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Pass the ball

Despite Timothy Geithner’s assurances to EU finance ministers, new rules for alternative investment fund managers are still being volleyed in Congress.

In a letter to four EU finance ministers this week, US Treasury Secretary Timothy Geithner outlined legislation making its way through Congress as evidence that the US is stepping up its regulatory game, and making real progress on its G-20 goals. Therefore, there’s no reason to deny US fund managers access to European LPs, he implies. 
The letter was a protest against the so-called ‘third country’ rules in the EU’s proposed alternative investment fund managers’ directive. It’s the second letter Geithner has written on the topic in less than a month. The rules would ban non-EU fund managers from marketing in any EU member state unless their home country has a marketing “passport”. To get a passport, the manager’s home country must have a regulatory regime that has been deemed rigorous enough to meet EU standards. The US, because it doesn’t impose liquidity and leverage caps on fund managers, doesn’t qualify. 
Geithner specifically mentioned parts of the US House of Representatives’ financial reform bill that would require many hedge fund and private equity managers to register with the Securities and Exchange Commission. After registering, those managers will be required to report information about their business and operations to a systemic risk monitor, Geithner said.
But it’s still very unclear whether the registration requirement will ever be signed into law. President Barack Obama proposed it, and the House of Representatives has approved it, but now the ball has been passed to the Senate, which is considering its own version of the bill. Geithner did not mention in his letter that the Senate bill currently includes an explicit carve-out for private equity and venture capital. Furthermore, there are indications that lawmakers, having learned a little bit more about private equity in recent months, are now more sympathetic to the plight of middle market managers who would be unduly burdened by the costs of registration. 
Once the Senate passes its version, that version will have to be reconciled with the House version in committee. No one can yet predict which provisions will make it into law. 
In a scenario where Congress does pass legislation requiring hedge funds to register and not private equity funds, we might see savvy hedge fund managers restructuring their operations just enough to qualify as “private equity”. The line between a private equity manager and a hedge fund manager blurs more and more every year, and Congressional legislators probably aren’t the right people to come up with a bright line test. More likely, they’ll pass the ball to the SEC. 
The SEC is likely to rely on things like lock-up periods to differentiate between hedge funds and private equity funds, but coming up with a foolproof set of rules is a truly daunting task.