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How Europe Wants Hedge Funds to Shape Up


Regulators are about to finalize new rules that they say will prevent another meltdown. Fund managers see lower returns and higher costs

London - Many Europeans have a dim view of hedge funds and private equity firms, arguing that their speculative trading aggravated the recent financial turmoil. Now, European regulators are readying rules they say will help avert another meltdown—and hedge funds aren't happy about it.

Although the measures won't be final until summer, some version is likely to be approved by EU regulators. One proposal would cap borrowing, which might curtail leveraged buyouts and trading of complex financial instruments. Another would require fund managers to hold capital with third parties for safekeeping, which could force them to pay more for insurance. A third would bar managers outside Europe from marketing to investors in the region unless they submit to EU oversight. "If funds don't want to follow the rules, then good riddance," says Andreas Botsch, an adviser at the European Trade Union Confederation.

IMPACT ON THE RECOVERY

The financial industry worries that the plans would do serious damage to profits. European hedge funds oversee roughly $262 billion in assets, 16% of the global total, according to analytical firm Hedge Fund Research. The added oversight may cost hedge funds and private equity houses $4.5 billion in one-time costs, with an additional $434 million annually for compliance, estimates financial consultancy Charles River Associates (CRAI).

Some economists say the proposals could harm the region's recovery, which already lags America's. EU researchers expect Europe's gross domestic product to expand a mere 0.7% this year, vs. 2.2% for the U.S. Advisory firm Europe Economics figures the rules would trim growth by 0.2 percentage points and boost unemployment. "I can't find a single investor who believes this is a good thing," says Douglas Shaw, a managing director in London for investment giant BlackRock (BLK).

Pension funds and other institutional investors, which often put money in hedge funds, are also unhappy about the idea. Ten Dutch pension funds say they'll lose a total of $2 billion in annual profit if the proposals are passed. "The [rules] could lead to an undue reduction of investment opportunities, higher costs, and lower returns for us," the group told the European Parliament in January.

With global competition for financial services intense, some say the regulations will spur managers to take their funds—and jobs—offshore. Poul Rasmussen, a former Danish Prime Minister and president of the Party of European Socialists who helped draft the proposals, counters that the new rules will protect jobs by clamping down on debt-fueled takeovers. Excessive borrowing, he says, "weakened firms, leading to an increase in corporate defaults during the crisis."

Scott is a correspondent in BusinessWeek's London bureau.

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