Europe’s controversial plans to regulate hedge and private equity funds were dealt a fresh blow on Thursday when the European Central Bank warned the proposals would put the industry at a significant competitive disadvantage.

The opposition voiced by the Frankfurt-based ECB, which feared a go-it-alone approach in Europe would backfire, is likely to be seized upon by the alternative investment fund sector – and influence the extensive re-writing of the proposals that is already under way.

Hedge funds have warned that business could be driven out of Europe as a result of the plans to regulate the sector for the first time on a pan-continent basis.

The UK had also voiced strong opposition, accusing the European Commission of producing “naïve” proposals.

ECB Legal Opinion:

"The ECB supports the intention to provide a harmonised regulatory and supervisory framework for
the activities of alternative investment fund managers (AIFMs) in the European Union. The
proposed provisions on reporting to the competent authorities should, in principle, contribute
significantly to enhancing financial stability monitoring and thus to better informed assessments of
the risks to financial stability connected with the activities of AIFMs and the Alternative
Investment Funds (AIFs) that they manage. The harmonisation of rules and the resulting passport
should benefit financial integration by improving the level playing field in the EU."

"The ECB urges the Commission of the European Communities to continue the dialogue with its
international partners, in particular the United States, to ensure a globally coherent regulatory and
supervisory framework. As noted by the Eurosystem in its contribution to the Commission’s
consultation on hedge funds, an internationally coordinated response is necessary given the highly
international nature of the industry and the consequent risks of regulatory arbitrage and evasion.
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."

In the legal opinion published on its website, the ECB warned that funds could simply shop around to find a country where the policing of the sector was less stringent. “An internationally co-ordinated response is necessary given the highly international nature of the industry and the consequent risks of regulatory arbitrage and evasion,” it said

Sources: FT and ECB