19 March 2008

ECON published working document on Hedge Funds

The EP ECON committee made public its working document on Hedge Funds which will look at the behaviour of private equity and hedge funds in the current crisis and examine their behaviour in worsened credit market conditions. The document will be discussed in Committee on 25 March. The document finds that hedge funds and private equity are becoming very substantive and strong players in today's financial markets which gives reason for reconsidering regulation aspects.

According to the rapporteur Poul Nyrup Rasmussen (PSE/DA) the working document will try to examine the current level of transparency and indebtness. The document will also look at their direct or indirect link to the current credit crunch following the subprime crisis and ask if either hedge funds or private equity within current regulatory and supervisory design contribute to smooth functioning of financial markets and thus enhance their stability. Finally, the document will deal with their contribution to the real economy and possible undesirable effects on workers.

With regard to Private Equity the document concludes that there is a need to review existing EU investor protection legislation (such as MiFID) to ensure that the appropriate level of protection is given to investors in private equity.

The leverage issue in private equity may require some analogue to existing thin-capitalisation rules in the tax field, but at the EU level. Limits might be set on the debt, with which private equity funds may burden target companies. This would, ideally, be an EU level response to the tax concerns about private equity.

The document also states that there is a need to review existing EU law to see how the capital depletion in target companies this might be redressed. There is a need to review existing EU investor protection legislation (in particular, MiFID) to ensure that the conflicts of interest that arise from private equity activities are appropriately regulated.

On Hedge Funds the report proposes measures to increase transparency, such as frequent reporting and disclosure, common global standards for portfolio valuation and  internal governance, better risk management, enhanced counterparty risk regulation, more effective overall supervision, and enhanced exchange of information and cooperation between supervisory authorities as well as between different tax administrations across EU and globally.

The document complains that complex matrix of existing EU directives and regulations together with different sets of national level regulation of hedge funds across Member States enhance the lack of transparency and seemingly high fees.

Furthermore, hedge funds' financial instruments should be appropriately valued according to harmonised standards applicable across borders.

Funds should also be obliged to disclose its overall exposure to the investors, supervisors and prime brokers.

The document also raises the question of whether there should be any set resolution mechanism available to regulators and central banks in case of a failure of systemically important hedge fund or a cluster of funds.

Finally the document complains about imperfect competition and a free market functioning in financial markets and especially credit markets.

However, any proposed regulation should “not stifle competition even further or limit innovation, support regulatory arbitrage or force funds and managers to move off shore due to high compliance costs.”

Therefore, the documents proposes incentives such as the establishment of an EU level legislative framework for cross-border marketing and sale of hedge funds as also for other non-harmonised whole sale investment products.

Report

For the discussion in ECON Committee see:

Home>Edited Minutes of key legislative Bodies>ECON meetings (link)

© Graham Bishop