ECB joins anti EU-directive bandwagon

The European Central Bank has become the latest influential group, including the UK Financial Services Authority and London mayor’s office, to raise concerns in the past week about the negative consequences that proposed regulations could have on Europe’s private equity industry.

The European Central Bank has warned that proposed EU regulations could place Europe’s private equity industry at a competitive disadvantage to non-EU funds, adding to the chorus of criticism in the past week that has included the UK Financial Services Authority and London mayor Boris Johnson.

The ECB said if passed as is, the European Commission’s “Directive on Alternative Investment Fund Managers” could drive funds out of Europe to countries and jurisdictions with less burdensome oversight. The proposals would subject EU managers to new annual reporting requirements to investors and regulators, as well as additional offering memorandum disclosure requirements and regulatory reporting about assets in which funds are invested.

Last week a report released by the FSA said the directive could impose substantial one-off compliance costs of up to €3.2 billion on alternative investment fund managers (AIFM), while private equity firms would bear the brunt of an expected €311 million in ongoing compliance costs. Shortly after that Johnson’s office released its own survey which said the negative impacts of the proposals could reduce London’s competitiveness and lead to an exodus of firms from the city.

In a legal position posted on its website, the ECB said it supported the intention of placing additional oversight on alternative investment fund managers in the EU, but urged the European Commission to work with international partners – especially the US – to ensure that resulting regulations were consistent with other regimes. Under the directive, foreigners trying to market their funds in Europe would have to demonstrate to the relevant authorities that they are subject to equivalent regulation in their home jurisdiction, and it is unlikely many US managers would be able to do so absent new proposal from Washington.

Meanwhile, not only would foreign fund managers have to set up shop in the EU to market to EU investors, but European investors would also face a serious loss of access to top-performing alternative investment managers in the US. “An internationally coordinated response is necessary given the highly international nature of the industry and the consequent risks of regulatory arbitrage and evasion,” the ECB said. “This might help to ensure that the requirements in third countries for AIFMs are equivalent to those to be put in place in the EU, and that non-EU domiciled AIFMs could benefit from access to the EU markets on a reciprocity basis.”

Other recommendations put forth by the ECB include:

– All central banks should be expressly excluded from the scope of the directive.
– Requirements should be coherently applied to AIFMs, credit institutions and insurance companies due to the risk of regulatory arbitrage and the lack of a level playing field between such institutions.
– An in-depth analysis should be undertaken to focus reporting obligations on data that can be reasonably expected to be relevant for monitoring financial stability. The proposed disclosure requirements have been opposed by industry groups which say they will put EU private equity funds at a competitive disadvantage to US and Asia funds by having to reveal confidential information and strategies about portfolio companies. 
– The concept of “leverage” – which is fundamental to the business model of many AIFMs – in the directive should be refined as it currently does not include specific leverage ratio concepts. The ECB expressed concern that without additional clarification it may be difficult to implement the proposed definition.

Javier Echarri, Secretary General of the European Private Equity and Venture Capital Association, said the ECB opinion demonstrated a growing recognition by organizations in Europe of the damaging consequences the directive would have. “But while such sentiments are well and good, revisiting the directive's proposals line-by-line is a massive task and it is the action of the Parliament and Council that now really counts,” he added. “A widespread acknowledgement that this directive was rushed is nice to hear. It is also nice to hear that the level playing field for companies should not be damaged. The directive itself talks of tailoring – but the real challenge is getting the text improved and that lies with the working groups and committees of the EU institutions.”

The piling on by the ECB, FSA and London mayor’s office against the directive comes amid increasing indications that whatever ends up getting passed will be far less onerous against the industry than previously feared. Current EU president Sweden is holding discussions with member states about possible changes, while the UK has lobbied Spain ahead of its accession to the EU presidency next year. Meanwhile, a vote in the European Parliament has likely been put off to later next year, while the current chair of the Parliament's economic and monetary affairs committee is on record as saying the directive will be substantially amended before then.