On Wednesday, the European Commission proposed a Directive on Alternative Investment Fund Managers. The proposed directive will regulate all fund managers with a portfolio of more than €100 million (or more than €500 million for funds that are not leveraged and have at least a five-year lock-in period for investors), irrespective of the fund’s domicile. These thresholds will bring approximately 30% of EU hedge fund managers and 90% of assets in EU hedge funds within the scope of regulation.

According to European Commissioner for Internal Market and Services, Charlie McCreevy, the aims of the new directive include:

  • Ensuring that all managers and their funds will be notified to authorities;
  • Imposing tight controls on asset depositaries and valuation agents, including appointing independent valuators and establishing a depositary for each fund, to be selected by the fund manager;
  • Requiring fund managers to provide periodic and comprehensive disclosure to regulators, including an annual report at the end of each fiscal year;
  • Requiring quality risk and liquidity management from the managers, with risks to be reevaluated annually, and implementing periodic stress tests to monitor liquidity risk;
  • Ensuring that professional investors can conduct due diligence and are treated fairly;
  • Permitting funds to be marketed to professional investors throughout the EU, subject to compliance with regulatory standards; and
  • Requiring authorization from Member State authorities before any fund manager’s duties may be delegated, with Member States regulatory authorities restricted from authorizing such funds if they fail to meet the standards of the directive.

The directive would require covered fund managers to provide to all investors a clear description of the fund’s investment policy, including descriptions of the type of assets and the use of leverage, redemption policy, valuation, custody, administration, risk management procedures, and fees associated with the investment.

The directive would permit fund managers that comply with the regulations to obtain a “European passport,” allowing these managers to operate throughout the EU. Commissioner McCreevy stated that the passport would not apply to the marketing of third country funds until 2012 at the earliest. In the interim, Member States could allow these funds and managers to operate within their borders, subject to national law.

Alternative investment funds domiciled in third countries would be subject to additional restrictions on delegation of duties, including those of the valuator and depositary. These restrictions include:

  • Ensuring that the third country entity that is authorized to provide services is registered in the country in which it is established and is subject to prudential supervision; and
  • Maintaining an appropriate co-operation agreement between the competent authority for the fund manager and the supervisory authority of the entity.

Restrictions specific to the domicile of third-country fund managers include:

  • Requiring the third country to be the subject of European Commission decisions stating that its legislation regarding prudential regulation and ongoing supervision is equivalent to the provisions of the directive and is effectively enforced;
  • Requiring the third country to be the subject of European Commission decisions stating that it grants Community fund managers effective market access comparable to that granted by the Community to fund managers from that third country;
  • Ensuring that the third country is the subject of a European Commission decision stating that the standards to prevent money laundering and terrorist financing are equivalent to those laid down in Community law; and
  • Requiring the third country to have an agreement with the Member State in which it applies for authorization which fully complies with Article 26 of the OECD Model Tax Convention.

The directive also requires a cooperative arrangement between the third country fund manager and the Member State that ensures an efficient exchange of information.

Commissioner McCreevy claimed that the Commission “followed the G20 agreement to the letter.” “We are putting in place a robust framework to ensure that the sector operates safely and effectively,” said McCreevy. “Our aim is not to drive the industry out of Europe.”

Earlier this month, a leaked draft of the directive came under harsh criticism from members of the Party of European Socialists. The party’s objections included that the funds themselves would not be regulated and that the directive failed to meet the goals established at the G20 summit, among others.