The EU’s road to hell

It is a scenario that could only have been dreamed up by Kafka: if certain aspects of the proposed EU Directive on Alternative Investment Fund Managers pass as currently drafted, Europeans would be able to raise funds in the EU and non-Europeans wouldn’t, while non-Europeans would be able to do leveraged buyouts in the EU and the Europeans wouldn’t.

Thankfully, the AIFM is a work in progress, and advocates for the alternative investment fund industry are working overtime to see that the craziest ideas are removed from the final draft. But it is safe to say that what should have been a welcome new set of rules to bring transparency to a growing asset class has become infected with protectionism, counter-productive red tape and self-defeating investment restrictions. Unless a chorus of voices in and out of the private equity industry make clear the folly of certain elements of the AIFM, the good intentions may well pave a road to hell.

Take for example the EU Parliament’s Economic and Monetary Affairs Committee (ECON) proposal to require a “cooperation agreement” between an EU member state and a non-EU fund manager in order for that fund manager to raise capital in the country. As Clifford Chance’s Simon Gleeson puts it: “In the current state of play, if you were dealing with a US manager, you wouldn’t have a cooperation agreement. That manager would be locked out of Europe.”

The ECON proposal also has an intriguing clause that would seem to favour foreigners over locals with regard to LBOs. Clause 27a reads: “[I]n order to avoid potential asset-stripping, the net assets of a target company controlled by an AIF shall comply with the provisions of the capital adequacy regime under the Second Company Law Directive.”

But as Linklaters’ Elizabeth Ward points out, capital adequacy rules stipulate that a company not give financial assistance for the purchase of its own shares. “[T]his would make leveraged acquisitions of companies by private equity investors subject to the AIFM Directive all but impossible,” Ward wrote this week.

Private equity companies not subject to AIFM – those that decline to sweat through an EU “cooperation agreement” to raise funds in Europe – would presumably face no restrictions in pursuing LBOs.

Trying to understand the details of the AIFM induces a headache, and actually coming to understand these details makes the headache worse. It is impossible to see who benefits from some of the proposed rules. The investors? Certainly more transparency is a good thing, but this is offset by European LPs being cut off from potentially hundreds of quality non-EU investment managers.

No wonder European private equity market participants are the most concerned about regulatory initiatives out of any market participants in the world, according to a new survey jointly produced by PEI Media and BNY Mellon.

The survey also found that most people, including European GPs, remain optimistic about the future of the private equity industry. Being a GP will be harder in the future, but with deft lobbying and a little luck, it hopefully will not be Kafkaesque.