FSA Outlines How to Make EU’s AIFM Directive More Workable

Karl Hindle – London UK

Sally Dewar, Managing Director of the FSA’s Wholesale Markets Division, gave a speech earlier today outlining four key areas which need to be addressed in order to ensure effective fund regulation and the regulatory approach which ought to be adopted.

 The full text of the speech may be found here.

Speaking at the FSA’s Asset Management Sector conference, Dewar said that “most of us can see value to the European and global capital markets, and the wider economy, in sensible and proportionate harmonization of regulatory standards in the areas under discussion.”

The four areas Dewar highlighted are:

• Correct identification of the weaknesses in the present regulatory arrangements and addressing them in a proportionate way
• Differentiation between types of alternative investment fund management
• Adoption of a risk-based approach – the scope and thresholds of the Directive need to strike the correct balance between imposing additional costs and enabling regulators to identify and mitigate systemic risks
• The need to take a global approach that recognises the global nature of the sector and does not impose unjustifiable geographical restrictions on firms' business models that would significantly restrict investor choice

How serious the FSA are regarding AIFM can be gauged by the fact that this year’s Asset Management conference focused solely on AIFM.  Also attending were Matts Odell (Swedish Finance Minister and Sweden currently holds the EU Presidency) and Lord Myners who set out the UK Government view.

Sally Dewar’s final point is the lynchpin around which “proportionate harmonization” will revolve; AIFM in its current form is a deeply divisive piece of legislation and as politically charged with short-term motivation as can be.  As Dewar stated, “But if there are restrictions on funds not domiciled in the EEA [sic US], then (based on current business models) the actual benefit of this regime is likely to be limited, particularly for the hedge fund industry.” [emphasis added]

I agree with Dewar, we all see value in “sensible and proportionate harmonization of regulatory standards”, but pan-European nor global regulatory harmony will be achieved by ignoring the geo-political realities of global markets and players therein (Dewar’s last point).  Under current proposals, many US banks will fail the requirements but the UK and US appear to be accelerating down the road of cross-border regulation (see this post on the FSA and SEC data share exchange agreement announced earlier this week) while many banks are looking to the Far East as an alternative to London or New York for establishing their operations.

It is hubris to suggest London is “the” European financial market but it is far more disturbing hubris on the part of AIFM proponents to believe raising barriers to entry for US players ( even when referred to as "non-EEA") is not going to be viewed as anything but anti-competitive in New York or Washington DC.  More unsettling than that, practically every EU financial centre with hedge fund operations is aware that money flows and if there are skilled personnel available in other world financial centers, such as Hong Kong or Singapore (or New York or non-EU Switzerland), so will the fund managers.  

Perhaps the French and Germans will finally come to some understanding of how legislating without the consent of the regulated is rule making for thin air. Societe Generale experienced one effect of French bonus restraint this week; several key players left the company to set up a hedge fund with US funding and will now determine their own remuneration.  This underscores the US and UK approach that remuneration, and especially bonuses, are effectively non-issues in the overall scheme of global and domestic regulation.

So much for bonus restraint President Sarkozy!

The FSA stance seems to demonstrate they have grasped the situation – AIFM in its current form is going to hit the London hedge fund sector extremely hard and along with New York, this is where the largest chunk of the world’s hedge funds are based. 

The Americans are in an enviable position in many respects; New York stands to gain EU (and London's) business if AIFM bites too hard, or maintains or expands its access to EU markets if it is less draconian.  

For London it's a straight win or lose which is why AIFM dominated the agenda today.