Hedge Funds

ECB says EU hedge fund plans could spark exodus

FRANKFURT (Reuters) - The European Central Bank has warned that EU plans to tighten regulation of hedge funds and other alternative investors risk creating a two-tier playing field that could drive the industry out of Europe.

Pedestrians pass an euro sculpture in front of the European Central Bank (ECB) headquarters in Frankfurt June 4, 2009. REUTERS/Johannes Eisele

European governments and the European Parliament have the final say on a new law that will require a wide range of alternative investment fund managers to register and disclose information to supervisors if they want to operate in the 27-nation bloc.

In a legal opinion published on its Web site, the ECB backed stronger controls for the lightly-regulated sector but warned that unless other countries adopted similar rules, the plans would leave Europe at a disadvantage and could drive funds to shift to states with looser regimes.

“An internationally coordinated response is necessary given the highly international nature of the industry and the consequent risks of regulatory arbitrage and evasion,” the ECB said.

“The ECB urges the Commission of the European Communities to continue the dialogue with its international partners, in particular the United States, to ensure a globally coherent regulatory and supervisory framework.”

The new rules would requires funds to disclose the main types of assets it invests in as well as provide details on their use of short selling, one of the tactics blamed for stoking the financial crisis.

Unless non-EU managers comply with the rules within three years of the law coming into force, probably around 2015, they will be barred from offering their products in the bloc.

Britain, the European Union’s main hedge fund and private equity centre, has mounted a strong campaign to water down several aspects of the draft law but faces stiff opposition from France, Spain and Germany, which all back strong regulation of the sector.

Consensus is emerging that a “one-size-fits-all” approach to all the different funds that falls within the law’s cope needed refining.

The ECB raised serious concerns. “The ECB sees a potential risk of regulatory arbitrage between alternative investment fund managers, insurance companies and credit institutions, among which the proposed directive does not create a level playing field,” it said.

It also flagged concerns over the new law’s definition of a fund’s leverage -- amount of debt compared to assets.

“The definition of ‘leverage’ under the proposed directive does not, however, include specific leverage ratio concepts. The ECB is concerned that, without additional clarifications inserted into the text of the proposed directive, it may be difficult to implement the proposed definition,” it warned.

It also said that central banks should be shielded from the new regulations.