29 April 2009

Commission proposal on Hedge Funds and Private Equity

The proposed Directive will require all AIFM within scope to be authorised and to be subject to harmonised regulatory standards on an ongoing basis. The Directive will apply to those AIFM managing a portfolio of more than 100 million euros.

The Commission proposed a directive on Alternative Investment Fund Managers, including managers of hedge funds and private equity funds, that aims to create a comprehensive and effective regulatory and supervisory framework the EU.

 

The proposed Directive will require all AIFM within scope to be authorised and to be subject to harmonised regulatory standards on an ongoing basis. The Directive will apply to those AIFM managing a portfolio of more than 100 million euros. A higher threshold of 500 million applies to AIFM not using leverage (and having a five years lock-in period for their investors) as they are not regarded as posing systemic risks.

 

AIFM should be authorised and subject to ongoing regulation and key service providers, including depositaries and administrators, are subject to robust regulatory standards.

 

Third country funds should be granted access to the European market after a transitional period of three years.

 

Justification of the proposal

 

The Commission recognised that AIFM were not the cause of the crisis but argues that recent events indicated that some of the risks associated with AIFM have been underestimated and are not sufficiently addressed by current rules, the Commission states, in particular in relation to the effective oversight and control of macro-prudential risks and the fragmentation of the regulatory environment.

 

The Commission argues that hedge funds have contributed to asset price inflation and the rapid growth of structured credit markets. The abrupt unwinding of large, leveraged positions in response to tightening credit conditions and investor redemption requests has had a pro-cyclical impact on declining markets and may have impaired market liquidity.

 

Funds of hedge funds have faced serious liquidity problems: they could not liquidate assets quickly enough to meet investor demands to withdraw cash, leading some funds of hedge funds to suspend or otherwise limit redemptions. Commodity funds were implicated in the commodity price bubbles that developed in late 2007.

 

On the other hand, private equity funds, due to their investment strategies and a different use of leverage than hedge funds, did not contribute to increase macro-prudential risks. They have experienced challenges relating to the availability of credit and the financial health of their portfolio companies. The inability to obtain leverage has significantly reduced buy-out activity and a number of portfolio companies previously subject to leveraged buy-outs are reported to be faced with difficulties in finding replacement finance.

 

Content of the proposal

 

The regime will apply irrespective of the legal domicile of the AIF managed. For reasons of proportionality, the Directive will not apply to AIFM managing portfolios of AIF with less than €100 million of assetsor of less than €500 million, in case of AIFM managing only AIF which are not leveraged and which do not grant investors redemption rights during a period of five years following the date of constitution of each AIF.

 

All AIFM will be required to obtain authorisation from the competent authority of their home Member State. Given the diversity of AIFM investment strategies, the precise requirements, in particular with regard to disclosure, will be tailored to the particular investment strategy employed.

 

The proposed Directive requires AIFM to provide to their investors a clear description of the investment policy, and to report to the competent authority on a regular basis on the principal markets and instruments in which it trades, its principal exposures, performance data and concentrations of risk.

 

The proposed Directive grants additional emergency powers to the national authorities to restrict the use of leverage in respect of individual managers and funds in exceptional circumstances.

 

It furthermore foresees that AIFM employing leverage on a systematic basis above a defined threshold will be required to disclose aggregate leverage in all forms, and the main sources of leverage to the home authority of the AIFM.

 

The proposed Directive permits AIFM to market AIF located in third country domiciles subject to strict controls on the performance of key functions by service providers in those jurisdictions. The rights granted under the Directive to market such AIF to professional investors will only become effective three years after the transposition period, because of the time needed.

 

Competent authorities of the Member States will be required to cooperate whenever necessary. The competent authorities of the home Member State will thus be required to transmit relevant macro-prudential data, in a suitably aggregated format, to public authorities in other Member States.

 

Accompanying impact assessment

 

The report assesses five options: 'do nothing', self-regulatory approaches, amd legislative action at Member State, European or international level. It concludes that the effective monitoring and mitigation of AIFM-related risks requires legally binding and enforceable measures to ensure a high standard of regulation and oversight throughout the EU. Industry-developed standards may have a role to play in informing these provisions and in providing additional guidance to industry.

 

Member States could in principle upgrade their own regulatory and supervisory arrangements and seek to improve cooperation between jurisdictions. However, an uncoordinated approach would risk failing to take account of the cross-border nature of risks and binding cooperation and information-sharing agreements may prove elusive. Moreover, it could not be guaranteed that single market freedoms would be achieved.

 

It is therefore considered that legislative action at the EU level offers clear advantages, both in terms of risk monitoring and control at a pan-European level, and in providing a secure framework for pan-European AIF distribution. Given the potential for international risk spillovers, action in the EU would ideally be coordinated with international action in this area.

 

The development of a robust framework in Europe could provide a useful starting point for global discussion and sharing of information.

 

Press release

Proposal

FAQ

Impact assessment

Summary of the assessment

 

© European Commission