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Jul 20 2010 | 11:05am ET
Amid the aftershocks of the world financial crisis, European lawmakers trying to ensure it never happens again have trained their sites on hedge funds and private equity. The directive on Alternative Investment Fund Managers (AIFM) was introduced in 2009 and has been the subject of much inter-EU wrangling in the months since. In May, the EU Council and the European Parliament passed competing versions of the directive and now must agree a compromise version.
The industry is generally not happy with the directive (dubbed “another European mess” by The Economist) and to find out why, FINalternatives' Mary Campbell spoke with Javier Echarri, Secretary-General of the European Venture Capital and Private Equity Association (EVCA).
I read the AVCA’s response to the AIFM, as originally proposed in 2009, but I know the directive has changed shape since then and I’m wondering how you now feel about it?
There’s been an enormous amount of things since then but there’s been no official decision, as such. The only thing that is valid for the time being is you had the initial [EU] Commission proposal and…that goes to the two chambers, the council and the parliament—the council represents the member states and the parliament the citizens—and both of them finalized their positions in May. So the council position is an agreement position by the council members and the parliament position is a position agreed by the ECON and ECOFIN committees, not by the whole parliament.
The way it works is that now the council, the parliament and the commission sit together at a table and try to see where they can compromise in the space left between the two texts…And that’s the process [we’ve been in] since late May. So, what we have done, rather than respond to the council position and to the parliament position, we have been responding in the space left by both of them and we have been talking to, well, everybody, as you would expect on what the potential outcome of this is. The truth is that there is a certain level of agreement between the two texts, although they may look different on the surface. There is a fundamental space where agreement seems to be possible—things like evaluation, depositary, remuneration, capital requirements, etc, etc, and there are only three big areas, three big chapters, were there are different positions and where it is unclear what the outcome is going to be and whether they will be able to iron out differences in order to work towards a consolidated text.
What are those three areas?
[The first of] those three big areas is, in my opinion, disclosure—disclosure at the level of portfolio companies, I think that [on the question of] disclosure at the level of the fund and the fund manager there is a fair level of agreement between the two positions and it is not anything that the private equity industry, in principle, would disagree with, although it’s something we don’t do today, it is new, it is [an] additional constraint, it is additional disclosure [but] I think that the industry would be okay with that.
Where the industry has major difficulties—major difficulties—is on the question of disclosure of the portfolio companies. And this is critical in the sense that the more aggressive version, which is the one from the parliament, would force portfolio companies [employing a minimum of] 50 people to disclose all kinds of things, including future financial projections, including market expectations, R&D effort, etcetera, which for portfolio companies in the venture stage, for example, would simply kick them out of the market. And if you happen to have a portfolio company that is competing against SAP, and you have to disclose how much budget you have for your R&D effort…basically you’re shooting yourself. …There is no level playing field here between private equity-backed portfolio companies and others for absolutely no reason.
We feel it is going completely against the stated declarations by different people, including Commissioner Barnier [Michel Barnier, internal market commissioner] but also the Competitiveness Council of the European Union or even the G20. So all these good intentions about 're-dynamicizing' the economy, the importance of venture, making sure portfolio companies can get financed, all that is exactly against what is in this current text and the impact of those disclosure requirements.
Is the council’s version of the directive equally strict on this issue?
It is less radical in terms of the amount of information that is to be given. Both of them are not good, but it is less radical. What we say is that if we think that more information is necessary at the level of companies then it needs to be done for everybody, with a review of the company law directives. And there is a place for that, there is a place to negotiate that between the employer and the employee organizations.
What is the second-biggest issue, in EVCA’s view?
The other big one is the scope of the directive. Now, you will remember that initially the commission came out with a directive that would be applied to fund managers with above EUR 100 million under management, if their funds were leveraged and had redemption rights. And for those that were neither leveraged nor had redemption rights, that threshold was at the level of EUR 500 million under management (and that is a consolidated 500 million—independent of how many funds you manage). Now, that was done by the previous commission in order to protect venture, to a large extent…because [there is] no systemic risk consideration.
The trouble is that some of the discussions right now taking place would have every single private equity house—private equity and venture capital—covered by this directive. Every single one. Which means, again, not only that the smaller venture funds would suffer, because they would have to comply with an enormous amount of constraints…it would also create a barrier to entry …so less money available at the end of the day. And on top of that, every single portfolio company would be covered by this, as of, as I said, 50 people. So it’s got major consequences; as far as the scope goes, it remains a big, big problem. There’s no justification whatsoever to impose these kind of Draconian conditions on the very small funds [that pose] no systemic risk whatsoever.
And the third area?
And then the third one, which is particularly important for the U.S., is the third-country treatment…This is a complicated one. What the initial commission proposal said is that everyone would have to abide by these directives and that any fund manager outside Europe and with funds outside Europe would not be able to market those funds to European institutional investors unless they would opt into the directive—so, have exactly the same constraints on the fund raising, on the fund manager and on the portfolio company management—and where the countries where they are based would have an equivalent regime to that of the directive. That means, if you happen to be a U.S.-based venture capital fund manager with your funds in Delaware, but you do fund-raise in Europe, you would no longer be able to do that, you would simply not be entitled to do that unless you opt into the directive and the SEC would inherit the responsibility of applying the European directive to those funds.
That is what the directive actually said and we believe that is very much where the discussions are going. The council, which is the representative of the member states, did not want to go in that direction—it said that is absolutely not workable, we need to have national placement regimes in place, so that we don’t challenge the current … fundraising potential of those funds…The problem [with] the council proposal was, at the time, that while you would have to go through the national private placement regimes and they may impose the European rules…you are actually only getting a national product rather than a European product. That means, you can fund-raise in France, but in the event you want to fund-raise in Sweden you still have to go through the private placement procedure in Sweden before you can approach their investors. So it gets very, very cumbersome; there’s no level playing field here with the Europeans who, by applying the directive, would have immediate access to the whole single market…But having said this, the private placement regimes already exist, people deal with them today, and they have a national product every time, so it doesn’t fundamentally change what is there today.
Now, the parliament went the other way around they said, ‘No, no, no—they need to get a passport,’ so once they get into the European Union they should be able to access every country. Which is a fair approach, I believe, but the trouble is that in order to do that they need to apply the directive and there needs to be equivalence, and the SEC needs to adopt the powers and the responsibilities of the European future regulator…So that obviously will create a lot of tension and it is that tension that was at the origin of the letter [US Treasury Secretary] Tim Geithner sent to Commissioner Barroso, to the rapporteur Gauzès [Jean-Paul Gauzès, the parliamentarian responsible for pushing the directive through the EP], and to a number of finance ministers in Europe.
How hopeful are you that, this month, when there’s a vote, the result will be something your industry can live with?
I’m a little bit pessimistic, I have to say, today and I’ll tell you why. Whereas there’s been some interesting progress at the G20, for example…at the same time, while the European member states are getting a very clear message from other countries saying ‘The critical thing in the economy today is not this directive, you guys should be putting all your efforts on the banking system, on the public debt, on the economics behind that, on a number of other things – that is where the priorities lay, why are you putting your time on the AIFM directive?’ …my fear is that our political leaders are trying to close the directive as fast as possible, regardless of the quality of the text, simply to get rid of that pressure and to move on to other things…And that is what makes me pretty pessimistic in the current situation.