The EUs draft Directive for hedge funds has been met with criticism from Stephane Puel, a Partner in international law firm, Gide Loyrette Nouel.
Puel states although there has been much criticism over control over leverage and short selling, confusion over regulatory overlap has been overlooked.
What may not have been focused on are some of the curious mismatches between MiFID regulation and what is now being proposed. The new directive intends to provide regulations for activities that are already covered by the MiFID – although no specific guidance is given on how the two sets of regulations will apply. Similarly, it does not take account of what types of European investor already invest successfully in hedge funds, explains Puel.
The Directive contains the apparent benefit of allowing marketing to Professionals. However it has not been drafted to take into account of the type of investor currently investing in hedge funds. The Professional definition, which was introduced under MiFID, means that many of the high net worth individuals or family offices that are likely to be investors in alternative funds will not qualify. Therefore, it will be down to national regulators to decide whether such sales are allowed, and under what limitations, so the supposed benefit of EU passporting from the Directive becomes partly meaningless.
Additionally, the Directive restricts the marketing process in a way not applying to products (including funds marketed to retail) which are subject to MiFID but which fall outside the Directive. Investments in funds subject to the Directive would be treated as a “complex instrument” so far as MiFID is concerned. MiFID then allow exemptions around non-solicitation and execution-only business. The definition of “marketing” in the draft Directive seems to suggest that no such exemptions would be allowed for investment in alternative funds. This is a draconian measure in the light of MiFIDs philosophy.
While there may be some areas that are over-regulated, Puel points out that there are gaping holes left uncovered by the EU proposals. [There is] something that appears somewhat absurd within the Directive. Alternative managers owned by a bank are exempt from the Directive. This is one of the biggest mismatches. How can an alternative firm owned by a bank be exempt from the Directive when it is probably more exposed to systemic risk; more likely to have conflicts of interest and is probably larger than the average hedge fund?