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.

American Sonderweg?

While the European Union is working on tighter regulation of hedge funds (see previous post), the Federal Reserve will effectively start acting as a prime broker for them, as the Financial Times reports: Hedge funds gain access to $200bn Fed aid. For a critical discussion, see also the corresponding entry in the investment banker blog naked capitalism with further links.

Hedge funds' access to Federal Reserve credit will take place in the context of TALF, the Term Asset-Backed Securities Loan Facility. (Fed's Press Release on the new rules for TALF.) In opening TALF for hedge funds, the Fed will help them get the leverage they need for their business model. In effect, the Fed will help hedge funds to stay alive in an environment that has become increasingly hostile for them. More on hedge funds' problems in times of the credit crunch can be found in FAZ: Kampf um die Zukunft.

This brings me to my question: Why keep hedge funds alive with public funds? I say: Don't do it! Let them wither away and die a natural death. Let them become the dinosaurs of economic evolution. One less problem to worry about.