Sweden has taken a welcome and sensible stance with the re-drafting of onerous EU regulations on hedge funds, argues Kleinwort Benson.

Sweden’s redrafting of a proposed new European Union regulatory crackdown on hedge funds is thoroughly welcome as it should avoid some of the heavy costs that the industry had feared from original EU plans, according to Kleinwort Benson.

“There is a common agreement amongst the financial services industry that the proposed [EU] directive was drafted in a hurry and is capable of vast improvement," said Peter Mills, managing director of Kleinwort Benson (Channel Islands) Fund Services Limited.

“As head of the Working Committee Group, Sweden has recommended radical changes to the proposed draft to regulate EU fund managers and the regulation of the investment funds which they manage. Some of the proposals - authorising alternative investment fund managers for example - are sensible and improve investor protection.  Others create unnecessary and costly bureaucracy and reduce investor freedom.”

Mr Mills echoed other industry voices in saying that a single standardised approach for the hedge fund sector would not work given the diversity of the alternative investment fund sectors.  “The prime brokerage model for a hedge fund for example varies significantly from that used in the management of a private equity or real estate fund.”

"With the current `one size fits all’ approach, the directive requires every fund to appoint a custodian. However this was not previously required for closed ended private equity funds and is an extra burden placed on the private equity industry. It is also difficult to see the added value of this function in a private equity vehicle when you consider the costs and reduction in investment returns for the long-term investor,” Mr Mills continued.

"However the issues associated with the proposed directive will affect people a lot closer to home than they realise. A reduction of investment returns in pension schemes would impact the viability and performance of those pensions going forward – a downside for everyone who has a pension.

“A further key point is that EU investors may not be able to access investment funds from US or Asian fund managers and will miss out on some great investment opportunities, simply because the directive in its original draft form prevents those promoters from marketing their funds in the EU. This restricts the freedom of choice for EU investors and the Swedish redraft would appear to pour water on this particular proposal,” he said.

“Furthermore, if those markets were to respond with the same style of protectionist measures that the proposed EU directive might adopt, then of course European managers would be disadvantaged as they will not necessarily be able to market their funds outside of Europe.

“Consider the position of an EU-based private equity fund with costly unnecessary disclosures designed for retail investors, and a custodian to comply with the directive competing for investors against a non EU fund which doesn't suffer these additional costs.  Investors are likely to plump for the more cost-effective structure and this could lead to greater non-EU ownership of EU businesses - another unintended consequence of the directive,” Mr Mills said.

“We are keenly focused to see how this will play out. It will be interesting to see how far Sweden will be able to resolve these issues in the proposed directive before their presidency ends in December and the approach that the Spanish will have when their presidency commences in January 2010,” he added.