EC draft rules would impose leverage limits on hedge funds

A draft European Commission directive, due to be released on April 30, would tighten European oversight of hedge fund managers, including leverage limits, increased disclosure and minimum capital requirements.

The EC has not previously attempted to regulate alternative investment funds, other than the retail funds covered by the Ucits directive - non-Ucits funds in the EU are estimated to control some €2 trillion in assets.

Although these funds were not as badly harmed by the credit crisis as other parts of the financial system, the directive links them to the speculation behind the 2007 commodity boom, with rapid entry and exit to small markets - increasing market volatility - and with failures of due diligence such as investing in funds run by Bernard Madoff. National regulation, it said, was inadequate to deal with the systemic threats such funds could represent.

Fund managers with less than €250 million under management will be exempt from the rules - a decision which leaves 85% of EU hedge fund managers (with 24% of total assets) uncovered. Managers covered by the directive would have to be authorised by their home state, and would have to maintain minimum capital levels of 0.02% of total assets, with a minimum of €125,000 in capital. Larger funds (over €500 million) would also have to report their leverage levels if they exceeded one, and there would be additional disclosure requirements on funds that held more than 30% of a single company. The directive also demands regular reporting of liquidity management plans and safeguards against abusive short selling.

The rules would apply to all fund managers based in the EU, regardless of where the funds themselves were based.

The Alternative Investment Management Association condemned the directive: "Hastily prepared and without consultation, the directive contains many ill-considered provisions which are impractical and may prove unworkable," it said in a statement today, adding that the directive could threaten thousands of jobs in Europe and even slow down economic recovery. But AIMA did not outline which of the directive's provisions would have these effects, as the organisation had not yet had a chance to read the directive in detail.

See also: Power to the investors
Madoff fallout
De Larosiere calls for ECB to lead European macro supervision
Business leaders want a tighter rein on banks