European Parliament-commissioned study warns of high costs from AIFM Directive

A new impact assessment commissioned by the European Parliament shows that an EU directive for alternative managers could raise compliance costs by billions, as Parliament and the European Commission work toward a consensus over their various regulatory proposals.

A new study of the potential impacts of proposed EU regulations on alternative investment funds says that one-off compliance costs could rise by between €110 million and €2.2 billion in total for private equity, hedge funds and venture capital.

The study by consulting group Europe Economics also says that should the European Commission’s “Directive on Alternative Investment Fund Managers” be adopted in its current form, transaction costs would rise between 30 and 45 basis points, while the annual growth rate in the European Union would fall by 0.1 to 0.2 percent. The report also predicted that such costs – as well as limitations and constraints on the use of leverage and certain strategies – would lead to an exodus of fund managers from the EU.

“Similarly, it is likely, in the short term at least, that EU investors would be more inclined to move capital from off-shore funds to reduce perceived risk,” the report states. “And analogously, EU fund managers may bring their funds increasingly on-shore where domestic investors are clearer on the regulatory regime in place. There is also the potential for non-EU domiciled investors to withdraw their funds in the short term, and in the longer term, EU investors to move their capital to compliant non-EU domiciled fund managers.”

The impact study was commissioned by the European Parliament, which in November proposed to broaden the directive to force all private equity and venture capital firms to comply with the regulations. The previous version of the directive would have applied just to leveraged managers with more than €100 million in assets and and unleveraged managers with  more than €500 million in assets. Parliament has also recommended that firms follow similar remuneration policies as those currently proposed for banks, which could potentially curb compensation for hedge fund and private equity managers by up to 60 percent in some cases.

Parliament’s proposed changes will have to be reconciled with earlier amendments suggested by the European Council. While both groups agree in principal on certain ideas – such as the need for remuneration curbs and the drawbacks of requiring each fund to have a bank as an EU depository – there is also a difference of opinion over issues such side letters. While the Council has said that managers should only disclose the nature of the terms of side letters, Parliament has called for the disclosure of the identity of investors getting the benefit.

“We are still quite a long way off from getting what the industry thinks is going to be an acceptable piece of legislation, and we are also a long way off from a position where the Council and Parliament are at one,” said John Adams of law firm Shearman & Sterling. “These are not complete revised proposals for legislation; in a sense they are working documents but they are indicative of the way things are likely to end up, especially where Parliament and Council both agree.”

Adams said that as working groups and committees seek to forge a consensus between both sides, it’s likely that any potential regulations will not be approved until the middle of next year at the earliest. Javvier Echarri, secretary general of the European Venture Capital Association, said his group was awaiting the results of a progress report to be published by current EU president Sweden on 17 December, ahead of Spain’s accession to the rotating presidency role next year.

“As today’s Impact Assessment from Parliament shows, there is still much work still to do, and we are hopeful that the incoming Spanish presidency will continue discussions at Council in the same manner,” he said.

A previous impact study by the UK Financial Services Authority said that EU regulations could impose one-off compliance costs of up to €3.2 billion, while a report released by London-based research organisation Open Europe in September estimated that that additional compliance costs could total as much as €1.9 billion in the first year of implementation and €985 million annually after that.