Hedge Funds Can Influence the AIFM Directive

The Key is to focus on a handful of vital points

Ronald Paterson, Partner, Eversheds LLP

“The UK government should do everything it can to ensure that the final proposals that emerge in the Directive do not damage the EU and UK economies to which the City of London makes an important contribution. We urge them not to agree to the Directive in its current form.”
[House of Lords European Union Committee report
published 10 February 2010]

The European Commission proposal for an Alternative Investment Fund Managers Directive remains highly controversial with continued pressure for further changes expected from hedge fund and private equity trade bodies and many others. Critical areas of concern remain in relation to the rules restricting sales of non-EU funds within the European Union and the provisions on depositaries, valuations, leverage, remuneration of fund managers, portfolio company disclosure and overall scope of the Directive.

The recent report of the House of Lords European Union EU Committee urged the UK government not to agree the Directive in its current form. The House of Lords Committee also said that unless the legislation is consistent with a global regulatory approach, it will “seriously damage EU and UK economies”. The Bank of England’s Financial Markets Committee has criticised the text of the Directive as “riddled with ambiguities”.

Unthinkable consequences
It is clear that the potential consequences of getting the Directive wrong, range from the unthinkable – a trade war with the US – to the merely disastrous, such as a serious reduction in the investment opportunities and investment returns available to investing institutions in Europe, and/or a major exodus of fund management businesses and their revenues from the EU. However, under current EU constitution, the UK government has no power to veto this Directive. Either a blocking minority in the Council of Ministers and/or an absolute majority of votes against the Directive in the European Parliament would be required to block it.

Votingin the Council is carried out on a qualified majority basis. Each Member State is given a vote weighted in proportion to its population: 255 votes from a potential 345 are required to achieve the necessary majority. This means a blocking minority requires 91 votes. The UK has 29 votes itself (the maximum that any Member State can have). So at least 3 other large countries within the EU (or quite a few more smaller ones) would need to join with the UK to create a blocking minority in the Council and the UK simply cannot achieve this on its own.

Politics is the art of the possible and the fund management industry is by-and-large resigned to the prospect of there being an EU directive to regulate managers of alternative investment funds so attention is really focussed on what can be done to affect the final shape of the Directive. AIMA has stated that it is not opposed to the Directive per se, but just wants the final directive to be proportionate and realistic. AIMA has tried to work with the Commission, EU governments and the European Parliament to achieve this result.

The key tactical decision for those pressing for changes to the Directive is whether to try to slow down the Directive or to speed it through but with a limited number of crucial changes. The EU legislative process is bicameral, which means that Council and the Parliament need to agree on a common position in order for the Directive to become law. Understanding the political dynamics of this process is key to judging the best way forward for those who want to change the Directive. The expected timetable for the AIFM Directive envisages a vote in the European Parliament in July 2010 on a final text of the Directive. If this is passed by Parliament, the Council will then vote on it. If the Council approves Parliament’s text of the Directive then the Directive will be adopted and will come in to force 20 days after the final text is published in the Official Journal of the European Union. EU Member States will then be required to bring into force the laws regulations and administrative provisions necessary to implement the Directive within 24 months of the Directive coming into force that is to say, on the envisaged timetable, by July 2012.

Timetable to vote
Key stages if this timetable is to be achieved will be the vote, currently scheduled for 12 April, in the Parliament’s Economic and Monetary Affairs Committee (ECON) on ECON’s report on the proposal and trilogues, currently scheduled for May, between the Council, the Parliament and the EU Commission. This formal process will be accompanied by a host of unofficial meetings and discussions which provide key opportunities to influence amendments to the text of the Directive. If the trilogue process between the Council, Parliament and Commission reaches a consensus the timetable described above will be met and the Directive will come in to force before the summer holidays.

This timetable is only likely to be slowed down if a blocking minority in the Council emerges either in response to Directive generally or triggered by a particularly controversial amendment in the Parliament. If the Council does not approve the Parliament’s text of the Directive, the Council must then adopt its own position and pass it back to Parliament with explanations. The directive will then be adopted if Parliament approves the Council’s text by an absolute majority or fails to take a decision within three months. The Parliament may reject the Council’s text, leading, at least in theory, to a rejection of the Directive, or modify it and pass it back to the Council for a second vote. If Parliament’s new text is not then approved by Council (by qualified majority) within three months, a Conciliation Committee is convened (composed of the Council and an equal number of MEPs) to agree a common text (by qualified majority of Council members and absolute majority of MEPs). If the Conciliation Committee succeeds in achieving a consensus on a common text, then the Council and Parliament must then separately approve the common text. If either failed to do so, the Directive would, again in theory, not come into force.

It is not a foregone conclusion that prolonged debate will improve the text of the Directive so far as the fund industry is concerned. The Parliament received over 1,000 amendments to the Parliament Draft from MEPs. The next draft from Parliament could be very different from the recent “Spanish Compromise” draft published by the Council under the Spanish Presidency. The Spanish Compromise itself contains unsatisfactory provisions, for example in relation to the rules restricting sales of non-EU funds within the European Union, which were not in the compromise proposals published under the Swedish Presidency and further texts may have other unfavourable provisions.

Therefore certain industry lobbyists are now concentrating their efforts on securing changes in a few key areas in the knowledge that late stage concessions in order to achieve consensus can have a real impact on the final form of a Directive. For example in relation to the Waste Electrical and Electronic Equipment (WEEE) Directive dealing with both waste from households and waste from businesses late stage concessions in relation to business WEEE were worth an estimated £1 billion to the electrical and electronic industries. Following this example the best prospect of affecting the final outcome of the AIFM Directive would for there to be a broadly based attack consensus focusing on a small number of vital points.

Ronald Paterson is partner at international law firm Eversheds. He has more than 20 years’ experience of advising the fund management industry and of helping portfolio managers to launch innovative funds in a wide range of asset classes including hedge funds, real estate and private equity funds.