did not attend) voiced their unease at the intense growth of hedge funds, demanding that the group be “vigilant” in the face of such a “challenging and complex” market.

In the EU, hedge funds are not currently subject to any legislation—including the investment funds regime, UCITS—and this remains a question of debate in Brussels. Indeed, a Commission-appointed expert group on hedge funds has reported and discussed alternative approaches—which do not call for new EU legislation—to make hedge funds available to different categories of investor.

The chance however of seeing a Hedge Fund Green Paper emerging from the Berlaymont in the near future is unlikely. When talking of hedge funds in London last week, Charlie McCreevy, Internal Market Commissioner, confirmed his desire not to regulate. He noted that the decision should be “recognised as the swallows of a new European regulatory spring. We are reducing the regulatory pressure post-FSAP.”

McCreevy stressed that this position is justified for two reasons. Firstly, he sees no current justification in terms of there being a threat to financial stability; and secondly, the dynamic of hedge funds is undisputedly international, and EU action would be lost in such a global market. Hedge funds have no national allegiance: if a market implements strict regulation, the capital will move elsewhere. Ben Bernake, US Federal Reserve Chairman, is also unconvinced by “heavy-handed, direct regulation of hedge funds”. Hence, waiting for global action is as good as saying that there will be no action. It is not, however, necessarily “case closed” on the matter.

There are fears that pressure for returns on hedge fund managers may be encouraging insider trading and market manipulation, breaking the rules of the Market Abuse Directive. Germany appears particularly keen to discuss increasing transparency in hedge funds and, given its presidencies of both the European Council and the G8, the issue is not likely to disappear from the forthcoming political agenda. In this respect, the views of Franz Münterfering, German Social and Labour Affairs Minister, could be cause for concern in the Commission: the Minister has referred to hedge funds as “locusts” and called for more regulation and transparency.

Münterfering is far from alone. Nicolas Sarkozy, current favourite in the French presidential race, has gone as far as demanding a European tax on speculative capital movements. German Employers Federation BDI has also voiced its discontent with the current light touch approach, demanding at the very least “voluntary self-regulation on the basis of a code of conduct or ratings”—a sentiment echoed by Jean-Claude Trichet, head of the European Central Bank. With condemnation also coming from the European Parliament, the European Commission seems more and more isolated in flying the flag for lifting the regulatory burden in Brussels.

From an EU perspective then, has the hedge fund industry grown too large to slip through the regulatory cracks? Increasingly, yes. So what action can we expect? A step up in scrutiny in the future is the most likely bet—but given the EU’s eternal stand-off between cutting red tape and creating fair and effective governance, any outcome will be a slow process.

Michael Cooper can be contacted on +44 (0)20 7665 9530 or click here to email.

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