The European Parliament is rushing through a draft report that threatens to have far-reaching implications for the regulation of the hedge fund industry in Europe.

Hedge funds have had an icy reception from the movers and shakers in Europe. Nicolas Sarkozy pitched in last year, telling the world what he'd like to do to "these aggressive hedge funds [that] buy into a company, sell it off in pieces, sack 25% of the staff, collect 25% profit and create zero wealth" and, in doing so, made the basic error of lumping all hedge funds into one highly questionable category.

Other comments have been downright rude. Being compared to a "plague of locusts" by the German Vice-Chancellor, Franz Müentefering, might have been enough to make even the most hardened hedge fund manager gulp back tears. At least he had the excuse of being a socialist. The German Chancellor, Angela Merkel, has been more tactful but no more complimentary.

There has been resistance of sorts. The professors at EDHEC have been supportive, absolving hedge funds from blame for the subprime crisis and the contagion that spread throughout the credit markets. EU Commissioner, Charlie McCreevy, a man whose opinion might be considered to count for quite a lot in Brussels, has been a staunch resister of regulation. And in the UK, the FSA have been generally in favour of a light touch approach, welcoming the Hedge Fund Working Group's recent report and being encouraging about the voluntary approach championed by AIMA and others. Yet it seems that resistance may yet prove futile.

The draft report sets out significant recommendations made by the former socialist Prime Minister of Denmark, Poul Rasmussen, and was pushed through the European Parliament and Commission at rapid speed.
The draft report envisages that the Commission will submit legislative proposals by 30 November 2008 on the basis that there is insufficient EU regulation of hedge funds (they lump in private equity funds and structured products too but that's another story). It goes on to demand various measures aimed at improving financial stability, increasing transparency, regulating the use of leverage and dealing with conflicts of interest.

• The report suggests that financial stability would be improved if the capital adequacy requirements of prime brokers were correlated to the "complexity and opacity" of the structure of a fund or to the nature of a fund's exposures.

No one would deny, especially now, that the actions of a prime broker can have significant ramifications for a hedge fund, but this is to ignore the fact that prime brokers are technically service providers to hedge funds and are not sponsors. Furthermore, the main players in the European hedge fund market operate, for the most part (and perhaps not for much longer), out of London and are therefore already subject to robust regulation at a local and European level.

• The report overstretches itself by providing for a European super-regulator of all financial services sectors. It is not clear why this is in a report about hedge funds and private equity funds. That aside, do we really need another layer?
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• It is suggested that all fund managers operating in Europe should become part of an EU framework for registration and authorisation. Those in the UK, and that's most of them (for now at least), might wonder what their compliance teams and consultants are doing if not dealing with registration and authorisation day-in and day-out. And is any EU framework, diluted to the nth degree, really going to offer more protection to hedge fund investors? Probably not.

What it would do, as the report points out, is to ensure that firms disclose the remuneration of senior executives and fund managers. This is thought necessary to assist in the struggle for "transparency", a concept that means different things to different people and nothing whatsoever to others. The proposal is, in fact, merely prurient.

• There is confusion as to what or who the Commission would regulate. In some places, they talk about regulation of the manager and, in others, the fund. Do they mean both? If so, where is the incentive for a hedge fund to abandon the offshore world and set up home in Europe? Perhaps in the promise to overhaul the private placement regime to facilitate the Europe-wide marketing of hedge funds? What a good idea! Will that be rushed through? Doubt it.
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• There is a commitment to ensure that investors in hedge funds should "receive not only sufficient but also relevant and comparable information" akin to the simplified prospectus/fact sheet for UCITS products. There is some sense in this if you want to sell to the non-sophisticated investor, and it would certainly make the job easier for those of us who spend all day writing or reviewing prospectuses, but for the time being direct sales to non-sophisticated investors are prohibited throughout Europe and we should let funds explain their proposition in their own way. To paraphrase Voltaire (although he might not have been talking about hedge funds at the time), you might not like what someone says but you ought to defend his right to say it. In any case, there are already lots of laws around that will have investors gunning for funds, directors, managers and everything else that moves if what is, or is not, written in the prospectus is wrong.
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• An upper limit is proposed on the use of leverage by hedge funds. Here we see the European Parliament returning to the devil they know – let's call it the UCITs model – and recharacterising hedge funds into a format that is, to them, more palatable and recognisable. In doing so, they make it impossible for many of the hedge funds they would like to regulate even to consider operating in Europe.
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• Conflicts of interest, a hot topic everywhere at the moment, are dealt with perfunctorily by suggesting that this is something that needs to be looked at and wondering whether increased capital adequacy requirements and effective information barriers for prime brokers might deal with the issue.

In a nutshell, the draft report, which its authors claim will assist in producing a "coherent approach", does exactly the opposite. It comes at a bad time too. Hedge fund managers are already wrestling with measures that seem designed to drive them out of Europe. On June 25 2008, MEPs will vote on the draft report and will consider a mountain of proposed amendments to it with a view to deciding on the proposal to make European regulation of hedge funds a reality by the end of the year.

Thomas Hardy wrote a poem about the Titanic, "The Convergence of the Twain". The poem threw up the image of an iceberg forming all the while that the Titanic was being built. The risk for hedge funds and their managers is that this draft report is the tip of the iceberg.

Mark Brady is a Partner at law firm Eversheds