EU Committee: Alternative Investment Fund Managers
Baroness Cohen of Pimlico
To move that this House takes note of the Report of the European Union Committee on the Directive on Alternative Investment Fund Managers (3rd Report, Session 2009–10, HL Paper 48).
Baroness Cohen of Pimlico
My Lords, in introducing this debate, I need to alert the House to a potentially major threat to the United Kingdom financial industry. The alternative investment fund managers directive is an unexciting title for a piece of European Union financial legislation that could cause substantial damage to an industry worth €250 billion in Europe and the UK, of which 80 per cent is located in the UK, and which sustains 40,000 jobs also in the United Kingdom. Unless the new Government can achieve some amendment to the present cumbersome proposals for regulation, much of this economic activity could vanish from the United Kingdom, leaving an ever higher financial mountain for us all to climb.
This particular directive has been bedevilled from the start by a misunderstanding of the industry and confusion of objectives. The Commission, which has been under acute political pressure to produce regulatory proposals for this rapidly growing sector and its highly paid employees, has not helped. The result has been politically charged and highly emotive rhetoric, which has resulted in a confused directive that risks killing the goose that has been laying the golden eggs. This is the more curious because, from the outset, from the report written by Monsieur de Larosière, all Commission officials have publicly accepted that the components of the alternative investments—mostly hedge funds and PE funds—did not cause the financial crisis. Investors in those funds lost money but those who lent to the funds—the banking community—lost virtually nothing. This was well controlled lending that left the risk with investors and produced no systemic threat, in stark contrast to the poorly controlled lending to individual householders and uncontrolled trading of products, such as CDSs and CDOs, which did threaten the financial system and whose effects we are still working through.
My committee spent quite a long time on this important inquiry, from June 2009 to February 2010. We found that the term “alternative investment fund” includes a broad spectrum that most significantly consists of hedge funds and private equity funds. We found serious problems with the European Commission’s draft of the directive, which, if it came in the form that we considered, could seriously damage competiveness. The effect would be wider than fund managers and investors. One is not just worrying about a few highly paid young men. Many pension funds and charities include alternative investments funds in their investment portfolios and, as such, anyone with a pension or a charitable contribution will be affected indirectly by this directive. We took evidence for the report from June to December 2009, including two lots of evidence from the former Financial Services Secretary to the Treasury, the noble Lord, Lord Myners. We also travelled to Brussels and heard from representatives of think tanks, the European Parliament and member states. We published the report in February 2010, just at the moment when it appeared that agreement might be reached on a Spanish presidency compromise in the Council, though that was not to be. I thank Professor Robert Kosowski of Imperial College, London, for acting as specialist adviser to this inquiry.
Before I discuss the main conclusions of the report, I shall say where the directive stands today and explain its passage through the European institutions. On 17 May, the ECON committee of the European Parliament, chaired by Sharon Bowles MEP, agreed its amendments to the Commission's original draft. On 18 May, the ECOFIN council, under the direction of the Spanish presidency, reached a general approach on the directive. But in order even to get to a general approach, a minuted statement was agreed setting out the opposition of some member states—actually very few—including the United Kingdom, to parts of the Council text. This has allowed tripartite negotiations to begin in Brussels, where the three parties—the Council, the Parliament and the Commission—attempt to reach a compromise between the texts of the Parliament and the Council. By all accounts, little progress has so far been made toward agreement and it looks as if the original objective of reaching a compromise by the summer will not come to pass. This apparently blessed relief in the timetable should not be taken as meaning that we are really making progress; it is just impossible to tell.
The necessity for regulation of some sort is not disputed. In our inquiry we found that the size of these funds and the potential for crowding out, when a lot of managers all follow the same financial strategy, can indeed unbalance the financial system. We welcomed the aspects of the directive that attempted to reduce the risk proposed by fund managers. It is perfectly true that there is very little supervision of managers at EU level and it is impossible to find an alternative investment fund manager who does not accept that some regulation is necessary. The principal difficulty seems to be the recommendation surrounding the alignment of the directive with the global regimes and the proposals on the EU passport. In our report, our principal recommendation was that the Government must ensure that the directive is in line with and complements global arrangements. Co-ordination with the US regulatory regime in particular is essential to avoid a situation in which the EU alternative investment fund industry loses competitiveness at a global level as a result of regulatory arbitrage. The industry can go overseas but much will be lost if European investors do not invest in it. I shall be particularly grateful if the Minister could explain in his speech how the new Government will ensure that this does not happen.
As it stands, the directive would provide the opportunity for authorised managers to market their funds to professional investors across the EU. The directive would extend to non-EU managers but would apply restrictions to these managers that would, as originally drafted, restrict investment into and out of the EU to the disadvantage of the EU economy. Many of our witnesses described these measures as protectionist. This is a sensitive subject and solutions need to be found to prevent disadvantaging EU investors, which, as I mentioned earlier, include charities and pension funds.
The EU passport could provide fund managers with access to the whole EU market, which would deliver all the benefits of the single market, and most EU fund managers are keen that this should be so. If, however, the requirements for attaining a passport are made too difficult to meet, then non-EU fund managers could be locked out from marketing in the EU and EU investors’ options for investment severely restricted. On the other hand, if the restrictions come out being too tenuous, that will not solve the difficulties of those who argue that regulation should be a gold standard in order to protect market stability effectively.
My committee supported the passport and the principle of its benefits being extended to non-EU funds, so long as the passport was not so difficult to attain as to prevent managers marketing non-EU based funds in the European Union. The committee also supported—this seems like a sensible measure—the continuation of national regimes until an equivalency regime with third countries could be set up. While national regimes continue, you can make adjustments to the passport regime to make it work effectively without damaging the EU economy. If the passport regime is set up before it works, it will damage the EU.
We concluded that the original draft of the directive made it difficult, if not impossible, for third-country regimes to achieve the equivalency required for managers to get EU passports. It appears that this issue is still where the biggest divide remains between the European Parliament and the Council. The Council text does not provide for a passport but would allow member states to continue operating national regimes, should they wish to do so. The Parliament text provides for a passport to third-country funds with either an EU or non-EU fund manager, but would not allow the continuation of national regimes.
It is important that the Government find a workable solution. How will the Minister ensure that an effective compromise is found between the Council’s and the Parliament’s texts that does not disadvantage non-EU fund managers—mostly us—or EU investors?
There are other difficult bits in the directive. One of those is the requirement for transparency. The provisions of the directive that aim to ensure increased market stability are its requirements for disclosure of information on funds by fund managers to supervisors. This seems like a good idea. It could include leverage caps that would set a cap on how much a manager could borrow, while disclosure and transparency requirements would also allow supervisors to spot build-ups in risk, the infamous crowded trade, and take some action to reduce it.
These requirements, however, are not free from the problems that bedevil the detail of the directive in its original draft. We concluded that the directive should differentiate more effectively between different types of alternative investment funds, in order to prevent the disclosure requirements from placing EU funds at a competitive disadvantage. We also argued that national supervisors, rather than a pan-European body, should play the key role in analysing and acting upon data retrieved from fund managers, as not only would they be most effective in carrying out this task but it is national supervisors who will carry the can if it all goes wrong.
We also suggest that it is important that national supervisors identify here and now what specific data they need from managers to monitor risk. The directive, as drafted, could require supervisors to collate huge volumes of data, most of which is irrelevant to stability. It is clear that the possibility of analysing such data effectively would be reduced, thereby reducing the effectiveness of supervision.
In fact, one of the things generally wrong with the directive is that it operates on a one-size-fits-all principle, so that big hedge funds would be regulated in the same way as very small property investment funds. This leads to the kind of overregulation that will disadvantage everyone. We therefore recommended that the Government push for the directive to be appropriately tailored to different types of funds, and I would be glad if the Minister could provide an update on how successful efforts in this direction have been.
I shall conclude by briefly discussing the process behind the drafting of the directive. We found that the Commission had not followed its own better regulation guidelines in the drafting. There was an insufficient consultation process, a wholly inadequate impact assessment and a general rush to draft the directive, driven heavily by political motivation. Most of the problems with the detail could have been avoided if the better regulation guidelines set by the Commission had been followed.
With this in mind, how will the Government ensure that in future the Commission has sufficient time to follow its own better regulation practices in order to prevent the problems with this directive occurring again in future directives? There is a large amount of financial legislation still coming forward that may well suffer from all these defects, and the pressure on the Commission for it to happen as soon as possible could easily cause the same problems all over again.
All in all, there is quite a lot to do to this directive. I am sorry that we were not able to press the previous Government to do more—they were very willing to do more but made no progress—and I can only wish the next Government better luck with making progress on this one. I beg to move.
Lord Woolmer of Leeds
My Lords, I congratulate my noble friend Lady Cohen on opening the debate and on her chairmanship of the committee over a considerable time. It is 14 months since the draft directive came out. It was conceived in a rush, it was supported by a very weak impact assessment, and it was conceived in a heavily political and politicised context both before and following the financial crisis. In many respects it is a very good example of how not to bring forward legislation in such an atmosphere.
I suppose it is easy now to forget that the mood at the time of the financial crisis was one of “something has to be done”. When something has to be done, people pile in behind that to solve many other problems at the same time. The objectives were stated to be twofold. The first was to increase the stability of the financial system. The second was to facilitate a single market in financial services. Those were the stated objectives but for some there were, in addition, at least two others. The third objective was to bring tighter controls on activist hedge funds and intrusive private equity in different cultures and environments, such as Germany and, in particular, France. The fourth was to bring all remaining financial services under regulation and have a full house of all nine UCITS funds—so achieving a single market, but achieving it with political aims and controls which often conflicted with the wider global nature of the financial services concerned.
There was also, at the time, very little discussion about who uses alternative investment funds and what their views were and are. It struck me, as I think it did many members of the committee, that much of the evidence was from people who felt that something had to be done and saw problems with the industry itself. However, there was not much discussion—certainly in the European Parliament—about who is investing in these funds. What were the benefits of them? Of course, in part, it is high-wealth individuals but, as we know in this House, hedge funds receive something in the order of three-quarters of their capital from institutional investors, particularly pension funds and endowment funds. This is not a retail operation; these are people who take a lot of time and care over which hedge funds they invest in. It is a very professionalised business. As my noble friend said, the industry itself is extremely important, not only to the UK but to Europe.
In a sense, this was a draft directive that was conceived as a series of objectives, many of which conflicted. In the European Parliament in particular, one sensed that, having got the draft directive going, there was then an attempt to reconcile those conflicting objectives in a way that was inherently very difficult, if not impossible. I am not at all surprised by the European Parliament for sticking to the directive as it is amended. Essentially, there are some objectives in the minds of Members of the European Parliament that conflict with a global environment and open global markets in finance, as I shall comment on in a moment.
What are the remaining issues 16 months after the draft was published? I shall mention just very few; the Minister will have all this at his fingertips. He knows that there are many problems but some are slightly more important. To everyone who has a problem, every problem is important, but some are probably more significant than others. There is no doubt that third-country issues are extremely important, not only for the operation of the alternative investment fund industry in this country, but because of the global nature of the marketplace. These issues include the ability of European fund managers to market non-European funds, which is a large part of the business; the ability of non-EU managers to market into the EU funds and non-EU funds into the EU; and the question of passport versus single placement.
In principle, I would like to see an EU-wide passport and so would the committee; that is, a measure conferring the ability to sell funds anywhere within the European Union on the basis of a single approval. However, the tough issues that remain of the equivalency conditions, access conditions, who would regulate and who would supervise are exceptionally important and conflict with the global nature of the business, as I said. The idea that we can simply say in Europe, “These are the rules, you have got to play by them; otherwise you do not sell into Europe” is not in my view the way in which we should handle relationships in global markets. When the crisis arose I sensed that the European Union felt that it had an opportunity to set global standards and to be the leader. It was slightly fed up with the United States always setting down the rules. There was a feeling that this was Europe’s chance to be the leader, that it should set the terms and that you either traded on those terms or you did not. Those feelings have moderated a little but when it comes to getting votes through the European Parliament, such views are not always easy to reconcile. That mood still exists in the European Parliament.
I mentioned supervision and the role of the European Securities and Markets Authority. I understand the position of the European Parliament is that ESMA—the European Union’s supervisor—should supervise whether funds meet the necessary criteria or equivalency tests. As I understand it, the Council of Ministers does not go along with that. I should be grateful if the Minister could confirm the UK’s position on that. As regards the Commission’s proposals for credit rating agencies, Her Majesty’s Government appear to be saying that they accept that the European regulator—or supervisor in our language—of credit rating agencies should be the body that approves them. That seems to me potentially something of a precedent. I am beginning to wonder whether we are seeing the early stages of Her Majesty’s Government beginning to believe or accept that supervision of European-wide matters will have to be carried out at European level. Rather than being given a simple yes or no answer, it would be helpful to be given an explanation of the thinking behind this. Will credit rating agencies be an exception?
Clearly, private placement is not ideal. In many senses it would be much better to move beyond individual countries approving funds for marketing. However, if that has to be the case, I will support it. I certainly would not want to see a European passport going forward on terms that were simply unacceptable to the industry and unacceptable to us in terms of supervision. There are still some unrealistic and uncommercial limitations in the draft directive and in the discussions going on regarding who can be used as depositories and on the liability of depositories. The Council of Ministers’ position seems to be more reasonable than that of the European Parliament, but there are deep concerns among alternative investment fund managers about the liabilities that might be imposed on depositors.
I will not say that the committee had an enjoyable time, but it had a busy time looking at this draft directive. It threw up a number of issues and I am greatly concerned that after 14 months the Council of Ministers has not been able to reach an entirely agreed position without the need for dissenting notes, and that the European Parliament seems fundamentally not to have changed its position, but in the fine print is seeking to retain what I would regard as a rather insular view of a very global marketplace. It also does not recognise the enormous experience and contribution that this country can make in the discussions on and resolution of difficult but nevertheless important global relationships.
Lord Newby
My Lords, I congratulate the noble Baroness, Lady Cohen, and her committee on producing such a clear and thoughtful report on an extremely esoteric but vital area for the UK.
The report highlights a number of areas where anyone, at least in this country, who has looked at the draft directive is in agreement. First, there is agreement that alternative investment funds did not cause the financial crisis, but equally, given their scale and size, there was a need to regulate alternative investment fund managers on an EU-wide basis. This is now accepted within the industry.
However, the proposals have major shortcomings from a UK financial services sector perspective. We have seen in recent months frantic attempts by the industry and government to make the proposals more palatable to UK interests. I do not intend to detail the shortcomings in the current text. The noble Baroness and the noble Lord, Lord Woolmer, have done that extremely well, but I should like to discuss the broader question of why we find such unsatisfactory detail in these proposals and how we should attempt to avoid this situation when future proposals come forward.
The problems flow in some part at least from the UK’s at best schizophrenic approach to EU initiatives in general. The predominant mentality of previous British Governments—not just the last one—has been to stand back or positively oppose many initiatives which are of vital concern to the UK. When it has become clear that a policy is to be adopted, we have none the less fought a series of rearguard actions at EU level to minimise the damage to UK interests of these initiatives, as we see them. This has been a debilitating and wearisome approach, but when applied to the financial services industry it borders on madness. London is the predominant financial centre in the EU and it is clearly in our national interests that it remains so. There has been much discussion, during and since the election, of the need to rebalance the economy, but the way to do that is not by humbling and bringing down the financial services sector but by building up other sectors. The figure quoted by the noble Baroness of 40,000 people employed in this sector, which is a relatively small subset of the financial services sector as a whole, gives some idea of the importance of the sector to the UK economy.
If we look at the attitude of the previous Government, we saw in Gordon Brown an approach which in my view, in terms of achieving the best deal for the UK in Europe, was almost completely misguided. It comprised an attitude of patronising disdain and an unwillingness to show the common courtesy of attending meetings to their conclusion, if attending them at all, with the inevitable outcome that those who were patronised and ignored were disinclined to be helpful to British interests when considering specific proposals that came forward. I strongly urge this Government to take a different approach.
I do not support the idea that was floated before the election, but not so far pursued, of posting a Treasury Minister permanently to Brussels. This would isolate them from events at home and deny them the joys of having to explain themselves and the Government to Parliament. No other EU member state, as far as I am aware, does that—and for a good reason. There needs to be a continued link between the domestic ministry and Brussels. However, Treasury Ministers should spend much more time in Brussels and also, just as importantly, should do the rounds and visit their opposite numbers in their own countries to discuss on a one-to-one basis what we believe is the sensible way forward on proposals like this. For example, during the Swedish presidency, the noble Lord, Lord Myners, did just that. We need to be in a position where we know our opposite numbers better, at an earlier stage, because the value of that kind of charm offensive in an international body such as the EU cannot be overestimated. I realise that this is very time-consuming, but diplomacy—which to a considerable extent is what we are talking about—is a time-consuming business.
I also think that the Government need to review not the quality but the quantity and seniority of officials dealing with European financial matters. It has been a constant theme of debates during my time in your Lordships' House that, while individual officials are extremely bright and work very hard, they are trying to do too much and very often they are not at a level of seniority where their voices carry as much clout as they should. I realise, of course, that in an era of cuts, talking about strengthening anything by putting in more resources is a difficult proposition to make. However, making sure the financial services industry is not hobbled is such an important economic necessity for the UK that I hope the noble Lord will feel emboldened to make representations in that direction.
It is also important, as the Foreign Secretary pointed out last week, that we make sure that we get more of our best civil servants working in EU institutions. The value of this has been well understood for many years by a number of other member states—the French and the Irish in particular spring to mind—but we have been woefully neglectful in this area, and it has been reflected subsequently in the policy documents that have flowed from the EU.
In the months ahead, Treasury Ministers will necessarily be in a defensive mode on this directive, mitigating the potential damage that it might cause. However, for the sake of the UK financial services sector and the British economy, they need to get onto the front foot, think ahead and get in first so that when the first drafts of future directives in this area appear, they will more broadly reflect UK interests than has so often been the case in the past, and has been in the directive that we are discussing tonight.
Lord Tunnicliffe
My Lords, I, too, thank my noble friend Lady Cohen for initiating this debate. We should all be particularly grateful to the European Union Committee for its report—more grateful than usual, as it has had to deal with a moving target. As the letters to the noble Lord, Lord Roper, from the noble Lord, Lord Myners, and from the Vice-President of the European Commission clearly demonstrate, improvements to the directive are still being made. It is clear that the committee has made a valuable contribution to the improvement of the directive, on which it is to be congratulated. I believe that everyone now welcomes the directive’s goal of providing a coherent regulatory framework, particularly for hedge funds and private equity firms. Indeed, this goal has been endorsed by the G20. The difficulty has been in agreeing what exactly a coherent framework would look like.
The committee’s report provides a useful overview of the tortuous history of the directive. I do not intend to go into all the political cross-currents that seem to have contributed to the lengthy saga. Instead, I shall concentrate on four areas that are important in going forward. First, is the report’s analysis entirely satisfactory and do any deficiencies in that analysis detract from the conclusions? Secondly, is the general criticism of the one-size-fits-all approach of the directive still valid? If so, what is to be done about it? Thirdly, are the conditions for passporting non-EU alternative investment fund managers now satisfactory? Fourthly, what can be learnt from the history of this directive for future regulatory reform?
I turn first to the analysis. The report devotes itself almost entirely to the impact of the directive on hedge funds and on private equity firms. The report accepts the widespread position that hedge funds did not cause the financial crisis, but I am not at all sure that that is correct. It should be remembered that the crisis at Bear Stearns, the first major investment bank to encounter serious difficulties, was precipitated by the collapse of two hedge funds that the firm owned. Even if we leave those direct losses aside, it is inconsistent for the report to accept the argument that hedge funds contribute significantly to the liquidity of markets but not to take into account the devastating role that hedge funds played in the downward spiral of prices once deleveraging had begun.
On the same theme, it is worth pointing out that the report’s acceptance of the argument that hedge funds’ contribution to price discovery is valuable activity is not now universally shared. Hedge funds’ trading may help to make a price, but the link between that price and wider economic efficiency is now recognised to be tenuous at best. Hedge funds are contributors to systemic risk—that is, the risk inherent in the structure of the financial system as a whole—and it is right that they should be incorporated in new attempts to mitigate systemic risk. Perhaps the report takes too benign a view of hedge fund activities in this respect.
With regard to private equity firms, the report is surely right to focus on leverage. However, it is not the leverage of the private equity firms themselves that is the relevant issue but the actions of those private equity firms that pursue a strategy of leverage buyout, leaving the firms that they buy burdened with excessive levels of debt. It would have been useful to have had the committee’s views on the economic value of this sort of activity. It would be helpful if the Minister would, when he sums up, comment on the Government’s attitude to leveraged buyouts and their impact on stability and growth.
Next, I come to the criticism of one size fits all. One of the oddities in earlier versions of the directive was the presentation of relatively precise regulatory controls on disclosure, capital requirements and independent valuation that were to be applied to firms with very different business models The consequence was not only a number of anomalies but the general feeling that the directive was not well fitted to any particular business model. Significant progress has been made since the early drafts of the directive to remove such anomalies and perhaps the committee’s conclusion on this point has been overtaken by events.
The position taken by the Commission, as outlined in the letter of the Vice-President of the Commission to the noble Lord, Lord Roper, is that,
“the all-encompassing scope of the Directive is a prudent approach to the regulation of a sector in which business models are diverse and fluid. An alternative approach based on rigid definitions of business models would not respond comprehensively to risk and would create real risks of circumvention”.
This is surely right. Moreover, it is in tune with the British approach to principles-based regulation. The issue, then, is whether the directive in the compromise form developed by the Spanish presidency is really playing that tune or whether it is a discordant cacophony of principles and rules. It would be helpful if the Minister could tell us whether the Government now feel that the key problems of one size fits all have been overcome and whether the directive has now assumed the flexible form that the Vice-President of the Commission suggests.
Finally on this topic, the report does not deal with the impact of the directive on investment trusts. These are peculiarly British institutions, which play an important part in the UK savings and investment industry. Is the Minister content with the application of the directive to investment trusts? It would be helpful if he could give us the Government’s assessment of the impact of the directive on the UK investment trust industry.
I turn now to the conditions for passporting non-EU firms. The report is surely right to argue that passporting should be available to all fund managers operating in well regulated, although not necessarily perfectly equivalent, jurisdictions. However, it was not clear whether the report supported one important aspect of the directive—the need for reciprocity between jurisdictions allowed passports into EU markets. Will the Minister help us on this point when he sums up? Are the UK Government wedded to the notion of reciprocity?
Finally, I turn to the question of what lessons can be learnt about future regulatory reform from this episode. The obvious first lesson is that, given the central role of the UK financial services industry in the economy of the UK, and indeed the economy of the European Union, it is vital that the UK authorities should be in the forefront of regulatory reform. In this respect, I must take issue with one of the report’s conclusions:
“The Government should ensure that EU regulation is in line with, and complements, global arrangements. We believe that the Government should not agree the Directive unless it is compatible with equivalent legislation with regulatory regimes in third countries and in particular in the United States, in order to avoid a situation in which the EU AIFMs lose competitiveness at a global level”.
That conclusion was rendered out of date by the Toronto G20 summit. At that summit, the consensus that had until then characterised the international reaction to the financial crisis substantially evaporated. Of course, we all hope that the G20 meeting in Seoul in November will reinvigorate a common approach to regulatory reform. However, it would be a serious mistake to allow the search for consensus to be an excuse for inaction.
The United States has already indicated by its actions—notably the passing of Senator Dodd’s Bill by the Senate—that it intends to pursue its own interests in the first instance. We should do the same—not to try to create division but to set the agenda and lead constructive thinking on reform. The most damage that the directive, with its tortuous history, could do would be if it were to stifle European, and more especially British, regulatory initiatives. On this count, it is disturbing that the committee established to consider the future of the banking system will not report until September 2011—10 months after the Seoul meeting. Will the Minister assure us that the Government will not be waiting for international consensus to publish their reform proposals?
This is a valuable report both because of its detailed assessment of the directive’s impact and because of the light that it sheds on the process of regulatory reform and the necessity for that reform to proceed with some dispatch. It is for the Government to lead in the development of financial regulation in Europe and the world. To do otherwise would be a grave disservice to this crucial British industry.
The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I thank the noble Baroness, Lady Cohen of Pimlico, for bringing forward this debate and I thank noble Lords for their contributions. It has been an important and thoughtful discussion. She started by giving an admirable summary of the importance of the alternative investment fund industry to the UK and indeed to Europe, and she drew attention to the troubled and tortuous history of the directive. It is striking that, in the debate, noble Lords have focused on the same series of key issues.
I commend the European Union Committee on producing such an excellent report. The Government have fully noted its conclusions, and my honourable friend the Financial Secretary has responded to the committee outlining the Government's position on the issues that it raised. These have indeed been difficult negotiations, with a wide range of views being expressed across the EU. We have considered a number of drafts and potential solutions but it is regrettable that, throughout this process, we have had no proper Commission impact assessment to refer to. We have stressed that this should absolutely not set a precedent for EU legislation. The noble Baroness rightly emphasised the importance of that point. I can assure the House that the Government will press for that, bearing in mind that decisions on the scope of Commission impact assessments are taken independently of member states.
Nevertheless, Ministers and officials have been in regular discussion with representatives of the industry and their associations to understand the impact of various measures in the directive and to find a way through. Of course, the EU negotiations are far from over. At ECOFIN in May, the Chancellor made clear that progress was needed on key issues before the UK could offer its support to the directive, and he secured an important minute statement from the Council to endorse further discussion on the issues. Separately, the European Parliament voted on its own compromise text. Following that, the trialogue was initiated, with a view to reconciling the different positions of the Council and the Parliament, with some significant differences still remaining.
I should like to outline some of those issues and, in doing so, respond to some of the points that noble Lords have raised, but first I shall set out the Government's overall position on the directive. The Government are committed to finding an acceptable compromise, and are looking forward to working constructively with the Belgian presidency in that spirit. However, we have made it clear to our European partners that we should not be seeking agreement for agreement's sake. We need to ensure that the directive is non-discriminatory, in line with our G20 commitments. We also need to find workable and proportionate solutions that provide a sufficient level of regulation, while allowing the industry to function effectively. The Government will use our influence with the European Commission, Members of the European Parliament and other member states to improve the drafts on the table to find a solution that meets the broad objectives that I have just outlined.
I turn to some of the specifics raised in the debate. First, on the question of international consensus—a point raised by the noble Baroness and by the noble Lords, Lord Tunnicliffe and Lord Woolmer of Leeds—the G20 agreed at its London summit in April 2009 that all systemically important institutions, including hedge funds, should be subject to regulation and supervision. Developing a harmonised EU framework for the regulation of hedge funds and other alternative investment fund managers is clearly consistent with that objective.
The Government are keen to ensure that, in line with the G20’s broader commitment to global co-operation in addressing those issues, and in line with the G20 communiqué of 5 June, the final directive adopts an open and non-discriminatory approach in respect of non-EU fund managers and service providers; and that, where it imposes equivalent standards, these are consistent with the emerging global norms. Furthermore, we support the approach in the Council text to align co-operation agreements between EU supervisors and international supervisors to international standards, such as the IOSCO standards, where such standards exist. We consider that using that approach is more likely to ensure that co-operation arrangements are achieved with third-country jurisdictions.
That takes me to the direct question of the third-party arrangements, which were drawn attention to by most noble Lords who spoke. That is perhaps the most difficult issue under the directive. The majority in Council favoured an approach that maintained national regimes but restricted a passport to EU managers of EU funds only. On the other hand, the European Parliament took a completely different approach that is more similar to the Commission’s original proposal. The Parliament voted for a harmonised EU regime to allow a passport for all EU and third-country alternative investment fund managers. However, those failing to meet the conditions of the directive would be excluded from marketing to member states. In other words, national regimes would come to an end. In addition, ESMA, one of the new supervisory authorities yet to be created, would have a role in ensuring that third-country managers of third-country funds were effectively suspended.
The Government agree with the conclusion of the European Union Committee report and have taken a clear position. First, we believe that this directive should be non-discriminatory. The G20 agreed this in principle and it is important. We therefore also do not believe in reciprocity as a condition for access to EU markets. Secondly, the directive should not restrict investor access. It is crucial that EU investors should continue to be able to access alternative investment fund management throughout the world. In line with these principles, the Government will push for what we call a dual regime, with an achievable EU passport operating alongside national regimes. This is precisely the position advocated by the committee. We have presented this to others as the middle ground between the ECOFIN and Parliament positions. It is very difficult to predict how this debate will unfold. Given the significant difference of view, it is one of the key issues in this debate for the Government.
The noble Baroness made a point about requirements for disclosure to regulators. There is some history here because over the past five years the FSA has been gathering information on the potential impact of hedge funds on the market through its survey of prime brokers. It is in the process of completing the second year of a hedge fund survey that focuses on the 50 largest managers that have the greatest potential impact on the effective functioning of markets. Deciding exactly what information alternative investment fund managers should provide to their supervisor is one of the questions that the FSA has considered in developing this survey. The FSA will continue to refine its approach as it undertakes further iterations of the survey, including reflecting on whether to broaden the range of managers to whom the survey should apply.
The Council’s general approach on the directive allows aggregate data to be provided for small firms. Managers above a threshold would have to provide more detailed information to their supervisor. However, the Council text envisages level 2 measures on this issue, and there is a clear requirement on the Commission to take into account the need to avoid an excessive administration burden for supervisors. The Parliament position does not make any distinction on the size of manager or fund and applies all the requirements on all managers. The Government clearly favour the more proportionate approach and so support the Council’s position.
A number of speakers raised the one-size-fits-all question. The Government agree with the committee that the one-size-fits-all approach of the original Commission proposals did not properly cater for different types of fund structure. In common with many other member states, the UK has argued for a more tailored approach. There have been significant improvements in this area in the text. The Council and the Parliament texts adopt a more proportionate approach to the various types of AIFM by including a number of important thresholds and carve-outs. For example, the Parliament approach looks to exclude investment trusts and private equity from certain requirements in the directive, and the Council approach recognises smaller private equity firms and self-managed firms by requiring lower capital requirements. The Government will continue to push for a compromise that adopts a tailored approach as far as possible.
The noble Lord, Lord Woolmer of Leeds, talked about ESME. I find it hard to see how a directive that is now being finalised can prescribe a role for a body that has not yet been created. The Government certainly believe that it would be inappropriate to set out roles for ESME through the AIFM directive. They certainly do not concede that there should be direct supervision at the European level more generally than there is over credit rating agencies, which has been the sole agreement to date.
The noble Lord also made an important point about depositories, which is another key issue of the provisions that remain open. While neither the Council’s nor the Parliament’s texts are ideal, we are working hard to find an acceptable compromise and we will continue to work to see that there is a proportionate system of liability in the framework for depositories.
My noble friend Lord Newby made a rather wider series of points that are fundamental to the UK’s approach to directives more generally. I completely agree with him that the rearguard action that the previous Government took was a bit late, although they pursued it with considerable vigour, and that we have to find a way of getting on the front foot more generally on directives. The UK has not been good at this over the past few years, and my noble friend the Financial Secretary spent a considerable time in Europe recently discussing the forward pipeline with Commissioner Barnier.
My noble friend also talked about being in other European capitals. I completely agree. The Financial Secretary was precisely on this type of operation last week in Paris. Yes, this is a charm offensive, but we have to be tough and realistic in our negotiations. As my right honourable friend the Chancellor of the Exchequer has made clear, we should be prepared to trade concessions on non-financial services directives, where appropriate, for what is in the UK’s interests on critical issues in financial services dossiers.
Finally, I endorse my noble friend’s point about getting the best UK officials into key positions in the European Commission. I was pleased that he recognised that my right honourable friend the Foreign Secretary highlighted this very point in a recent speech.
The noble Lord, Lord Tunnicliffe, talked about leverage buyouts and private equity. I trust that the Government’s position on private equity is clear. We consider that EU private equity should not be unduly disadvantaged against its competitors, and again the requirement should be proportionate to the size of the business. The Government are well aware of the proposals in the EU Parliament text on private equity, and consider that many of the provisions that are proposed would increase costs to EU private equity and would be likely to leave those investors at a disadvantage compared with other forms of investors. We consider that the threshold for private equity disclosure is set at a more appropriate level in the Council text, which is the definition that is used in the Commission’s recommendation on micro, small and medium-sized enterprises. We also consider that the directive should take care not to require the disclosure of sensitive information about target companies so that it is in the public domain and could be used by competitors to secure an advantage over it, thereby risking not only the prospects of the target company but possible returns for EU investors. We also consider that the Parliament’s approach to apply the second company law directive to private companies may be problematic, so we do not support that approach.
The noble Lord, Lord Tunnicliffe, also talked about investment trusts and the scope of the directive. We agree that investment trusts should in principle be excluded from the scope of the directive. The European Parliament text on this matter is very positive. It applies a more proportionate approach to investment trusts and private equity by drawing all firms into the scope of the directive but then disapplying a number of the provisions of the directive for these managers. However, not all member states in the Council or the Commission agree with that approach. They instead favour the Council’s approach to have a simple scope threshold without any disapplications of provisions. The Government will continue to push for a proportionate approach to cater for small and large firms. We are also supportive of the European Parliament’s approach, which we consider to be to the benefit of investment trusts and private equity.
Before I conclude, it may be helpful if I set out the likely next steps for these negotiations. Given the difficulty of some of the issues, it now seems extremely unlikely that there will be consensus on a single text before the summer break. However, I anticipate the Belgian presidency taking up this dossier as a priority in September. The Government will use the time available to further the UK’s position on this directive. We do not want to stand in the way of agreement, but it is clear that progress needs to be made before the Government can support the directive.
I hope that noble Lords have found this statement useful in setting out the Government’s position in the negotiations as they progress and in responding to the many important points that have been made this evening. I would welcome continued support and co-operation from both Houses as we continue this vital work.
Baroness Cohen of Pimlico
My Lords, I thank everyone who has taken part in this debate at the end of a long, hot day. I very much wanted the debate to take place before the summer break because, although progress has clearly been made—I congratulate the Government on the progress that is being made—this is a difficult issue on which nothing is really settled until the final deal is signed. It could all go pear-shaped quite quickly.
I hope that the Government are taking advantage of the slightly easier atmosphere in Europe. When this directive was first drafted and we were also dealing with the initial drafts of other financial legislation, we were coping with a situation where the whole of the financial crisis was regarded as the fault of the Anglo-Saxon model. The figurehead for the Anglo-Saxon model in Europe is and was the United Kingdom. I hope that I see signs of a more rational approach beginning to appear. I wish this Government every luck in dealing with this important directive.