Leverage Limits in EU Hedge Fund Rules Garner Strong Opposition

The European Union’s much-criticized hedge fund regulation proposal is now drawing fire from two powerful places.

In response from a request from the Council of the EU, the European Central Bank warned that the current proposals for hedge fund and alternative investment regulation could drive the industries out of Europe altogether.

“The ECB sees a potential risk of regulatory arbitrage between alternative investment fund managers, insurance companies and credit institutions, among which the proposed directive does not create a level playing field,” the central bank said in its response, which was posted on its Web site.

In particular, the ECB took aim at the proposal’s definition of “leverage.” The proposed rules could restrict the amount of leverage that hedge funds and others in Europe are permitted to employ.

But the European Commission’s proposals do not “include specific leverage ratio concepts,” the ECB complained. Without them, “it may be difficult to implement the proposed definition.”

Instead of the strict rules proposed by the EC, the ECB said it favors international coordination over unilateral action.

“The ECB urges the Commission of the European Communities to continue dialogue with its international partners, in particular the United States, to ensure a globally coherent regulatory and supervisory framework,” the legal opinion opined. “An internationally coordinated response is necessary given the highly international nature of the industry and consequent risk of regulatory arbitrage and evasion.”

The proposed leverage limits are also the target of Sweden, which holds the rotating presidency of the EU. The country has been trying to broker a compromise between more hard-line countries, such as France and Germany, and Britain, the continent’s most important alternative investment center, which fears the regulations will severely damage its economy. But it seems to have sided more with the British.

Under the Swedish proposal, the controversial leverage limits would be replaced by a regulator to monitor hedge funds and which would be empowered to impose limits on specific funds for specific reasons. The Swedes also want to see provisions that could keep foreign hedge funds out of Europe softened, and are in favor of treating private equity, venture capital and other market players differently from hedge funds.

“The leverage cap is being taken out,” one diplomat told Reuters. “That was too blunt. It is still possible for the supervisors to impose a cap, but on a case-by-case basis.”

Comments

[dertre]

Don't regulatory capital ratios will fix leverage throughout hedge funds industry ? I mean Leverage used by these funds is fully loaned by their prime broker which is 'in fine' a bank under these ratios.

We could further impose specific accountting rules to these loans. it should be accounted as if it was capital used in trading books, not a classic loan, this way the leverage will automatically stabilize through a capital allocation arbitrage from banks.

2009 Oct 23 10:46 AM

[bob adamson]

The debate within the EU is important but leaving aside the merits of the various sides in that debate doesn’t the debate itself highlight the fact that, to really be successful, the eventual reforms must be developed and implemented through coordinated efforts across the EU, US and Japan?

2009 Oct 24 12:37 AM