The European Union earlier this month moved closer to placing wide-ranging regulations on the private equity industry that could make it difficult for U.S.-based firms to market their funds to investors on the other side of the Atlantic Ocean.
Both the European Council, which is composed of finance ministers from EU countries, and the European Parliament, composed of directly elected representatives, endorsed their respective versions of the new regulations, which would also affect how hedge funds operate on the continent.
The Council and the Parliament will now begin negotiations to create a compromise regime from the two proposals. Their aim is to finish by July.
“The next few months are going to be very important,” says Lisa Cawley, a partner at law firm Kirkland & Ellis. “This is potentially the last window of opportunity to influence the outcome, and certainly on the key issue of the marketing of non-EU funds to European investors there is a real difference in approach between the Council and the Parliament.”
“Non-EU managers from America, Switzerland and Asia, and even EU funds domiciled in places like the Cayman Islands will be affected,” says Andrew Baker, CEO of the Alternative Investment Management Association (AIMA).
The United States and other countries may also retaliate against the EU should the proposed regulations become law, causing investors to fragment into groups that take money from only a certain part of the world, Baker says.
“History and common sense tell you that some of the extreme positions will be diluted,” says Baker, who adds that he is uncertain to what extent the conditions will be relaxed when the directive comes into law.
AIMA, which is based in London, represents more than 1,100 fund managers, about half of which are based in North America and Asia. It says its members combined together account for more than 75% of the $1.5 trillion in assets managed by hedge funds.
Baker said other issues that could arise under the draft European directive include lower investments into emerging and frontier markets as banks acting as custodians may not want to be held responsible for losses arising from fraud and other problems that are more frequent occurrences in such places.
Parliament’s version of the proposed legislation is generally seen as more restrictive. For example, both Parliament and the Council would empower European regulators to set limits on the amount of leverage buyout firms use. But the Council version would monitor and impose limits on leverage used at the fund level, whereas Parliament’s version would oversee leverage on a per-deal basis.
Similarly, the Council’s version would require firms that buy controlling stakes in companies to disclose limited information about the company to other shareholders and employee representatives of the companies, while Parliament’s version would require much more extensive disclosure, potentially of commercially sensitive information.
Perhaps most important to U.S.-based funds, the Council’s proposal would impose hurdles for marketing funds in EU member countries. Among these is a requirement for “appropriate cooperation arrangements” between EU regulators and U.S. regulators.
For example, if a U.S. fund manager wanted to solicit investors in the United Kingdom, there would need to be a regulatory cooperation agreement in place between the Securities and Exchange Commission and the U.K.-based equivalent, the Financial Services Authority, before fund-raising would be allowed.
Parliament’s version, again, is even more restrictive, requiring non-EU funds to voluntarily comply fully with the laws while under supervision from their respective regulators, which would in turn be required to implement the EU laws. It’s highly unlikely that the SEC would, in effect, adopt EU laws.
Certain funds are exempt from the regulations in both versions. Under the Council’s proposal, EU member countries can exempt fund managers who do not use leverage and control less than $625 million.
The legislation, called the Alternative Investment Fund Managers Directive, was first proposed in April 2009 and has since been modified. Drafted in response to the financial crisis, the directive promises to affect dozens of U.S. firms that raise money from European investors, including The Blackstone Group, The Carlyle Group and Kohlberg Kravis Roberts & Co., not to mention placement agents that help U.S. firms raise money from European investors.
In 2008, placement agents that collectively raised $24.1 billion for private equity funds reported that 42.4% of their capital came from Europe, according to a survey in Buyouts, an affiliate publication of PE Week.
Kevin Lim of Reuters contributed to this report.