LONDON Europe's move to tighten regulation of the hedge fund industry could give home-grown funds an edge over foreign rivals, many of which are still trying to absorb the new rules on attracting investor cash.
The rules, known as the Alternative Investment Fund Managers Directive (AiFMD), were launched a year ago to create a single market for hedge funds and help protect investors by requiring funds to be more transparent and improve their risk management.
A one-year grace period for funds to get a licence to sell across the region runs out on July 22, but bureaucratic inertia, a patchy interpretation of the rules by member states and the costs of complying means few have signed up so far.
European funds appear likely to adopt the rules sooner because, unlike their foreign counterparts, they have little choice.
"We found that alternative asset managers headquartered outside Europe are potentially sleepwalking into the unknown despite the potential impact on their business," said Georg Reutter, a partner at advisory firm Kepler Partners.
Without a licence, funds will be restricted from selling freely across Europe and will have shrinking options to tap the 27 percent of the global industry capital that comes from large investors in the region, data from research firm Preqin showed.
Nearly half of the funds approached in a global survey of managers running a combined $300 billion by European fund structuring firm Alceda said they had not yet applied for a licence and just a third were already compliant.
The rest were in the process of applying or were not planning to apply.
"You can feel there's a bit of a scramble out there from managers who aren't prepared for it," said Jeff Holland, co-founder of Liongate Capital Management, a London-based money manager that invests in hedge funds.
"We're getting emails from managers saying 'we're taking you off the marketing list' or 'you need to opt in to remain on the marketing list'," he said.
Many of those doing the scrambling were U.S. managers, with smaller managers often the ones with fewer resources to interpret and understand the implications of the rules, Holland said.
That creates an opportunity for European managers who are compliant to tap into the many billions that have flooded into the hedge fund industry from institutions such as pension funds, which themselves value safety and transparency.
"Hopefully in 12 months' time we'll know a lot better what is allowed and where... It's a great opportunity for European managers as competition will diminish," said Mark Baak at Dutch-based Privium Fund Management.
More than 4,000 European hedge funds manage a total of $492 billion, data from industry tracker Eurekahedge showed, about a third of the $1.4 trillion invested in nearly 5,100 North American funds.
A study by BNY Mellon suggested the one-off cost to funds of complying with AiFMD would be around $420,000, while average ongoing costs would be around $300,000 a year - fixed costs that would hit smaller fund firms much more than larger ones.
Reutter at Kepler, which co-authored the Alceda survey, said 41 percent of respondents said they had just a "limited understanding" of AiFMD.
A survey of 150 hedge funds released on Thursday by research firm Preqin found 59 percent of the managers thought AiFMD would have a negative impact on the industry.
There are several options left for those without a licence.
If a fund is happy to forego the right to pitch to clients anywhere, say because they only have UK clients, then all they need to do is adhere to UK "private placement" rules on approaching investors.
And with three quarters of the region's hedge fund assets located in the UK, for many smaller managers that could prove the most cost-effective option.
But that get-out clause only lasts until 2018, when all countries must ensure a minimum level of compliance in law with the directive, which includes rules governing disclosure of positions and fund manager pay.
While European firms and those big global managers with heavy commitments in Europe will have no choice but to become AiFMD compliant, many smaller and mid-sized firms are less sure.
In the Alceda/Kepler survey, 4 percent of respondents said they would market in each country on a separate basis, 8 percent said they would consider using a third party to access investors, while 7 percent said they would not market at all within the European Union.
That caution was evident at a recent hedge fund conference.
"There are non-European managers that don't even hand me their card because they don't know if it's allowed... There's no market practice yet of what's possible or not, what's considered to be marketing or not," said Privium's Baak.
"We need market practice or some court cases or something to explain what is allowed or not, but no one wants to be the first test case."
For many foreign funds, the answer will lie in a strategy known as 'reverse solicitation', where you rely essentially on the investor to come to you.
"If you're a $2-3 billion equity long-short house in Connecticut, you've probably got about 20 percent of your assets out of Europe, then you're probably going to say, and this is what I think a significant proportion of U.S. clients are thinking, 'I'm going to rely on reverse solicitation only'," said the head of prime brokerage at a London-based investment bank.
(Editing by Tom Pfeiffer)