Europe and UCITS - the good, the bad and the ugly

Mon Jun 1, 2009


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By Neil Wilson

In last month's column, I was perhaps a tad premature in my praise of the Alternative Investment Management Association, the international hedge fund association, for steering the G-20 toward a more sensible stance on hedge funds at its recent summit in London. At the time, the possibility of crippling new regulations - demanded loudly ahead of the G-20 meeting by France and Germany, among others - appeared to have been successfully averted.

Unfortunately, it now appears that I spoke too soon. Almost as soon as the ink was dry on the G-20 communiqué, the European Union came out with a draft - some would say daft - new directive for fund managers that was completely contrary to what had been agreed to at the G-20. Not surprisingly, it elicited howls of protest from AIMA and the hedge fund community, the private equity community and the wider financial world.

In proposing a raft of new rules and capital and reporting requirements for all offshore funds managed or marketed in Europe with assets as low as €100 million, the European Commission appears to be taking aim at the whole community of independent boutiques that until recently fostered a thriving investment industry in London. The draft directive appears brazenly protectionist - in stark contrast to solemn promises made by European leaders at the G-20 - potentially blocking distribution in Europe of funds managed outside the EU (including from the United States).

For the hedge fund industry, it is a worrying turn of events. As my colleague Nick Evans put it recently in EuroHedge: "Those who were always opposed to Anglo-American financial market capitalism believe that events have proven them right - and that now is the time to bring the speculators to heel."

At a time when the UK government has recently announced plans to raise the top income tax rate to 50% - albeit only for earnings of more than £150,000 (well over $225,000) a year - the EU has added to genuine fears about a potential exodus of talent from London.

It is of course possible that the proposed directive will be amended significantly before it is put into practice. There will be some months of consultation, and industry leaders are hoping that when implemented, it will look very different. But the outcome is far from certain, and it looks like it will be a tough fight - especially against an entrenched political and economic establishment in key European countries that has never understood nor liked hedge funds and would happily see them all disappear.

As Paul Ruddock, co-founder of Lansdowne Partners and one of the most respected figures in the European industry, said in a keynote address at the recent EuroHedge Summit in Paris: "The industry remains at risk of political backlash - as we see in these current EC proposals - and we ignore this at our peril."

There is, however, a huge irony in what is going on politically in Europe. For, at the same time, an increasing number of European managers who run offshore hedge funds have been moving to offer onshore funds as well. These onshore vehicles are being designed to comply with another set of rules promulgated by an EU directive - governing so-called Undertakings for Collective Investments in Transferable Securities, or UCITS.

The latest version of this directive, known as UCITS III, has in fact relaxed the rules considerably for onshore funds. For instance, it allows a much greater ability to use cash and money market instruments as well as derivatives, including equity swaps and contracts for differences (CFDs), and not only for hedging but also to achieve effective leverage of up to 200%.

As more and more managers have come to realize, this UCITS III framework is now flexible enough to allow for quite of lot of hedge fund techniques. Among the first London-based firms to offer an onshore UCITS III-compliant version of one of its hedge funds was Marshall Wace Asset Management, which began a version of an MW TOPS equity market-neutral strategy early last year and now plans to offer more UCITS products.

More recently, BlueCrest Capital Management launched a UCITS version of its hugely successful $7 billion BlueTrend CTA strategy, managed by Leda Braga. There is clearly a lot of interest in these UCITS-compliant funds -- as an attendance of more than 300 people at a recent seminar on this held by Merrill Lynch in London clearly showed.

It is ironic, therefore, that at the very time when EU politicians are proposing new rules meant to crack down on the detested hedge fund "locusts," smart managers are responding by using the EU's own rules to expand their footprint onshore. Nobody knows how big this onshore market can become, but seems certain to grow.