04 May 2007

FT: Hedge funds to escape EU plea for curbs

European Union finance ministers will next week urge investors and regulators to be vigilant towards the risks posed by the booming hedge fund industry, but will stress that the funds have so far contributed significantly to the efficiency of the financial system.

Crucially, ministers will refrain from urging tighter regulation of hedge funds – despite repeated calls from some European politicians demanding curbs on the industry. In a statement to be agreed formally at their meeting next Tuesday, the 27 ministers will also stop well short of repeating the kind of criticism the industry has endured recently across Europe, including in France, Germany and the Netherlands.

Hedge funds have been attacked for allegedly sacrificing companies' long-term health in favour of short-term profits, and Germany's labour minister famously referred to them as 'locusts'. The industry also faces mounting pressure over fears that hedge funds' typically high leverage and greater appetite for risk may pose a threat to the stability of the financial system.

But in their first formal statement on the industry, the finance ministers will point out that the current approach towards regulating and monitoring hedge funds has worked well and 'enhanced resilience to systemic shocks'. At present EU regulators try to monitor the sector and the risks it poses by closely scrutinising how and to what degree banks and other mainstream financial services companies are exposed to the funds.

This approach – known as 'indirect supervision' – also has the support of Charlie McCreevy, the EU internal market commissioner and the man responsible for drafting and proposing pan-European financial services legislation. Mr McCreevy has defended hedge funds and private equity against political attack, and ruled out any new regulation for the sector.

His supportive stance now looks set to be endorsed by finance ministers – though they will also stress the need for a better understanding of hedge funds to allow the proper monitoring of the financial stability impact of their activities. Finally, the ministerial conclusions will inject a note of caution about allowing retail investors to invest in hedge funds – an idea that has been studied by Mr McCreevy as part of a wider overhaul of the EU's rules on asset management. Pointing to 'concerns' in several member states, the ministers will tell the Commission to think carefully before making any such move.

Hedge funds and private equity groups have been criticised by European policymakers recently. Some say they undermine companies' long-term health, others fret about risks to financial stability. The fear is that regulatory crackdown might drive the funds abroad and fail to control their ability to trade and invest worldwide.

© Financial Times