Academics attack one size fits all EC regulations

Jorg Rocholl, an associate professor at the European School of Management and Technology (ESMT) – the Berlin-based international business school - has analysed the European Commission’s (EC) proposed Directive on Alternative Investment Fund Managers (AIFM), and what this means for hedge funds and private equity.

Rocholl said: "This directive risks creating an administrative structure that will harm the international competitiveness of our system, fails to resolve the risks that remain, and is ineffectively tarring a number of different industries with the same regulatory brush.

He believes that any information disclosed by hedge funds disclosed will be obsolete before reaching the regulator.

"The business of hedge funds is characterised by the substantial use of leverage to exploit primarily short-term arbitrage opportunities," Rocholl points out.

"Demanding substantial information from hedge funds is tantamount to shutting the stable door after the horse has bolted. Information relating to short-term positions will likely become obsolete as soon as it is produced, failing to achieve the transparency that is sought, whilst placing an unnecessary burden on Europe’s financial industry."

Rocholl warns that the proposals open the door to significant regulatory arbitrage – for the US and offshore funds in the short-term.

"Creating a paper trail will do nothing but open the door to regulatory arbitrage. Offshore funds will be unaffected until 2014, whilst the US industry can expect a serious shot-in-the-arm and migration of talent to its shores. The international principles set out in the G20 warranted industry consideration, and a response that created a more uniform international financial environment. We can expect the response from the US to be more benign - New York must be popping open the champagne corks!"

In a last minute change to proposals, private equity scored a significant victory as the Commission accepted the industry does not pose systemic risk to the financial system. In its proposals, the threshold for those funds being regulated increases from €100m funds under management for hedge fund managers to €500m for private equity fund managers (so long as they are not leveraged, and have a five-year lock-in period for investors).

However, Rocholl believes the proposals have significant ramifications on the private equity industry.

Private equity measures are inappropriate, and risk penalizing the industry against other private forms of investment, including SWFs, he said.

"Private equity is targeted with regulation on risk modeling, liquidity and minimum capital requirements, in addition to more justifiable disclosure standards. These are inappropriate tools for an industry that is far more long-term oriented and typically has an eight-year investment interest in its assets.

"Why not look at the transparency and governance of all private funding, from sovereign wealth funds, to larger family offices, and endowments? If anything, private equity should perhaps be treated more sympathetically in that its deep pockets are particularly needed in times of financing constraints for a substantial number of corporations. The current directive does not help to alleviate these financing constraints."

Rocholl concluded: "The current directive is an outcome of long-term continental European political goals, rather than an effective remedy for the current financial crisis. The fact that the threshold has been lowered to include funds as small as €100m is indicative of this fact, and will affect the smaller end of the sector that it claims will be unaffected.

"So too is the threat to the taxation arrangements of offshore funds, which has nothing to do with financial stability. In spite of attempts to draw distinctions between hedge funds and private equity, it remains unclear how the vast array of alternative investment businesses can all be regulated under a single directive. The City’s squeals are justified."

The EC plans have also come under attack from hedge fund industry groups.