Study: EU Directive to cost billions

A new report by London-based research organisation Open Europe has highlighted the growing concern, especially in the UK, over the financial impacts of proposed regulations on EU private equity firms, with a recent survey estimating that additional compliance costs could total as much as €1.9 billion in the first year of implementation and €985 million annually after that.

Open Europe is a think tank that supports “radical reform” of EU institutions, with the goal of making regulatory bodies more flexible and economically liberal. After conducting interviews this August with members of the British Private Equity & Venture Capital Association, as well as the Alternative Investment Managers' Association, Open Europe has come out against the “Directive on Alternative Investment Fund Managers” as “overly burdensome” and “prescriptive”.

If passed, the Directive would subject EU managers to new annual reporting requirements to investors and regulators, as well as additional offering memorandum disclosure requirements and regulatory reporting about assets in which funds are invested. Ongoing compliance costs will arise for funds directly or through their service providers, including fund manager/depositary costs associated with the reporting requirements.

EU fund managers would also have to hire independent valuators and depositories to hold assets in segregated accounts. “My sense is you are going to have to involve more third parties than ever before in the normal administration of a fund,” said Adam Levin, a partner at Dechert. “Everyone wants to get paid. Now third parties are going to come in and bless everything, and they will want their share. The costs will inevitably trickle up.”

And according to the survey by Open Europe, much of this cost will be passed on to investors. The group said it received responses from 121 hedge fund and fund of funds managers, over half of whom are located in the UK. Those who took part in the survey manage more than $340 billion in assets.

The report also said that if the regulations are passed by the European Parliament later this year, the ability of European investors to choose freely from among the best performing funds and managers could be cut by up to 80 percent. It said 84 percent of all hedge funds managed by EU-based managers are domiciled outside the EU, while eight out of 10 managers are based in non-EU countries. Such funds and managers could find themselves cut off from European investors.

Meanwhile, several private equity managers said their ability to deliver returns for investors could be cut by between 1 and 2 percent. Others also complained about the “one-size-fits-all” scope of the regulations, which captures funds that have no impact on the stability of the financial system, as well as the requirement for all funds marketed in Europe to deposit their cash and assets with an EU-based bank. In addition to imposing massive costs, such a requirement could increase the risks associated with depositing assets.

“Our study shows that the proposal comes with a huge cost: it will hurt the EU’s competitiveness, lead to more protectionism and mean less investment in European firms,” Mats Persson, Open Europe’s research director, said in a statement. “Perhaps most importantly, the directive could really hurt investors such as pension funds through loss of choice, lower returns and increased costs.”

He added that fund managers could have little incentive to remain in the EU. London, which is home to about 60 percent of Europe’s private equity firms, is already dealing with the exodus of managers such as Terra Firma’s Guy Hands for more hospitable tax havens such as Guernsey.

Among the recommendations Open Europe made to improve the directive was for a separation for different types of funds and an exemption for funds with little potential systemic risk to the financial system. The research firm also said that restrictions such as limits on leverage should be scrapped, the directive’s organisational requirements should be brought in line with existing EU law such as equivalent requirements in the UCITS directive, and protectionist elements like requirements for various reciprocal agreements with non-EU countries should be dropped.

If approved by the European Parliament and the Council of Ministers, the proposed EU regulations could become law by 2012. However, Levin has said that based on recent news reports and statements by officials such as the chair of the European Parliament’s economic and monetary affairs committee, the stage may be getting set to water down some of the most heavily criticised proposals.