European Commission Acts on Hedge Funds

The European Commission has tabled a proposal for regulating the activities of hedge fund managers. According to the proposed "Directive on Alternative Investment Fund Managers", the managers will need prior authorisation by the authorities in the Member States in which they have their registered office (art. 4). Moreover, the managers - not the funds they manage! - will be required to hold a minimum capital of 125.000 Euros (art. 14).
Besides, the proposed directive contains the "usual suspects" which are included in all such rules, such as the command to act honestly, rules to avoid conflicts of interest, and disclosure requirements.
But one rule in particular stands out: art. 13, which contains a rule on firms that repackage loans into tradable securities or other financial instruments. What is meant thereby are the notorious Asset-Backed Securities (ABS) or Collaterized Debt Obligations (CDOs). According to the proposed rule, hedge funds managers will only be allowed to invest in such securities if the originator of the securitization process retains a "net economic interest" of no less than 5%. Details will be spelled out by implementing measures to be adopted by the Commission. This rule seems somewhat misplaced in the directive, because it deals with problems that are not directly connected to hedge funds and their managers. It is a kind of indirect regulation of ABS and CDOs, which uses hedge fund managers as an anchor instead of the originators, which often sit in other countries. One can doubt whether this is the appropriate way of limiting the risks that these instruments present.
As was to be expected, the proposal has met with criticism by the industry. For instance, the Bundesverband Alternative Investments (BAI) has cautioned against an isolated European approach. It remains to be seen whether the proposal will be adopted as EC legislation.