How EU Financial Regulations Affect Hedge Funds
Date: 6 May 2016 Share on Twitter Share on Facebook
Almost half of Britons are planning on voting for Brexit in the EU referendum to be held in the United Kingdom this year. One profession inclined towards Brexit is hedge-fund managers. Two billionaire hedge fund managers, Crispin Odey and Michael Hintze, have led the community of hedge fund managers backing the “Out” campaign due to regulations that, besides significantly curbing their profits, are also widely seen to be unfair. So why does the EU place such regulation on hedge funds, and what effects do the rules have on hedge funds?
The regulations originated with the financial crisis, born from an overleveraged US property market and overleveraged banks. Hedge funds played a small role in the crisis, with a small number profiting from the market chaos that followed the crash but most losing out. However, the European commission largely ignored the issue of bank leverage and focused on hedge funds instead, proposing in 2009 the Alternative Investment Fund Managers Directive (AIFMD), which came into force in July 2011.
The resulting rules affected many aspects of hedge funds’ operations. The AIFMD essentially bans hedge funds from outside the EU from marketing their financial products in the EU. The directive also restricts hedge funds’ ability to lend money, how much they pay their employees, the availability of liquid assets to hedge funds, as well as their valuations.
Another result for hedge funds is, some allege, the very reason why the AIFMD was introduced in the first place. The regulations on hedge funds mean that banks, which, in the EU, have remained unfettered by stringent regulations, can reign supreme in the financial industry, effectively putting hedge funds out of the race for clients and assets. The fact that banks in Europe remain relatively unregulated is surprising given that, firstly, overleveraged banks were the main cause of the 2008 financial crisis and, secondly, banks in the United States have had stringent measures placed upon them as the US government has recognized this fact. This means that, even though EU bank leverages have been reduced since 2008-9, bank leverages are 18 times debt-free capital, versus 12 in the US. Some larger banks, like Deutsche bank, still have leverage ratios of between 25 and 30. Banks, therefore, are borrowing much more than hedge funds and can reap the benefits thanks to limited competition, as hedge funds can neither leverage as much as they can nor even market their products to the same customers.
The reason for this may be that banks’ lobbyists are some of the most powerful in Strasbourg and Brussels. Paul Marshall, the pro-Brexit co-founder of Marshall Wace, one of Europe’s leading hedge funds, alleges that especially in France, “énarques”, graduates of France’s Ecole Nationale d’Administration who fill many of the top political and civil service roles, are stuck in a revolving door between banks and politics. According to Marshall, these politician do as much as possible to protect the interests of banks, hence why the EU never took measures against bank leveraging as strict as America’s and why hedge funds took the rap for the financial crisis. Marshall even argues that the financial crisis was not a reason, but an excuse for the AIFMD: one European Parliament member he quotes uses the analogy that “If you are in a bar and a fight breaks out, you do not hit the person who started the fight but the person you have always wanted to hit”.
Some dismiss allegations such as Marshall’s as mere conspiracy theory. Believe them or not, however, UK hedge fund managers are unlikely to want to stay in a Europe that punishes them for a crisis they did not cause when the lack of regulation that did cause it continues to significantly reduce their potential profits. Disgruntled hedge fund managers make up part of a wider group of voters who feel that unelected European commissioners, whom companies spend €1.5 billion a year lobbying to, no longer have the interests of the population, but rather of large private institutions such as banks at heart.