Regulatory Brief: EU-passport proposals for hedge funds

The plan involves setting up an EU-wide special regulatory regime across all 15 member states to accommodate sophisticated alternative investment vehicles (SAIVs), including hedge funds and funds investing in property, currencies and commodities. 

John Purvis, Vice-President of the Economic and Monetary Affairs Committee and author of the Committee’s draft report on hedge funds, stated that the aim was to develop a “more supervised environment” for hedge funds.

According to the report, the global hedge fund industry manages around USD 600 billion of assets worldwide, and funds managed in Europe represent around 15 percent of the total. 

Purvis added: "These new rules will go some way to coaxing investors back onshore. Sophisticated investors will have an alternative way of investing at a reasonable level of regulation." 

The Committee on Economic and Monetary Affairs said the proposed new EU rules will be lighter than for conventional investment funds, focusing on the provision of information to investors.The proposals will have to be adopted by the EU’s Council of Ministers before becoming law.

 Benefits for EU fund centres 

The rules are expected to effectively help with job and business creation in the EU, acting as a boost to EU fund centres such as Dublin and Luxembourg. 

Luxembourg‘s fund administration business was built on the back of the UCITS Directive that created an EU passport for mutual funds. Dublin followed in Luxembourg‘s footsteps over a decade ago and has never looked back. 

Both jurisdictions have in recent years built their hedge fund administration capabilities, and both are already well placed for the proposed EU-passport hedge funds, with Luxembourg concentrating its efforts on large institutional vehicles. 

Legal firms with cross-border links will also benefit strongly from the need for advice on the setting up and distribution of these funds. 

Pitfalls of the proposed regime 

As EU fund managers have already seen with the UCITS Directive, implementing an EU-wide passport system is fraught with problems. 

In the case of UCITS, the reality was that most UCITS funds established in Luxembourg were done to take advantage of the Grand Duchy’s low cost, low tax regimen and were sold back mainly into the fund promoters’ home country, be it French banks selling back to their French customers or German banks selling funds back into Germany. 

Only a handful of firms such as Fidelity and some large European banks such as Deutsche Bank were really able to sell into more than one country because local country marketing rules, which still have to be followed, failed to keep up with the regulations from Brussels, and cross-border fund promoters were caught up in endless red tape and mounting legal bills. 

Will the EU-passport for hedge funds suffer a similar fate? It will take a hedge company with deep pockets to use these products, limiting their EU-wide use to bank-owned hedge fund companies and larger independent groups with strong distribution networks.  

The rest of the hedge fund industry are likely to limit their use of these products to penetrate one or two specific markets of interest.

Sunil Gopalan

Editor-in-Chief

Hedgeweek

copyright hedgeweek 2004