The motives behind the draft EU directive on Alternative Investment Fund Managers may be questionable, but it is hard to disagree with policymakers' objectives to enhance transparency and to create harmonised regulatory standards for alternative investment managers in Europe. The dilemma is how to put these ambitions into practice in a cost effective, coherent and fair-minded way.
The directive would require fund managers, rather than funds, to register and seek government authorisation. Fund managers would also have to meet reporting, governance and risk management standards. Opponents of the directive are urging the investment community to take action before it is too late to save the alternative fund sector from destruction.
Andrew Baxter, chief executive of the Alternative Investment Managers Association (AIMA), fears that if fund managers and end users do not unite in order to prevent the directive muddling through in its current format, the market for alternative investments will be crippled by bureaucracy, escalating costs and limited access to innovative investment strategies.
"This is not just about publishing annual accounts and restricting the amount of leverage allowed," said Baxter. "It is a thinly veiled assault on funds based in perfectly well-regulated offshore jurisdictions. Many investment strategies will be lost if investment managers are forced to move funds onshore in order to market them across Europe. Even assuming investment managers are prepared to change tax codes and tweak strategies, it will take years – and a significant financial outlay - to make the transition."
An increasing number of hedge funds have been structuring UCITS three vehicles, enabling them, in theory, to be distributed to retail investors across Europe. However, the constraints make the structure only suitable for certain strategies. Baxter warns that around 95% of alternative investment managers currently available to European pension funds would be out of bounds if the bureaucrats in Brussels have their way.
Daniel Pinto, managing director of the London-based commercial multi-family office Stanhope Capital, shares Baxter's concerns. He asks: "Do we really feel that a Brussels-based civil servant, who has never set foot on a trading floor, can understand complex investment strategies well enough to come up with a sensible agenda?"
Pinto adds: "There is a huge difference between asking a hedge fund to disclose its debt level and imposing a maximum debt level. Some hedge fund strategies can cope with much more leverage than others without necessarily being riskier. Imposing European custodians to hedge funds and other alternative investment structures used in Europe aims to unravel years of globalisation in the financial sector. Investors will find it harder to access US alternative investment vehicles such as private equity, real estate funds and hedge funds."
Many industry commentators believe the directive smacks of protectionism, but if their objections are to be taken seriously Brussels has to be presented with a viable alternative agenda. Baxter said: "We welcome proposals to create a common regulatory framework for investment managers in Europe, but there is no need to dictate which jurisdiction funds are to be based in. In the rush to condemn offshore centers, which tend to be chosen to suit investors, policymakers have overlooked the fact that many countries, including the UK, have established successful and well-regulated investment industries in other territories."
Baxter has a long shopping list of proposals that require modification or, in the case of leverage caps, dropped altogether. "A one size fits all approach to leverage is nonsensical," he argues. "Some investment managers do not employ leverage in their funds and those that do may want to change their strategy depending on the market environment."
Pinto is comfortable with the US approach to regulation. He explains: "Investment institutions which are deemed to be systematically important from now on will be regulated by the Federal Reserve. If you are a major player of the 'shadow banking' system, you might as well be regulated by the central bank. The ECB or the National Central Banks should seriously consider this option."
Joan Major, director of Wealth Management at Sandaire, also a commercial multi-family office based in London, suggests another tack. "Those fund managers that deserve to attract institutional or retail money will need to be regulated and they should seek to ensure compliance becomes part of their business, but those managers that offer their services on a niche basis to investors with 'professional status' should be treated differently."
Perhaps regulators should heed Pinto when he asks us not to forget that the financial system collapsed a few months ago because banks behaved irresponsibly. "Hedge funds may have played a part, but they were not the root of the problem," he says.