Kaushik Ray
Few reasons for Africa to fear EU’s fund directive
By Kaushik Ray | Published: 28 July, 2010
Much has been written in the financial press about the draft EU directive on alternative investment fund managers. The usual focus is on the directive’s potential impact on remuneration and the additional regulatory burden it seeks to impose. A lesser-told story is the potential impact of the directive on Africa-based funds, whose investments play a key part in the economic development of the continent, particularly with regards to infrastructure. We look at the history of the directive and how it might affect Africa-based funds.
The directive aims to provide a framework for monitoring and supervising fund managers who manage, administer or market alternative investment funds (encompassing property, venture capital, private equity and hedge funds which are currently unregulated). The directive’s stated aims include mitigating risks posed to investors and aiding financial stability in the EU.
The directive intends to have extra-territorial effect and applies to all managers of alternative investment funds located anywhere in the world.
The EU Commission issued the first draft directive last year. The EU Parliament and the EU Council have each since produced various drafts of the directive, which are being harmonised in the ongoing trialogue process between the Commission, Council and Parliament. An agreed text is expected to be passed to the European Parliament for a plenary vote this September. If adopted in the Parliament, it will take up to 18 months before the new measures are put into national law in member states.
The differing drafts of the directives are riddled with inconsistencies and differences of approach, for example in relation to exemptions for smaller funds and the way in which managers of funds established outside the EU – for example in Africa – can market to EU investors. The Council’s draft is generally recognised as preferable to the industry.
The final directive will affect different funds in different ways, but key for Africa-based fund managers will be the following (which all remain subject to the final harmonisation of the Council and Parliament drafts):
Restriction on the ability of EU investors to access non-EU investments
The directive states that member states may allow third country funds to be marketed in the EU for three years. Thereafter, a “passport” to market funds may be granted, but only if stringent requirements are met by the fund managers, requiring equivalence of third country regulation, supervision and access criteria, as determined by the Commission. These provisions will restrict the sale of African funds in the EU, which is potentially significant given Africa’s reliance on European capital.
Custodian and depositary businesses
Prime brokerage and custodian businesses will be affected as despositary functions outside the EU will also be subject to equivalency requirements in terms of regulation. Restricting local depositaries not only limits choice and adds to cost, but may also end up concentrating risk in a smaller number of parties.
Investment management functions
Administrative or portfolio management functions outsourced out of the EU will require the relevant entity to be authorised in its home country, with a co-operation agreement in place between national regulators. Since the regulated fund manager remains responsible under the directive for the activities of the delegated entity, this appears to be unnecessary and will lead to increased costs.
How does the market see it?
Since many private equity funds in the African market are partially or fully funded by EU governments, several African funds whose investors are European development finance institutions have refused to publically comment on the directive, given the political sensitivity involved.
The main reaction by commercial fund managers is “let’s wait and see”. Given the significant differences in the competing drafts, this is understandable.
Nonetheless, a majority of fund managers believe that the directive will impair growth in the industry. There is some divergence in opinion as to whether returns will suffer but there are significant fears in relation to the relocation of investment management talent.
Ultimately however, the industry has been successful at lobbying the EU institutions to water down the original draft. Despite differences in principle, heads of large commercial asset management funds publicly acknowledge that further EU regulation demanding transparency should not be feared by funds managing their assets in a fiduciary manner.
Kaushik Ray is a finance lawyer at Trinity International LLP
