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Laven Partners AIFM Directive Update – July 2010

Posted on 13 Jul 2010

Welcome to the thirteenth edition of the monthly Laven Partners’ Monitoring Update on the proposed AIFM Directive. Laven Partners is a global leader in advising on financial regulations in a practical and comprehensive way. Please do not hesitate to contact us if you have any questions with regards to the new Directive and how it will affect your business.

The new Directive seeking to regulate hedge funds is charging ahead to become law. Laven Partners provides a monthly update on the development and status of this Directive. In the true Laven Partners style, we also look at any interesting comments made by regulators and leading industry players in relation to the Directive. We have now decided to include brief comments on related regulatory developments as the EU goes legislation mad!

Our aim is to involve the financial community and notably to aggregate the representation of investors as we believe the Directive severely reduces their access to investment opportunities. Please register your interest and comments by emailing us at ecdirective@www.lavenpartners.com. Please feel free to forward our monitoring update to anyone who may be interested.

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The AIFM Directive

The uncertainty in the alternative investment management industry regarding the AIFM Directive continues. After months of negotiations between the European Commission, the Economic Financial Affairs Council (Ecofin) and the European Parliament’s Committee for Economic and Monetary Affairs (Econ), the “Trilogue” failed to agree on a final version of the AIFM Directive which was scheduled to be voted on at the Plenary Sitting of the European Parliament on 6 July 2010.

The discussions between the legislators, government representatives and lobby groups will thus continue at least until the autumn’s European Parliament Plenary Sitting which is scheduled for 21September 2010, pushing the finalisation of the directive into the Belgian presidency which took over from Spain on 1 July 2010. It is feared that, unless an agreement is reached before September, the proposed directive may go through a second reading, adjourning the process possibly until the beginning of 2011. With the current EU Parliament Summer Recess, the space left for further negotiations may not be sufficient and some parliamentarians have reportedly already argued that a September vote is unlikely. The September deadline has been described as “feasible but ambitious” by a Brussels source for HFM Week magazine while Jean-Paul Gauzes, the Rapporteur for Econ, is reportedly “confident that an agreement will be reached in time for a September vote”.

The extension of the negotiations was announced just before EU representatives including German Chancellor Angela Merkel and the French President Nicolas Sarkozy travelled to Toronto for G20 meeting at the end of June. The conflicting views on eminent issues such as marketing restrictions for third country funds (highly opposed not only by the UK, but also by the United States), and the reported discussions about the possibility of partial exemptions for private equity funds, represented particular difficulties. The likelihood of the United States refusing to meet the equivalence requirements of national regulations and/or standards to allow investment in such third country funds can eventually put the EU at a competitive disadvantage as previously warned by the House of Lords European Union committee.

The political pressure regarding the Directive is also growing. Off-shore jurisdictions such as the Channel Islands of Jersey and Guernsey feel their interests are not being properly represented by the UK government and have thus decided to pursue their own diplomatic mission to fight for their interest in the financial services industry. The Financial Secretary to the Treasury Mark Hoban pledged at the Lord Mayor’s Private Equity and Venture Capital Dinner on 8 July the UK government’s determination to ensure the final Directive is “workable and non-discriminatory”.

The AIFM Directive is becoming all the more controversial. Even its general supporters such as AIMA see many of the Directive’s provisions as “impractical” and “unworkable”. General comments within the industry have described the Directive as “populist” and not achieving its objections of solving the problems within financial sector. Paul Marshall, the co-founder of Marshall Wace told the Financial News that he believes over-sedulous regulation is “catastrophic” and forms a potential base for new financial crises. Marshall Wace has however reportedly moved its Cayman Islands funds to Dublin in anticipation of the AIFM Directive.

Capital Requirements Directive and the UK Emergency Budget

On 7 July 2011 the European Parliament passed a vote on the amendments to the Capital Requirements Directive regarding bank and building society bonuses. The Directive shall be implemented as from January 2011. Bankers are to receive only 30% (possibly 20% depending on the size of the bonus) in cash with 40% – 60% being deferred by 3 to 5 years. At least 50% of immediate bonuses shall be paid in shares or similar performance-linked instruments. According to the industry this is so far the most stringent bonus regime in the world. The European Commissioner for Internal Market Regulation Michel Barnier reportedly said the bonuses regime sends a “strong political message”. There is now a fear amongst hedge fund managers as to how far the FSA will implement the Directive and it has been suggested hedge fund managers’ bonuses may be equally affected by the EU law.

The UK emergency budget adopted by the coalition government on 22June 2010, despite not being as harsh to the public sector as originally feared, may affect the hedge fund industry in various ways. Questions are pending regarding the £2bn bank levy and its potential application to hedge funds. The practical definition of banks will thus be crucial for hedge fund managers. The capital gains tax has increased to 28%, substantially lower than initially expected. It has been argued this could nonetheless affect existing beneficiaries during hedge fund M&A deals. Despite entrepreneurial relief available for the first £5m of qualifying income gains, offshore tax heavens will allegedly remain more competitive.

The negative impact of the new budget on the alternative investment management industry may partially be offset by the gradual reduction of corporate tax from 28% to 24% starting on 1 April 2011. Nevertheless several hedge fund managers and City professionals are considering moving and some relocations have been reported into more tax friendly jurisdictions with less stringent regulations; mainly Switzerland.

It remains to be seen however how the budget together with any new laws may affect hedge fund migration.