Extending the EU Financial Regulatory Framework to New Investors and New Markets

Abstract

Under the impulse of the G20, since the Washington Summit in November 2008, the Financial Stability Board (FSB) and its members have advanced a programme of financial reforms to build a more resilient and less pro cyclical financial system. This includes the extension of the regulatory perimeter to include, among other things, the OTC derivatives markets and hedge funds. In particular, the G20 Leaders agreed that all standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs) by the end of 2012. They also agreed that OTC derivatives contracts should be reported to trade repositories. Concerning hedge funds, legislation to establish registration, reporting and oversight arrangements for hedge funds/advisers has advanced in most G20 jurisdictions, with the objective to achieve an appropriate level of consistency across national and regional initiatives and avoid regulatory arbitrage or disadvantaging cross-border participants. On the other hand, shortselling is not identified as a regulatory priority neither by the G20 nor by the FSB.

Multilateral regulatory response concerning OTC derivatives stemmed in the first place from the difficulties encountered by the US insurer AIG which had built a large and uncollateralized CDS position and by the failure of Bear, Stearns & Co. On the contrary, multilateral action on hedge funds seems to have been promoted mainly on a prudential basis since hedge funds were among the financial intermediaries less involved in the recent financial crisis.

The European Commission followed such impulse by adopting a proposal for a Directive to mandate the clearing of suitable classes of OTC derivatives (the so-called EMIR proposal) and a proposal on alternative investment funds (AIFMD). However, the Commission further enlarged the regulatory perimeter by including in the AIFMD proposal also private equity funds and by adopting a proposal for Regulation on short selling.

In particular, the EMIR proposal, currently (March 2011) under discussion at the Council and the European Parliament, follows closely the multilateral regulatory efforts by providing mandatory clearing for suitable OTC contracts, penalisations for the remaining contracts, and disclosure requirements for all kinds of derivative contracts.

The AIFMD proposal, on which the European Parliament and the Council reached a political agreement in October 2010, besides introducing authorization requirements and disciplining operating conditions, reporting requirements and a passport regime for all the non-UCITS funds, contains a chapter specifically devoted to private equity funds which introduces, among other things, a differential treatment for private equity funds vis-à-vis other shareholders as regards special notification requirements and limitations to shareholder rights.

Finally, the short selling proposal, also under negotiation at the Council and the Parliament, adopts a more restrictive stance with respect to the recommendations of multilateral fora and of the Commission appointed experts group, and does not seem to be comforted by the available empirical studies on the effects of the limitations to short selling adopted around the world during the recent financial crisis.

Keywords: Hedge funds, credit derivatives, short selling

JEL Classification: G23, K22