European threat to the investment company industry

The overriding concern for the investment company industry remains the potentially fatal threat to the sector from Brussels, namely the Alternative Investment Fund Managers Directive (AIFM). This proposed directive was conceived to tackle systemic risk to the financial system by identifying and regulating against potential sources of risk. Sadly, it has provided ammunition for those who dislike the "Anglo Saxon Model" of capitalism and the primacy of London as the world’s leading centre of financial services. Unfortunately all the AIC’s members are caught by this Directive, as any fund which is not regulated under the UCITS Directive is defined as an "Alternative Investment Fund".

In its original form the Directive would mean investment companies would not be able to issue new shares, which would stop all new launches. Though this is an unintentional consequence of the Directive, which we are confident of being able to rectify, it arises from a broader failure by policymakers to understand the governance structure which investment companies operate within. The Directive fails to recognise the role of an independent board, creating conflicting obligations between the board and the manager. The Directive would also stop investment companies using some non EU service providers or potentially prevent them domiciling outside the EU. In addition, there are rafts of additional regulatory burdens including a leverage cap and a requirement for independent valuations.

The original version of the Directive would clearly be deeply damaging to the sector and for investors it would at best increase costs and reduce their investment choice. However, the worst case scenario, according to the FSA commissioned research by Charles River Associates, would be much worse. This research concluded that investment companies would be forced to wind up completely and transfer to a different type of structure at a cost of £64bn.

The good news is that last week the Swedish Presidency published possible amendments to the AIFM Directive. The new proposals are wide-ranging and highlight possible changes to the specific obligations implied by the Directive (eg on leverage, liquidity management, requirement for independent valuation) as well as the overall framework for its application (eg who it applies to, the way any marketing passport would operate).

The proposed amendments demonstrate that policymakers are seeking to get to grips with critical issues, including those which are fundamental to the future of the investment company sector. Importantly they raise the possibility of the company itself taking responsibility for compliance with the Directive. This would maintain the legal status of the board, remove the possibility of regulatory conflict between it and the manager and preserve its ability to ensure the company is run in the best interest of shareholders.

We will be analysing the proposals in detail to fully understand how the investment company sector might be affected if the Directive were amended as suggested. However, it is important to recognise that these changes are not set in stone and they could still be changed by Member Sates or MEPs. Nevertheless, these suggestions confirm our view that the discussions we have been having with policymakers in the UK and Europe have been constructive and that there is a serious intention to amend the draft Directive so that it delivers workable rules. Over the coming months Members of the European Parliament (MEPs) will feature more prominently in the legislative process so the AIC is now lobbying MEPS directly. We are also encouraging our members and shareholders in the sector to engage and influence this audience.

To fulfill our priorities on the Directive we will continue to make representations to the European Commission, – practically every week the AIC has attended meetings in Brussels, to lobby MEPs and to work closely with the UK authorities. Currently the timetable is for the AIFM rules to be finalised at the European level in July 2010 and introduced into the UK around eighteen months later so this suggests they could be in force by mid 2010. With this timetable in mind the next months will be critical to ensure that investment companies not only survive into the future but thrive too.

Annabel Brodie-Smith is Communications Director at the Association of Investment Companies (AIC). The views expressed here are her own.