CHAPTER 8: BETTER REGULATION
194. There has been widespread criticism among
our witnesses that the Commission did not undertake adequate consultation
when preparing the Directive and that the Impact Assessment that
accompanied the proposal was not sufficiently informed. The main
points of the Commission Impact Assessment are described in Box
10. The Financial Services Authority commissioned the Charles
Rivers Association to conduct an impact assessment on the proposal,
the main points of which are summarised in Box 11. We noted above
that the Parliament had used a provision under Article 192 of
the Treaty to push the Commission to bring forward proposals on
this issue.
BOX 10
The Commission Impact Assessment
The Commission impact assessment, which accompanied the original draft of the Directive, commented on the basis for the monitoring and controlling of systemic risks provided by the Directive. Key findings included:
- The current fragmented regulation of AIFM does not represent an effective basis for the monitoring or control of cross-border risks associated with AIFM.
- The absence of consistent standards of supervision was a source of continuing uncertainty for investors.
- The report found a horizontal approach to be an appropriate model for regulation, providing it was proportionate and targeted. It acknowledged that regulation must be sensitive to differences in business models.
- It acknowledged that ideally EU action would be coordinated with international action.
- The executive summary states that "Due to uncertainty about costs, it is not possible to assess or to quantify precisely the impact of the proposal on the competitiveness of EU-domiciled AIFM".
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BOX 11
The FSA Impact Assessment
The UK Financial Services Authority commissioned Charles River Associates (CRA) to prepare an Impact Assessment, Impact of the proposed AIFM Directive across Europe, on the Directive. The report examined whether the Directive would be effective, what unintended consequences it may have and its proportionality. Headline findings included the following:
- Under the proposed Directive, 40% of hedge funds, 35% of Private equity funds, 19% of Venture Capital funds and 2% of Real Estate funds would effectively be no longer available to EU investors.
- If no AIF were available in Europe in any form, portfolio returns for European investors that use AIF would be reduced by around 25 basis points (0.25%). Combining this with estimates above, the report suggests that EU investors could be expected to lose 5 basis points or €1.5bn assuming EU Pension funds have around €5 trillion of assets under management.
- Benefits can be expected to accrue from the passport which brings access to funds not previously marketed in certain member states.
- The Directive would impose estimated one-off compliance costs of up to €3.2 billion on AIFM and ongoing compliance costs of around €311 million. These costs would be passed on to investors thus reducing returns.
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BOX 12
The European Parliament Impact Assessments
| The European Parliament's Economic and Monetary Affairs Committee (ECON) commissioned European Economics to produce two further impact assessments on the Directive.
The first "quick" Impact Assessment considered impacts, objectives and alternative approaches. Key conclusions included:
- The Commission Impact Assessment's analysis of the policy problem was vague, sweeping, and inadequate as a basis for justifying regulation.
- Although it argued there was a strong case for additional regulation the rationale for a directive of this form is weak.
- It found the Directive poorly constructed, ill-focused, and premature.
The second Impact Assessment, published in December 2009, was a quantitative assessment of the impact of the Directive. Key findings included:
- The annual growth rate of EU GDP would fall by around 0.1-0.2 per cent, and booms and busts would be around 0.8 per cent of GDP less.
- There would be a short-term rise in unemployment of 0.8 per cent of current employment as the AIFM sector adjusted, whilst in the longer term peak unemployment would be around 1.3 per cent less as an consequence of busts being smaller.
- There is also the potential for non-EU domiciled investors to withdraw their funds in the short term, and, in the longer-term, EU investors to move their capital to compliant non-EU domiciled fund managers. However, capital outflow from Europe is likely to be modest in the short-term.
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195. The ABI noted that the publication of the Directive was
preceded by a consultation lasting seven weeks, and focused solely
on hedge funds (p 20). Other AIFMs were not consulted. Lovells
LLP argued the consultation process has been "insufficient
and inadequate" (p 223). AFG regretted that stakeholders
were not publicly consulted "contrary to what is usually
done". They noted, however, that "many of those who
are now complaining about this situation were, not so long ago,
completely opposed to any EU regulation and thus not very open
to debates or consultations" (p 192).
196. The Initiative for Policy Dialogue, Columbia University
disagreed. They observed that the consultation period was shorter
that for MiFID, but was comparable to that for the Directive on
credit rating agencies. They argued that long consultations do
not necessarily enhance the quality of the legislation since they
increase the risk that legislation will be influenced by groups
with "vested interests" in minimising the regulatory
burden and not primarily concerned with the stability of the financial
market (p 249). In this context it should be noted that we
concluded in our previous report that the Commission had not followed
its Better Regulation principles in relation to the Directive
on credit rating agencies.
197. The predominant view among witnesses was, however, that
the legislation was rushed. Sharon Bowles MEP told us: "we
know that the legislation was issued in haste, although some of
it had been brewing for a long time" (Q 372). The FSA
argued that "the process for producing the Directive has
not followed the good consultative approach usually taken by the
Commission. In the past, pre-consultation has generally resulted
in better proposals with a more considered impact analysis, and
greater buy-in from, and fewer surprises for, those affected"
(p 94). Citadel remarked that it took four years for the
USA to agree the Security Act of 1933 and the Securities and Exchange
Act of 1934 that followed the financial crisis in 1929 (Q 452).
This reaction is in line with our preliminary findings on the
Directive as expressed in our report, the future of EU financial
regulation and supervision, which concluded that "rapid
action must not come at the expense of thorough consultation,
impact assessment and risk analysis by the Commission in line
with their own Better Regulation principles."[41]
198. The Government commented on the efforts made by key stakeholders
to improve the draft Directive and reflected that "if the
EU had followed its own best regulation practices and had carried
out detailed consultation … [and] a proper impact assessment
then some of the failings … would have been headed off at
a much earlier point" (Q 410).
199. When we asked the Commission about the consultation process,
they pointed to several previous consultations on related subjects
which contributed to the formulation of the Directive (p 130).
They also referred to the "enormous" pressure placed
on the Commission by the European Parliament to come up with a
proposal on the regulation of hedge funds and private equity funds.
They acknowledged that this meant the Commission had to produce
a proposal "much quicker" than would normally be the
case (Q 345).
200. Particular attention was drawn to the lack of adequate
research included in the Commission's Impact Assessment. The Polish
Financial Supervisory Authority (KNF) argued that Directive lacked
any clear assessment of its impact on the financial market as
a whole and on the national market. The KNF complained that the
Commission's Impact Assessment did not estimate the implications
of the legislation to the industry and the danger of a potential
withdrawal of the affected alternative investment industry from
the EU. Lovells also noted that the Directive's impact on sectors
other than hedge funds and private equity funds seemed to have
been ignored (pp 298-299).
201. During the course of the inquiry, the Committee on Economic
and Monetary Affairs of the European Parliament (ECON) commissioned
two impact assessments on the Directive. Carrying out impact assessments
is not a common practice in the European Parliament. We discussed
the issue with Sharon Bowles, the Chairman of ECON. She explained
that the Committee was not satisfied with the Commission's Impact
Assessment and had decided to produce their own. She explained
that this was not the first time the EP has undertaken impact
assessments; "it is unusual but not unheard of." The
EP decided to commission a short initial Impact Assessment to
assess some crucial issues (including leverage, depositaries and
marketing of EU funds in third countries) in order to feed in
to the rapporteur's report. The second Impact Assessment was to
be completed at a later stage to look specifically at the impact
of the proposal on the real economy and competitiveness and some
other aspects. Sharon Bowles considered that the Impact Assessments
would significantly influence the EP approach to the Directive.
She acknowledged that the impact assessments were carried out
on a proposal that was inevitably going to be changed, but thought
the impact assessment helped point to "the way forward in
terms of what those changes should be" (QQ 372-381).
202. Had the Commission followed its own Better
Regulation principles, the shortcomings of the Directive could
have been dealt with at a much earlier point or might not have
been there in the first place. The Government must put pressure
on the Commission to ensure that future proposals are subject
to the better regulation agenda.
203. We are pleased to see that ECON is taking
the better regulation agenda seriously as there is no obligation
for the European Parliament to scrutinise the Commission's Impact
Assessment. We welcome the initiative of the Committee on Economic
and Monetary Affairs in the European Parliament to commission
two independent impact assessments to understand the impact of
some critical aspects of the proposed Directive.[42]
41 European Union Committee, 14th Report
(2008-09), The future of EU financial regulation and supervision
(HL Paper 106), p. 26. Back
42
The Committee will comment on Impact Assessments in a forthcoming
report expected to be published in March 2010. Back
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