GLOBAL - Harvey Pitt, chairman of the SEC from 2001-2003 and during the 9/11 and Enron years, has warned that the European Commission's draft directive on alternative investment fund managers could end up exacerbating the systemic risks it is supposed to regulate if it leads to hedge funds abandoning Europe.

At a press conference organised by CQS, the London-based hedge fund on whose advisory board he sits, Pitt said institutional investors like pension funds could find themselves "severely constrained" by the directive, which he said could gain approval this calendar year and be in force as early as 2011.

He suggested there was a danger that the quasi-regulation achieved through institutionalisation of the industry, as it began managing more money for large fiduciaries, could be put at risk.

He also warned, however, of "real concern" about an "exodus" of hedge fund managers from Europe, leading to job losses in significant European industries and a flight of capital which would pose potential risks to the security of financial markets and the economy.

"Germany and France basically see hedge funds as one of the causes of the crisis," he said. "The US seems to be heading in that direction, too. But the difference is that the US and the UK, because they have substantial hedge fund industries to think about, are more cautious about regulation: they want more transparency, but they do fear that bad regulation could drive business away."

Hedge funds can exacerbate problems that are systemic, Pitt conceded, though they did not cause them. In fact, as the many hedge funds that profited from the subprime fallout suggested, and unlike most government and regulatory bodies, the industry has a strong track record in price discovery and "ferreting-out" potential systemic risks long before the rest of the market.

"If this capital leaves Europe, it might actually be more difficult to detect systemic risks in the future," Pitt warned.

Pitt is now CEO of investment management consultancy Kalorama Partners and a member of CQS's advisory board, though he stressed the views expressed were his own and do not necessarily those of CQS.