In a blaze of publicity, the European Union has just adopted a regulatory code for hedge funds to manage the systemic risk that they impart to the general economy. In reality, observes Jean-Claude Paye, the new directive is a sieve which will have an effect contrary to that announced. Its real objective is to summarily control the European funds, while opening the door to U.S. funds which will be able to speculate without restriction at the expense of Europeans.
Unlike the financial institutions, banks, insurance companies, investment banks which draw on savings, the hedge funds have no designated regulators. They are able to fully utilise the exemptions allowed by the relevant statutes. However, if the speculative funds are not the cause of the actual crisis, but rather the easing of bank credit conditions and the money creation that it triggered, the systemic risk that hedge funds spread to the entire financial system has been brought to light. To enhance their performance, hedge funds have recourse to leveraging. They borrow heavily from the banks, to compensate for the smallness of their outlay and thus induce, in case of problems, a multiplier effect on the imbalances.
By failing to address the system’s potential for going into debt and generating speculative bubbles, the European Union avoids tackling the essential question. The EU directive on hedge funds formally designates a scapegoat: the speculative funds; yet it does not increase their surveillance. On the contrary, it eliminates, in practice, the means of their control by the national authorities.
This project simply pretends to exercise oversight over the hedge funds  and does not incorporate surveillance at the Community level. It does not constitute a step forward in the creation of a European financial space. On the contrary, the directive extends the national level of accreditation of these funds, in permitting organisations domiciled in a member State to have - without authorisation from each national authority - access to the totality of national territories comprising the EU. Contary to the effect foreshadowed, the text reinforces the financially dominant country and thus the City of London which manages the bulk of speculative funds situated on European soil.
The directive is also presented as being part of the fight against tax havens, whereas, in reality, through the City, it will open the door of the European Union, with no oversight by its member States, apart from that, ‘benevolent’, of the British authorities.
After having been accepted by the EU Finance Ministers on 19 October , the Proposal for a Directive on Alternative Investment Fund Managers (AIFM)  has been finally ratified by the European Parliament on 11 November. It requires the Assembly to legitimise a legal framework that gives discretionary powers to the Commission. The directive leaves a wide margin of manoeuvre to the Commission to determine or to be imprecise on the key points of the legislation, such as the establishment of the maximum levels of gearing, evaluation procedures, restrictions on short selling operations, both at the time of the directive’s deployment and after its establishment.  It is for the European Parliament to give the Commission a blank cheque, and to the financial system a green light for ‘self-regulation’.
The text formally fixes a European framework for the hedge funds, in setting up a ‘passport’ allowing the funds to market themselves across Europe, without having to obtain authorisation in each country. The European managers will be able to freely market their funds from 2013. The ‘passport’ will be granted to offshore organisations in 2015. The passport will be reserved to those registered in signatory countries with agreements with respect to taxation and money laundering.
The question of the ‘passport’ was at the heart of the negotiations on the AIFM directive. They were started a year and a half ago between the European Commission, the Council and the European Parliament. The conflict has formally opposed the UK, hesitant at any regulation of hedge funds, to France and to the European Parliament.
Passport to the global European market
If the passport gives access to the entire European market, the national supervisory authorities will be solely responsible. It will be supplied by the supervision authority of the country of origin, once it receives accreditation from the future European Securities and Markets Authority (ESMA), to be operational from 2011. In addition, the ESMA will manage the register of fund managers authorised to operate in the EU. It will have at its disposal an arbitrage power in case of conflict between national authorities on the nature of and guarantees given by a fund.
Like any financial market situated in a member State, the City of London, where 70-80% of hedge funds are domiciled, will be solely dependent on the British regulatory apparatus. Thus, instead of forming a European regulatory framework, the directive encourages competition between the member States. Nothing will prevent the managers from choosing their country of registration as a function of the degree of accommodation by the national authorities towards them.
Fund managers currently are required to specify their maximum debt leverage. This information is transmitted to the national authorities of the European country where the manager is registered. But nothing in the directive obliges the authority to act if the leverage is judged excessive. And the ESMA will have no power to compel the national authority to do it.
The directive gives no means to genuinely control the level of debt. Yet it is precisely this that underlies the systemic risk induced by the hedge funds. They have very little of their own capital and borrow heavily from the banks. It results in an enhanced capacity for action in the markets, out of all proportion with their own capital.
In practice, the directive ignores the degree of leverage; it simply requires the funds to communicate the details to their authorities, without obligation on the part of the authorities to intervene in case of problems. Above all it is a matter of maintaining the independence of the entire financial system. As noted by Guido Bolliger, Chief Investment Officer of Olympia Capital Management : “… rather than going through a directive, it would have been simpler to constrain the leverage that the investment banks in the prime brokerage operations are able to allocate to the hedge funds in increasing the amount of capital required.”
Domination of Anglo-Saxon finance
A provision of the accord presents itself as a means to fight against tax havens. The speculative funds, located in some countries which inhibit effective information exchange, especially on taxation matters, are no longer able to be marketed in the EU. The issue is important when one knows that 80% of hedge funds are located in these offshore centres.
However, following pressure from London, the final text limits the scope of the directive to ‘active’ marketing. This signifies concretely that nothing will prevent a European investor, a bank, an insurance company, a mutual fund, from buying units of funds located outside the EU, which should not have obtained a European passport for non-compliance with the directive’s criteria. This provision thus gives access to European territory to capital located in the tax havens but in contact with the City, such as the Channel Islands and the Cayman Islands or, for example, those managed directly by the US, such as Delaware.
This is a violation of the spirit of the legislation for, in this case, no information will be conveyed to the regulators who will not be able to evaluate the exposure to risk of European ‘investors’. But above all it is a new abandonment of the EU member countries to the omnipotence of Anglo-Saxon finance. Even the formal possibility for an EU member State to appeal before the ESMA, in case of disagreement with the national authority of a third country, will not produce a modification in the balance of forces.
This directive thus falls within the restructuring of financial markets, revealed by the G20 of April 2009 regarding “the fight against tax fraud” , that is to say in the legitimation of the Anglo-American stranglehold on European finance. However, if the primacy of the City throughout the European Union, regarding the management of the speculative funds, is overwhelming (80% of the industry is British, as against 5% for France), this power must be put into perspective. The British funds represent $212 billion, compared to a total of $1000 billion for those located in the US. Thus the London market appears above all as the Trojan horse of U.S. hedge funds.
Translated by Evan Jones and Delphine Rabet.