EU finance ministers agree new hedge fund curbs

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Canary Wharf and Docklands in London. File photo

EU finance ministers have reached full agreement on tighter regulation of hedge funds and private equity firms.

It will affect the way hedge funds pay staff, by forcing them to defer up to 40% of performance-related pay so they are tied into the fortunes of the fund over a longer period of time.

This 40% figure rises to 60% for the really big earners.

Half of this pay will be paid in shares of the hedge fund, something also designed to link pay to performance.

In the UK, however, the Financial Services Authority has said it will implement this directive "proportionately", meaning some funds may not be forced to comply completely with the directive.

Greater disclosure

The proposals also include the creation of a so-called "passport" - something that would allow hedge funds authorised in one EU territory to operate in any of the other countries in the 27-strong bloc.

The UK, where 80% of Europe's hedge funds are based, pushed hard for this, arguing it was in line with the single market principles of the EU.

The industry argued non-EU funds simply would not bother to carry on business in the UK if the rules were too restrictive.

This passport can be acquired by hedge funds based in the US or elsewhere, but it will mean them complying with a whole new set of regulations, particularly on pay.

Hedge funds will also be forced to disclose more about their "positions" - whether they are betting the market will rise or fall.

This is intended to help regulators spot so-called "systemic risk", or the building of a potential chain reaction of failed investments.

A hedge fund will also need to agree with regulators the level of "leverage" it can take on - essentially how much they can bet with borrowed money.

Finally, investors in hedge funds will get greater protection if the fund goes bust because the banks that hold the cash and assets of a hedge fund will have increased liability. This could well push up insurance costs for the industry.

'Heavy compliance'

In its initial reaction, the Alternative Investment Management Association welcomed the agreement.

"There is still much in the directive that will be difficult to implement for the industry, and there will be a heavy compliance burden that the industry will have to bear. But the impact will be far less severe than if something close to the original proposal had been agreed," said Andrew Baker, the trade body's chief executive.

The proposals look very likely to come into force.

They will be voted on in November by the European Parliament and could begin to take effect by the end of this year.

However, EU governments have until 2013 to write them into national statute books, so that is when the new laws will really begin to bite.