The cutting hedge
The European Union moved closer to regulating hedge funds with separate positions adopted in the European Parliament and by the Ecofin council of finance ministers within 24 hours.Hedge funds, which often borrow heavily and pursue complex investment strategies to generate high returns, have been fingered as one of the main culprits to blame for the global financial crisis, and the need for stricter regulation of such entities was unanimously backed by participants in the G20 summit in London in April 2009.The precise details of the proposed new EU directive remain to be hammered out between MEPs and national governments of the 27 EU member countries by July, when the European Parliament is expected to hold its first reading of the bill.The stated goal of the directive was to establish "a harmonised framework for monitoring and supervising the risks that alternative investment funds pose to their investors, counterparties, other market participants and to financial stability".In effect, the directive would set restrictions on pay and borrowing at hedge funds, the main target of the more stringent provisions in the bill, and would force a higher degree of disclosure by a branch of the financial industry notorious for its reluctance to do so.Private equity and investment funds were subject to fewer requirements, while other types - banks and pension funds investing their own money - would be completely exempt from the scope of the directive.The European Parliament's economic and monetary affairs committee adopted its position on May 17, adding new disclosure requirements for fund managers and provisions on risk reduction, with an outright ban on naked short-selling and an opening for temporary bans on "short-selling activities in exceptional circumstances".Short-selling is a trade that bets that the price of the security will fall by selling borrowed securities."This position will ensure better transparency and better investor protection while at the same time being on the side of the financial industry when it is working for the real economy," the committee's rapporteur on the issue Jean-Paul Gauz?s said in a statement.A day later, the Ecofin council agreed a mandate for the negotiations with the European Parliament, to be carried out by the rotating presidency of the EU, now held by Spain.‘Gracious' BritainBritain's new finance minister George Osborne attended his first Ecofin meeting with no chance of affecting the outcome of the debate. An estimated 80 per cent of all hedge funds in Europe are managed from London and the proposed regulation has sparked fears that the City financial district would lose business."I came here given a challenging position bequeathed to me by the previous government," Osborne was quoted by news agencies as saying.With Britain isolated and facing strong German and French support for the draft, Osborne chose not to antagonise his counterparts, hoping perhaps that some of the bill's provisions could be softened during negotiations with the European Parliament, Reuters said.The Financial Times take was similar: "Rather than fighting a last-ditch battle over hedge funds, Mr Osborne wants to keep his powder dry for a much bigger debate next month over plans to create an EU-wide regulatory system for financial services".With the common European currency facing its worst crisis since inception, the new rules are meant to discourage future speculation on financial markets.Hedge funds have been accused of aggravating Greece's public finances situation by betting against its debt, which resulted in rising interest rates and crippled Athens' ability to refinance from international markets.If the rules now being proposed were in effect, that would have given regulators more information on what was going on and given them the ability to clamp down, but with the draft directive expected to go into effect in 2012, it left other countries such as Spain and Italy vulnerable to a similar run despite the $1 trillion rescue package designed to prevent the crisis from spreading to other euro zone countries.‘Aggressive' GermanyConcerns about the health of the euro area prompted Germany to unilaterally impose a ban on "naked short-selling", the practice of selling securities without borrowing them first. The ban went into effect at midnight on May 19 and expires on March 31 2011.It covered euro area government bonds, shares in 10 German financial institutions, as well as transactions in credit default swaps linked to euro government bonds.An abundance of short-selling offers tends to push the price of securities lower and the ban is seen as aiming to limit pressure on euro zone peripheral economies such as Greece, Portugal and Spain. However, the interdiction could backfire on Germany if other financial centres do not follow suit, Reuters said."I'll boil it down to its core: The euro is the foundation for growth and prosperity, along with the common market - also for Germany. The euro is in danger," German chancellor Angela Merkel told parliament, as quoted by news agencies.The move, however, caught EU institutions and the bloc's governments by surprise and had not been discussed at the Ecofin meeting. French economy minister Christine Lagarde said, as quoted by Reuters: "It seems to me that one ought to at least seek the advice of the other member states concerned by this measure".Lagarde said that France did not plan to follow suit.European Commissioner for internal markets and financial regulation Michel Barnier said: "It seems to me that one ought to at least seek the advice of the other member states concerned by this measure."Others struck a more conciliatory note. European Economic and Monetary Affairs Commissioner Olli Rehn said, as quoted by Bloomberg, that he understood the reasons for Germany's decision and pushed for accelerating regulatory reform of financial markets.The immediate impact of the ban was limited, analysts quoted by news agencies said, since most short-selling was done in London and New York.