Friday, May 08, 2009

Regulating Hedge Funds - The View from Europe and Scotland

I suspect that we will see more regulation of hedge funds on this side of the Atlantic. The Sunday Herald published EU puts Scotland’s small hedge fund sector in jeopardy giving us an idea of how the Eurpoeans wnat to regulate hedge funds
SINCE THE global financial meltdown began, financial services sectors across the world have become increasingly nervous about European and/or US politicians forcing through punitive and ill-considered regulation to appease public anger.

This anxiety eased with the appearance of carefully considered reports on the possible shape of future regulation, such as those by Lord Turner, chair of the UK's Financial Services Authority (FSA), and an influential European report by the former head of the International Monetary Fund, Jacques de Larosiere. However, the sector's anxieties have been fully justified with the European Union's announcement on April 29 of a draft directive, cobbled together without consultation, aimed squarely at the European alternative fund management sector - often dubbed "the shadow banking system".

Seen as throwing subtlety to the winds, the EU has produced a piece of draft legislation that sweeps together hedge funds, private-equity funds, commodity funds, real estate funds and infrastructure funds. It proposes to regulate them all if the funds under management exceed 100 million.

To put this in context, in hedge fund terms, a 50m fund is a start-up fund and most such funds would expect to exceed £100m in a year or two. This means that the EU has used rather a fine mesh for its regulatory net, and apparently intends to scoop up even the tiddlers - funds which by no stretch of the imagination could be classified as a "systemic threat" to the Eurozone. The legislation, if allowed to pass, will, as an incidental by-product, impose a heavy regulatory burden on Scotland's tiny hedge fund management sector.


David Aldrich, managing director of alternative investment services at The Bank of New York Mellon, (BNY Mellon) called the directive "a political attack on hedge funds, rather than a rational approach". A survey by BNY Mellon showed that while the global hedge fund sector is expected to shrink from just over $2 trillion in 2008 to $1trn by the second quarter of 2009, the sector will enjoy a resurgence - if it is not regulated to death - and by 2013 will have surpassed the high-water mark of 2008.

Commenting on Scotland's hedge fund sector, Aldrich said: "The reason why Scotland, which has no advantages such as the beneficial tax or corporate structures offered by offshore havens such as Bermuda or the Cayman Islands, enjoys a strong, if small, hedge fund sector has purely to do with the excellence of Scotland's fund managers - a few of whom have been attracted to the absolute return philosophy of hedge funds."

The sector in Scotland tends to focus on long/short equity strategies rather than on the more exotic strategies offered by London-based hedge funds. However, its performance through the crash has been outstanding.

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