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U.S., Britain Say EU Proposals Will Damage Hedge Fund Industry

The European Union (EU) on Thursday defended its sweeping hedge-fund reform proposals against criticism from the United States and Britain.

British Prime Minister Gordon Brown met with French President Nicolas Sarkozy Friday in hopes of compromising on the proposed regulation.

Many EU countries are determined to change the hedge fund industry, which is often murky. The use of derivatives, such as credit-default swaps have been linked to the downfall of Lehman Bros. and exacerbating Greece's sovereign debt difficulties.

The new rules in question aim to increase transparency in the financial system: Hedge funds would report their trades and debts to regulators, hold a minimum level of capital to cover losses, and disclose trading strategies, risk management systems, and how they value and store assets.

However, the United States and Britain feel the overhaul would invoke unneeded barriers.

Britain is afraid the new regulations, if implemented, would hurt both London investors and fund managers, causing further harm to a hedge fund and private equities market already suffering from an investment decline.

Fearing proposals were close to receiving EU approval, U.S. Treasury Secretary Tim Geithner on March 1 sent a letter to EU internal market commissioner Michel Barnier asserting that some of the EU proposals – which have been a discussion topic for six months now – are protectionist, and discriminatory against U.S. firms.

The EU argues these provisions are not discriminatory and are in line with previously decided Group of Twenty (G20) policies to tighten financial regulation.

The most contested topic is a "third country" issue, outlining how and if alternative investment fund managers (AIFMs) operating outside of the EU could market to EU countries' investors.

Britain is Europe's biggest hedge fund country – 70% of EU hedge funds are London-based – and it stands to suffer more than its EU counterparts if hedge funds that hold money in accounts outside the EU are treated differently than funds with inside-EU accounts.

Another Geithner-opposed provision is that hedge funds obtain authorization from each EU country in which they seek to secure investors. Both the United States and Britain supported a "passport" provision that would only require approval from one EU jurisdiction to do business with the whole region. The current proposal only gives passport rights to EU-based financial services providers.

"All the guys here are very worried about the free flow of capital," said Javier Echarri, director-general of European Private Equity & Venture Capital Association, at a Geneva investors' forum.

Spain, who currently holds the EU presidency seat, is working on a text for Tuesday's finance ministers meeting but not all details are available. The text supports foreign funds' access to the EU, provided there are "appropriate co-operation arrangements for the purpose of systemic risk oversight and in line with international standards … in place between the competent authorities of the member state where the fund is marketed and the competent authorities of the AIFM", according to The New York Times.

Most countries – excluding Britain – were expected to support the proposals at Tuesday's meeting. Before becoming a law, the legislation would need to be approved by the European Parliament, a process that could take months.

Commissioner Barnier will visit the U.S. shortly and hedge funds are one of the top discussion priorities.

"We need to ensure any regulation is sensible and proportionate. There have already been significant improvements to the EU proposal since it first emerged last year and we'll keep working with our European partners to improve it further," a U.S. Treasury spokesperson told the Financial Times.

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