By Barry Cohen and Amanda Cantrell

Hedge fund managers in the U.S. may think the new rules being contemplated in Washington are tough, but perhaps they should take a look across the pond. For if lawmakers in Europe have their way, it will soon be harder to run a hedge fund in Europe than ever before, and it will be tougher than ever for managers of funds based outside the European Union to market those funds to European investors.

The European Commission, which is responsible for proposing new legislation for the 27-nation bloc, proposed a draft piece of legislation, the Directive on Alternative Investment Fund Managers, in April 2009. The AIFM directive was designed to govern hedge fund operations throughout the EU.

Two entities within the Commission—European Parliament and the Council of the European Union—are hammering out a final version right now, in a process similar to the reconciliation...