Baroness Cohen of Pimlico
Main Page: Baroness Cohen of Pimlico (Labour - Life peer)EU Committee: Alternative Investment Fund Managers
Baroness Cohen of Pimlico Excerpts
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.
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.