Regulating hedge funds

European finance ministers reached a breakthrough agreement on regulating the hedge funds industry on Tuesday.

"The big change is that at European level there was no regulation and no supervision, and now there will be one," the EU's market regulation commissioner, Michel Barnier, said in Luxembourg.

The EU is seeking greater transparency from hedge funds. Some argue that hedge funds contributed to the 2008 financial crash due to destabilizing moves on the markets.

Mandatory license for access to EU market

The new regulations would require each hedge fund to obtain a "passport" in order to have access to the European market. This license would be issued by the European Securities and Markets Agency (ESMA), a new EU watchdog based in Paris, which is to start work next year.

For around two years, the dispute between Britain and France made an agreement impossible. Britain - home to most European hedge funds and foreign-owned funds operating in the EU - fought to ensure that funds based in the Commonwealth's outposts, for instance in the Caribbean, but managed in the UK, would be able to sell to all of Europe on Britain's regulations alone. France, on the other hand, wanted stricter rules, with the hedge funds industry regulated by the EU sooner rather than later.

Long transitional period as a compromise

Now, as a compromise, there will be a long transitional period. If the European Parliament votes to approve the proposal next month, the new regulations will likely come into force in January 2011.

EU member states would then have two years to corporate the new rules into their national legislation. There is an additional three-year-transitional period during which old national authorization procedures for hedge funds would still be valid and co-exist with the new EU regulations.

This means, between 2013 and 2015, a London-based fund without a ESMA-issued license would be allowed to sell across Europe, although "third-country" funds such as American or Cayman island based products would not.

But officials indicated that a new clause allowing the ESMA to order national regulators to ban those hedge funds that pose a threat to financial stability was instrumental in getting France's approval.

Regulated hedge funds to protect consumers

Belgian Finance Minister Didier Reynders who chaired the talks in Luxembourg, said the stricter regulations would allow the EU to pressure international partners to match its rules while offering "protection for investments" for consumers.

British Financial Services Secretary Mark Hoban said that it was a "significant advance from the situation in May, when member states were on the verge of voting through an agreement that would have closed the EU market to funds from third countries."

German Deputy Finance Minister Joerg Asmussen expressed delight at the breakthrough. Managers of alternative investment funds had been without supervision on the European scale, whereas Germany had already implemented regulations. He said he was confident that the new regulations would be passed by the European Parliament ahead of the G20 summit in November in Seoul.

Author: Sarah Steffen (dpa, AFP)
Editor: Chuck Penfold