Since the release of the EU’s draft Alternative Investment Fund Manager Directive earlier this year, many Hedge Funds have been speaking out about the new legislation and the potential effects on the industry.

At present, the Alternative Investment Fund Manager (AIFM), of which Hedge Funds come under, are regulated predominantly by a number of national financial and company legal regulations. The global financial crisis has highlighted much stronger hazards than initially thought, especially in reflecting cross-border risk.

Hedge Funds have been directly linked to the growth of structured credit markets and asset price inflation resulting in market turbulence throughout the credit crunch. Many have been struggling to withdraw cash for their investors, as they are unable to liquidate assets promptly.

One of the key requirements from the directive is that an AIFM cannot provide services to a Fund unless they have been registered and authorised by ‘a competent authority in the Member State’. In the UK this means the Hedge Fund Manager must be authorised by the FSA (Financial Services Authority) and comply to all Directive requirements in order to continue to provide the service.

There are also stricter requirements for AIFMs to prove that they have risk procedures in place and that they carry out regular ‘stress tests’ and annual reviews on all portfolios and risk management. An annual report for each Fund will be required within four months of the end of the financial year and include a full financial breakdown with all activities to be disclosed. An independent valuator will also be appointed to review each fund on a minimum of an annual basis.

Some of the most controversial changes involve Fund Managers (AIFM) making ‘pre-investment disclosures’ to investors and will also be required to disclose details of any leverage on which they use, which could be restricted by the FSA if it is seen as being high on a regular basis. The requirement for Hedge Fund Managers to disclose all their positions has been met with great resistance by the industry and it remains unclear as to when and how it will be enforced if the Directive is approved.

Where matters get murky is whether or not the Directive applies to the Fund Manager. There are a number of exemptions, for example an AIFM who is managing a Fund portfolio of less than 100 million euro (or 500 million euro with a five year lock in) is not applicable.

The increased level of reporting expected by the new Directive will raise the amount and thoroughness of administrative time required at the very least, although at this point it is unclear how much of the Directive will go through as it stands currently in draft form. If approved later in 2009, it is expected to be enforced by 2011 with a third of countries joining in by 2014; but there is clearly a lot of work to be done in assisting Hedge Fund Managers in complying with the new Directive, if the new compliance regulations do indeed apply to them.