EU rulemakers rethink regulatory 'excommunication'

European regulators are now seeking to water down proposed rules that effectively would make it more difficult for EU limited partners to invest with non-EU fund managers, say legal experts.

Recent media reports are signaling new EU regulatory proposals that have raised alarms on both sides of the Atlantic will likely be watered down into something more amenable to the private equity industry.

The European Commission’s “Directive on Alternative Investment Fund Managers”, which is coming up for debate in the European Parliament, would create a comprehensive regulatory framework for hedge and private equity fund managers in the European Union, applying to leveraged fund managers with more than €100 million in assets and unleveraged funds with more than €500 million in assets.

Among the biggest concerns are the potential consequences for US-based alternatives managers who raise and manage assets in the EU. Specifically, foreigners trying to market in Europe will have to demonstrate to the relevant authorities that they are subject to the equivalent regulation in their home jurisdiction. Absent stricter rules in the US such as leverage caps, it is unclear whether US managers would be able to do clear this proposed hurdle.

As the directive heads toward debate in the European Parliament later this year, it appears that Washington has begun to quietly lobby against potential barriers the rules may place against US private equity funds. In a report in the Wall Street Journal last week, the paper noted a recent speech by US acting secretary for international affairs Mark Sobel, who said that although the US cannot deviate significantly from international regulatory standards, neither can other countries impose standards on one another if they are not identical.

The report also said that US Treasury officials have been holding talks with their counterparts in the European Commission and governments in the EU. The message may be getting through, as the Financial Times this week quoted Sharon Bowles, the new chair of the European Parliament’s economic and monetary affairs committee, as saying the directive will be substantially amended, as European pension funds and institutional investors faced “excommunication” from global capital markets if it is passed as is.

“I think the tide is finally turning on this particular directive; it’s the early stages but there is a bit of momentum building up this week based on those two articles,” said Adam Levin, a partner at law firm Dechert. “People are finally beginning to take note of the serious implications of the directive and the unlevel playing field that this is going to create. Effectively it will be the EU and everyone else.”

Levin said it is likely that there will be a greater public focus on “unintended consequences” – such as the loss by European investors of access to top-performing alternative investment managers in the US – as a justification for revising the proposals into something closer to the US system. In fact, the UK government this week announced that it is launching its own inquiry into the directive, including the potential danger of unintended consequences.

“Basically the politicians will say they didn’t do anything wrong when they came up with their first draft, but there were all these unintended consequences, and this will give them the opportunity to align the EU with the regulatory flow elsewhere,” Levin said. “I think they are going to take a leaf out of the US’s books and do similar things. There is a lot of similarity between US and EU approaches: registration of the fund manager is the same, for example, and passing on data to the regulators is the same more or less, but not these disclosure rules. That’s different in Europe and creates the unlevel playing field.”

Such changes to the directive would make it substantially easier for Europeans to regard the US as a suitable jurisdiction for fund managers who are registered there to come and raise money in Europe from professional investors. “This idea of building a fortress around Europe, that will go,” said Levin.