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EU to Rein in Hedge and Private Equity Funds

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In March, the EU announced plans to restrict the operations of private equity funds. This is far from surprising, since US and UK firms have exhibited a nasty propensity to lever up firms, pull out a lot in the way of special dividends, and too often overdo the cash extraction and leave a bankrupt hulk in their wake. The irony is that while that is peculiarly seen as a legitimate way to do business here, most EU member states are not at all happy with it. The EU has been working on a proposal to restrict investors in the EU from putting funds in private equity and hedge fund firms outside the EU, and also limit the ability of foreign investors to buy European companies.

The amusing aspect of this initiative, as we noted in an earlier post, is the private equity industry immediately started threatening that the proposal would “seriously disturb” many of the world’s biggest PE funds. So? That would seem to be a feature, not a bug. Swedish Lex offered this observation:

What I find silly is that the Industry, in its efforts to convince the Parlamentarians, and the other relevant EU Institutions, are using the same bad old arguments like if you regulate in Europe, it will scare off investment and the pensions of ordinary people are jeopardized. Well yes, the EU does not welcome trashy short-term cancerogenus cash spreading from Cayman funds run by math nerds that design real nukes one day and their financial equivalent the next.

Yves here. The day after the EU announced its plan, Geithner swung into high gear to oppose it, looking like a complete industry toady. From our post then:

The next step was Geithner issuing a letter contending that the proposed EU regulations were discriminatory. While on paper that argument might appear sensible, it deliberately obscures a bigger reality: the way these firms operate, particularly the PE firm practice of using leverage, and the consequences of leverage (if you get it wrong, firms go bankrupt more so that if they had not borrowed, leading to unemployment) runs afoul of other government policies. This is a matter of sovereignity conflicting with an ideology that more open markets are ever and always better. You cannot have both in absolute form, and the EU is deciding to trade off one versus the other in a manner different than the US does.

Needless to say, the EU is not taking this lying down, and points out that some of the actions that Geither was taking aim at in his broadly-worded letter were in fact consistent with G-20 commitments….

While this is all very entertaining, the focus on the tit-for-tat misses the elephant in the room: what the hell is Geithner doing lobbying for hedge funds and PE funds?

The Volcker rule makes clear that the US does not regard these as functions integral to the operation of a healthy financial system and deserving of backstopping. The vast majority of PE and hedge funds, in terms of their staffing, are small businesses. Since when do small businesses have the Treasury secretary going to bat for them in a major international spat (this is the lead story in the Financial Times right now, lest you have any doubt).

Follow the money. Its “change” and populist pre election branding to the contrary, Obama raised more money from the financial services industry than any previous Presidential candidate. And the procurer-in-chief, Rahm Emanuel, concentrated his impressive fund-raising efforts on hedge funds and private equity firms (see here, here, and here). They expect a handsome return on investment, and it sure looks like they are getting it.

Yves here. The Financial Times reports that the effort to rein in the hedgies and PE firms continues to move forward, much to the consternation of the US and the industry, and now the UK:

European Union countries led by France and Germany plan to push through controversial new hedge fund regulations next week after turning down British pleas to defer a vote in Brussels. …

Britain looks certain to lose any vote and George Osborne, chancellor, could be forced to swallow plans requiring greater transparency from hedge funds and private equity groups….

Under the new rules, hedge fund managers and private equity firms could be forced to curtail the amount of leverage they use, make regular disclosures about their portfolios and would be forced to hold their assets with European banks.

Non-EU hedge funds could face similarly exacting requirements if they wish to market themselves to EU investors. Managers and investors have said the proposed changes could force much of the industry from Europe.

Yves here. This part is rich:

The directive has also caused concern in the US. In March, Tim Geithner, US Treasury secretary, wrote to EU officials warning that, if unchanged, the new regulations could trigger a transatlantic rift by unfairly locking US funds out of European markets.

“The Americans are going absolutely ape,” said a person involved in the negotiations. “There’s this overwhelming belief now in Europe that if we legislate first, then the US will follow what we do.”

Yves again. Did you catch that? Look at what the Europeans want: to regulate hedge and PE funds, as in prevent them from engaging in behavior proven to be dangerous (abuse leverage) and give investors more disclosure, and restrict firms that refuse to agree to play by those rules. That is hardly a radical agenda, yet Treasury Department is working in lockstep with the industry to defend its ability to operate with minimal constraints. And note that no one is mounting an argument that these businesses are socially productive and hurting them will hurt the economy because no such argument can be made credibly. Instead, an effort to impose “prudent regulation” is begin branded as “discrimination.” The problem is no one outside the industry will buy the argument. And Team Obama’s zealous defense of these firms again reveals how, despite its efforts to present a populist, pro-reform image, that it will never cross its best friends, the big financiers, in a serious way.

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18 comments

  1. attempter

    While this is all very entertaining, the focus on the tit-for-tat misses the elephant in the room: what the hell is Geithner doing lobbying for hedge funds and PE funds?

    The Volcker rule makes clear that the US does not regard these as functions integral to the operation of a healthy financial system and deserving of backstopping. The vast majority of PE and hedge funds, in terms of their staffing, are small businesses. Since when do small businesses have the Treasury secretary going to bat for them in a major international spat (this is the lead story in the Financial Times right now, lest you have any doubt).

    Yes, but as Naked Capitalism has discussed before, Geithner rejects the Volcker rule.

    (As did the Senate Dems, and as has Obama by now. I’m willing to believe that Obama, freaked out by the Massachusetts senate election and under that duress, momentarily was serious about the Volcker, only because if he wanted nothing but a pretense he could have easily found a less politically risky one than giving Volcker his imprimatur.

    But it was a textbook case of wife-beater’s remorse. He’s since then gone back to his normal Wall Street flunkey self.)

  2. Brick

    Whilst I think there is a lot wrong with the hedge fund inductry arguing that they do not play a part in a healthy financial system may not be true. They can provide liquidity at times and if they are actually providing a hedging service then they can reduce price volatility.
    It seems to me that the problem is that too many of them are leveraged too highly and involved in gambling rather than hedging. So transparency and leverage limits seems like a good idea to me. I can also see arguments for forcing hedge funds to hold assets in european banks.
    What does concern me is putting up barriers to restrict investors in the EU from putting funds in private equity and hedge fund firms outside the EU, and also limit the ability of foreign investors to buy European companies. This smells of protectionism rather than anything to do with hedge fund activities.

    1. Diego Méndez

      Any foreign fund willing to abide by European rules can open a European subsidiary. Hence, it’s not protectionist, but protective: European rules must apply when investing in Europe, irrespective of the fund’s geographic origin.

      1. Paul Repstock

        Gerald..You wrote-Yves, you are being mild for a change towards these hedge funds and private equity firms that buy a healthy company, squeeze as much money out of it as fast as they can and leave the workers on the street after the obvious subsequent bankrupcy. Personnaly, whenever I hear of such conduct, I feal like grabbing my Kalachnikov (figuratively speaking of course) and taking out the bastards.
        I fully agree with legislation that makes such conduct illegal and put these greedy bastards in jail.-

        While this is all true and I agree comletely;
        A lot of the problem rests with the regulatory environment and the companies themselves. If shareholders had some real stake in the company and if the employees viewed their jobs as more than a paycheck, then these maggots would not find such easy carcases to strip. The trouble is that the common person’s relationship with a company be it as investor or employee is tenuous. Once the original venture capitalists or proprietor founders are gone, a corporation reguards the shareholders as a mere nuisance. And empoyees are not much higher on the manure pile, robots and voice mail are much cheaper.

        I think that the hedge funds need to have a defined buisness model. If they want to be called an industry. They should have strict guidelines. In definition, these companies are meant to protect individuals against economic crises, not to create the crises so that they can profit from it. That is the same game as selling subprime funds that are tailored to fail and then buying insurance on them.

        So yes, Hedge Funds should be severely regulated infact they should probably be formed only to protect those people who might be directly affected. Rather than as a way of buying insurance on some third party.

  3. Gerald Muller

    Yves, you are being mild for a change towards these hedge funds and private equity firms that buy a healthy company, squeeze as much money out of it as fast as they can and leave the workers on the street after the obvious subsequent bankrupcy. Personnaly, whenever I hear of such conduct, I feal like grabbing my Kalachnikov (figuratively speaking of course) and taking out the bastards.
    I fully agree with legislation that makes such conduct illegal and put these greedy bastards in jail.

  4. chad

    This post is hilarious.

    Abusive leverage?

    Whiskey Tango Foxtrot DO YOU CALL ZERO INTEREST RATES YVES?!

    Small wonder the big banks had a perfect quarter!

    I didn’t read that about too many hedge funds.

    Its just that easy sometimes.

  5. the.Duke.of.URL

    Personally speaking, I think that the situation that Geithner doesn’t want, restrictions on US firms in the EU market, is exactly what would be good for the EU in the short run. Especially since Geithner is doing his best to protect US the institutions that primarily brought all this on in the first place.

  6. Francois T

    While this is all very entertaining, the focus on the tit-for-tat misses the elephant in the room: what the hell is Geithner doing, lobbying for hedge funds and PE funds?

    Yves,
    Don’t you remember Obama’s remarks about “savvy businessmen”? I mean, it behoove Da Leader to do everything in his power to help those among us who know and do better at “high” finance than the unwashed masses, no? Hell! It’s even supposed to be good for our economy. :-D

    Seriously now, I’d posit Obama truly believe that helping everything finance related is in the interest of the United States. After all, his (very restrained) circle of advisers are constantly parroting the need to keep our “international competitive edge” in finance, as if it was a matter of national security.

    Viewed under this prism, the collateral damage at home may elicit (fleeting) pangs of regret, but hey! that is what leadership is all about: making tough decisions, huh?

  7. Jaap

    what about a nice conspiracy theory: Europe and the Euro are punished by the hedgies for trying to push through this regulation. just a little brainfart…

  8. Doc Holiday

    Meth, not math …

    See: EU does not welcome trashy short-term cancerogenus cash spreading from Cayman funds run by ==>math<== nerds that design real nukes one day and their financial equivalent the next.

    In the case of Cayman hedge fund math, there is no difference between the destructive outcome of meth use and math abuse.

  9. Hugh

    Geithner is correct in the sense that the current system is so corrupt and unstable that any serious reform could blow it up. Of course, left to its own devices it will blow up anyway.

  10. Carlos

    Reading this post one would get the impression that the EU is standing up for the little guy. But then one remembers the deflationary policies being imposed on the “PIIGS” countries as a condition for the bailout: the money goes directly to the accounts of French and German banks, and then the economies of the “rescued” countries are sucked dry of any assets, just as the EU core did in Eastern Europe (and the US did in Latin America during the 80´s and 90´s). The PIIGS countries, just like the Eastern Europeans, will end up being colonies of the EU, at the mercy of German industry. That is, the German bankers and industrialist, because working and middle class Germans will go on slaving away for a pittance. There’s no doubt hedge funds and private equity firms are carrion birds of the worst sort, that they should be banned together with tax havens in the Caribbean, but the EU Commission, by keeping them away, is just protecting the interests of its most powerful members, as their bankers carry out their own rapacious neo-feudal business in another, more old fashioned way. Unfortunately the EU economic imperialism can only go so far without an army to back its diktats. The moment one of the PIIGS countries give them the finger and leave, the EU will go the way of the Holy Roman Empire.

  11. Tim

    What no one seems to understand are that there are other countries other than the US/EU where hedge funds are based. Places like Canada, Australia, Switzerland, Hong Kong, Singapore, Israel etc. New Zealand’s Prime Minister John Key a former Wall Street fatcat himself elected right in the teeth of financial crisis(November 2008) has launched a taskforce to make NZ’s regulation of hedge funds more “industry friendly”. In Canada hedge funds are regulated by the individual provinces and territorries not even the federal government some of which like Alberta are well known for their industry “friendliness”.

    Most of the countries listed above had no bank bailouts so their public’s are totally uninterested in finance. In Canada people are more interested in a former MP named Rahim Jaffer’s escapades or the NZ PM’s cannabilism jokes(To be fair Canadian TV such as TVO and BNN gives more voice to people like Yves and Felix Salmon in their discussion of the “US” Financial crisis than US TV does). Why does everyone assume that all hedge funds will always be based in either the West End of London or Greenwich CT.

  12. ddf

    The HF industry is squealing because it has not yet given up on the illusion that it can keep its current operating model for ever. But actually a more grown up view of the political and economic transition we are going through would cast the regulatory changes in a more positive light. More regulation could be good for the HF industry if it increased investor confidence. The EU should enlist the support of large investors in HF, especially those who were not allowed to pull out their money, made huge losses, or were the victims of outright fraud.

  13. xct

    If you ask why the French public in general is aware…
    The French documentary “La Mise à mort du travail”(2009) recently unveiled the tradegy these private equity funds brought; it shows how Goldman and KKR (Henri Kravis) private equity “overdid the cash extraction and left a bankrupt hulk in their wake” (as you wrote). I think the DVD has English subtitles.

    http://www.amazon.fr/mise-mort-au-travail/dp/B002UQ9UL2/ref=sr_1_1?ie=UTF8&s=dvd&qid=1273886219&sr=8-1

    http://recherche.telerama.fr/recherche/recherche.php?ecrivez=La+Mise+%E0+mort+du+travail&go-rech.x=12&go-rech.y=7

    http://television.telerama.fr/television/la-mise-a-mort-du-travail-recompense-par-le-prix-albert-londres,55459.php

    http://television.telerama.fr/television/la-mise-a-mort-du-travail-documentaire-2-2-de-jean-robert-viallet-france-2009,48540.php

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