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News analysis: Decision time looms for EU’s alternatives directive

The European Union’s Directive on Alternative Investment Fund Managers is poised to step significantly closer to becoming law this week, with decisions on the directive scheduled to be taken in the European Parliament and the EU’s Council of Economic Affairs and Finance Ministers.

Today members of the parliament’s Economic and Monetary Affairs Committee are due to vote on the directive, following a week’s delay resulting from a disagreement with the parliament’s Legal Affairs Committee about disclosure requirements affective companies with 50 or more employees that accept venture capital funding.

On Tuesday a different draft of the directive will be voted upon by the EU’s economic affairs and finance ministers. Up to now the UK has managed to stall a decision while seeking concessions on access to the European market for non-EU managers and funds, but the new Conservative-Liberal Democrat coalition in London is reported to be resigned to being outvoted, with only the Czech Republic likely to join the UK in opposing the draft currently on the table.
A reconciliation procedure to hammer out a single version of the draft directive could conceivably yield some progress on issues of concern to members of the industry and to the UK, where the vast majority of the EU’s alternative fund managers are based, but nobody’s holding their breath.
Instead industry organisations have launched a fresh round of lobbying and public relations initiatives in a bid to remove or water down aspects of the directive that they believe will effectively bar European institutions and individuals from investing with managers or funds based outside the EU, including funds domiciled in traditional alternative fund centres such as the Cayman Islands, British Virgin Islands, Jersey and Guernsey as well as vehicles run by US managers.
Last week the Alternative Investment Management Association and two UK organisations, the Investment Management Association and the National Association of Pension Funds, wrote to European Parliament members urging them “to support a pragmatic and workable solution on non-EU alternative investment funds and fund managers”.
A compromise amendment on third country access before the parliamentary committee, the groups say, will not provide access for non-EU funds and fund managers, but will have the effect of banning European investors from investing overseas.
“It will reduce choice and drive down returns for pension funds and other investors, as they will no longer be able to select their investments from among the best available products globally,” the letter says. “This will undermine Europe’s competitiveness. There is a real risk that it would provoke retaliatory action in non-EU jurisdictions, which would damage the European financial services industry and the whole European economy.
“There is no contradiction between setting criteria for some funds and fund managers to avail themselves of a ‘passport’ for cross-border marketing and maintaining member state discretion on which non-EU funds may be marketed to qualified investors. This approach has already been supported by the Legal Affairs Committee in its opinion on the proposal and is supported by the European Council. It is the only pragmatic and workable solution on the third country issue.”
Alan Brint, head of corporate and institutional business for the British Isles at RBC Wealth Management, believes that the fledgling recovery of the alternative fund sector, underway for barely a year following the turbulence of 2008 and early 2009, could be derailed by the directive.
“The barriers to third country funds that the directive in its final form will likely contain would close off most of Europe for distribution to Channel Islands-domiciled funds, which would instead be replaced with EU-domiciled Ucits-regulated funds. Offshore custodians of the assets of these funds would also be restricted from acting in this capacity for European based funds. They would likely suffer as a result of a general reduction of offshore fund assets caused by the closure of offshore funds whose assets transitioned to new or existing EU-domiciled funds and a general downturn in the launch of new funds.”
The draft directive’s provisions governing the role of depositories, as custodians are described, have been coloured, many observers believe, by the losses suffered by French investors in the Bernard Madoff fraud. The role that the custodians of feeder funds based in Luxembourg and Ireland could or should have played in protecting investors is the subject of ongoing legal action.
Says Brint: “The depositary will be liable to the alternative investment fund manager and the fund’s investors for any losses suffered by them as a result of its failure to perform its obligations under the AIFM directive. This liability is not affected by delegation, so depositories will need to weigh up the risks and benefits of providing services to alternative investment funds within the EU.”
He is confident that if the final directive does set out standards of equivalency under which funds from offshore jurisdictions could access the EU market, Jersey and Guernsey will be able to meet them, but warns that they could be penalised by the cost of meeting those standards.
“The Channel Islands will likely be in a strong position to meet the challenges of the directive through obtaining equivalence status for the jurisdictions impacted,” Brint says. “But even were this to happen, the costs of operation for service providers would increase and in some cases make the operation unviable.”
Aima chief executive Andrew Baker warns that if the EU pushes through a “flawed” directive the impact will extend far beyond the hedge fund and private equity industries that are the main target of the legislation to institutions whose investment activities ultimately affect the fortunes of ordinary people, such as pension funds and insurance companies.
“We have already heard how the directive would hit small firms across Europe and make it more difficult for new businesses to be created, and how development banks investing in emerging markets would be affected,” Baker says. “Real estate and infrastructure investment in Europe would also be impacted because funds in this sector would also be covered by the directive.
“We are particularly concerned about measures that would ban European investors from accessing funds [domiciled] outside the EU. Major investors in alternative investments include pension funds and insurance companies, and there would be very negative social consequences across Europe if their investments were adversely influenced by such a ban. Ordinary European citizens would have to pay higher pension contributions and insurance premiums.
“Closing Europe’s borders would send all the wrong signals out to the rest of the world about Europe’s place both as a global centre for financial services and as a destination for international investment. It would significantly affect international trade and capital flows and result in protectionist consequences. And it would impact ordinary citizens and small businesses across the EU and emerging markets internationally.”

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