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AIFM could bring less fund choice, claims law firm

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EUROPE - A Paris-headquartered law firm has warned current proposals for the Alternative Investment Fund Managers (AIFM) Directive could lead to a lack of choice of funds in the future unless European officials can work with US and international counterparts to improve regulatory terms on alternative investments.

Financial services law firm Gide Loyrette Nouel has conducted an initial analysis of the AIFM Directive and suggested many organisations will be disappointed with the detailed and complicated proposals on the table but should try to tap the opportunities available once the directive comes into force by 2012.

David Malamed, partner at Gide Loyrette Nouel, said while the new directive is designed to assist EU passporting of alternative funds - including hedge funds, private equity and real estate funds - it could actually reduce the number of alternative investment funds that institutional investors have access to because it is likely to deter overseas managers from providing access to funds based in the Cayman Islands and Asia.

"Whether funds in external countries [outside the EU] would be allowed to be passported is not clear," said Malamed.

"We are creating Fortress Europe. And the rules for marketing a Cayman [Islands] fund in Europe are so stringent that in practice they will be impossible to follow so the US will retaliate. The consequence will be lack of choice for investors," he said.

More specifically, Malamed and his team are concerned that the regulations are going to be so stringent on alternative investment fund managers that they will be substantially more than placed on US and other overseas funds, such as those registered in Hong Kong and Singapore, and fund managers in those countries will be less willing to provide access to European institutional investors.

Initial proposals for the AIFM Directive were only recently unveiled but it is anticipated, according to Gide Loyrette Nouel, that once a Rapporteur is appointed - by September - the directive will progress rapidly and contain much more prescriptive rules - than are usually seen in EU financial services directives.

Louise Forrester, consultant at Gide Loyrette Nouel, said although many organisations are calling for separate directives to be created for the individual alternatives funds markets - hedge funds, private equity funds, investments funds (such as listed investment trusts) and real estate funds - it is unlikely to be broken into separate offerings, and will be much more detailed in terms of requirements than earlier directives.

"Everyone is trying to distance themselves from the others: private equity and real estate say they should be treated separately in regulation and a lot of the lobbying will be to say we need something separate from them. But I don't think there will be separate regulation."

She continued: "I think it will be more complicated and more cumbersome. We may have to have a directive that has provisions which work for different types of funds, but we will have one directive. And there will be a lot more detail, even compared with something like MiFID. By the time we get to implementation of the directive, there will be little flexibility to prescribe in local markets as the directive will be so detailed."

Part of the problem with formalising this directive is the funds concerned, such as private equity, do operate under different terms and conditions which are not necessarily suited to their requirements. The directive is described by the law firm as being targeted mainly at hedge fund managers so the addition of private equity and real estate means there is no ‘one-size-fits-all' solution.

Private equity fund managers have told the law firm it is not possible to assimilate the hedge fund position with private equity, and open-ended funds as have different issues to the closed-ended funds.

Real estate funds, for example, will be required to conduct an independent valuation of their assets once a year, which could be difficult given there is no EU-wide valuation process reflected in the directive. Similarly, such funds may be required to hold regulatory capital yet smaller real estate funds with just over €100m in assets under management - the level at which fund managers must be compliant with regulations -  could find this difficult because they hold such large assets. And managers would be required to gain approval for their business strategy yet the UK regime, for example, does not currently regulate the property business.

Gide Loyrette Nouel believes regulation of some kind for alternative investment managers is needed, in part to restore investor confidence on the continent in offering they do not really understand.

"It has been said that this is a direct attack on the City of London but we disagree," said Malamed.

"There are political motives behind this directive, but they are linked to the crisis and the Madoff scandal. They led to the belief that some was clearly wrong in the financial world and there was need for financial accountability. But this is politically motivated in that the continent believes that the industry should be regulated. We cannot continue business as usual. In light of the Madoff scandal, we absolutely need to restore trust in the system. We believe that regulation is needed for the fund industry but whether this should include tackling systemic risk is debatable.," he added.

Some of the issues the law firm believes need to be tackled include the use of a registered custody or depository as one example. Whether the answer is the introduction of a depository for funds, as suggested in this directive, is debatable according to Gide Loyrette Nouel.

Similarly, what might be most helpful, according to the team, is clarification of international bankruptcy rules, especially as the regulation of the European investment industry is thought to be stricter than the US.

Malamed claimed the directive as it stands has been written with concessions to the French government, as it currently mimics the more restrictive rules of French regulation - many French investors cannot invest in Cayman Islands funds - but is also designed to allow EU passporting.

What is unlikely to happen however, suggested Malamed, is the City of London would lose a significant chunk of business to other countries once the directive is introduced, though Zurich and Dubai might be able to entice smaller investment houses to relocate.

"The issue is infrastructure to support the industry and support the families. Nobody seriously believes the City of London will lose its edge in the European industry. And we also believe it is an opportunity for the UK industry to do what they were never able to achieve and create an inshore industry, rather than an offshore industry. It is true the City of London could suffer, but there are also opportunities. Your Fidelitys are not likely to move to Zurich, but hedge funds with eight staff can move, and will threaten to move. The larger firm cannot [move] soare talking more about the positives.

What is really needed, suggested Forrester, is recognition of what more paperwork might mean for regulators such as the UK's Financial Services Authority. And as the UK is the country regulating most hedge funds in Europe, for example, what the FSA does not need is substantially increased paperwork on the back of this directive.

"The FSA regulation is underestimated because it is more than a tick box exercise, yet it is not quite sufficient partly because they do not have to the resources and the knowledge at the FSA to do a full risk review of hedge funds, and there are not specific rules to hedge funds," said Forrester.

"Hedge funds were regulated but they were not subject to much regulation. So this [directive] brings the balance. What countries don't realise is they would be receiving tons of paper every day on short-selling etc, and the capacity for information received is out of the range of knowledge and handling," she continued.

Malamed added: "Sending more information to the regulator is not going to solve anything. We need to speak to the SEC. The SEC has been interacting with the EU for the last 4-5 years, and they need to have more cooperation with the EU."

Gide Loyrette Nouel is the largest law firm in France operating in international business and finance law, and has 50 lawyers in London along with a further 15 operating out of New York.

If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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