The illogical in pursuit of the unspeakable

By Buttonwood

TO THE very traditional restaurant, Simpsons-in-the-Strand, this morning for a discussion on the EU's planned rules on fund management. The main speaker was Lord (Paul) Myners, once head of Gartmore, author of a spiky report on pensions reform and now a minister in the British government.

The new Alternative Investment Fund Managers directive was first drafted last year, and has been the subject of the odd diatribe from this direction. Those relying on the sensible Swedes to amend it were disappointed when the Swedes ran out of time in December (the EU has a six-month rotation system for running things) and were replaced by the Spanish.

To sum up Lord Myners' remarks:

- most people in Brussels acccept that hedge funds and private equity were not at the heart of the financial crisis, but they never liked them anyway, so they are taking their chance to regulate. "You never let a serious crisis go to waste" as Rahm Emanuel said.

- the rules are set by qualified majority voting so Britain won't get the directive it wants

- the current proposals discriminate against non-EU fund managers. Politicians may not like private equity managers but they will protect their own bunch*. The general principle that funds, if approved by a regulator in one nation, can be passported across the continent is being ignored.

Apart from this last issue of passporting, Myners also disliked the fact that remuneration rules, designed for banks, were being applied to fund managers and that leverage caps were proposed, regardless of the strategy concerned.

Readers may feel they have no dog in this hunt, that hedge fund and private equity managers are paying the price for their greed in the last cycle. And there are plenty of things that are hard to justify, such as the carried interest tax break highlighted by James Surowiecki in this week's New Yorker. I would agree that the industry's fees are too high (see a column from two years' ago on this very point.) Nevertheless, this is badly-designed legislation, which will not solve the problem of systemic risk it is (apparently) designed to tackle and is instead a crude attempt to hobble London as a financial centre.

So what should be done? One comes back to the point that systemic risk comes from excessive credit growth, growth that leads to asset bubbles. Usually this shows up in the real estate market, as it did in the last cycle. If central banks monitor credit growth and regard rapid rises in asset prices as a subject for suspicion, not celebration, the need for a lot of complex regulation can be avoided.

*Tim Geithner has written to the EU on this protectionist point. Incidentally, I had coffee the other day with a senior manager who assumed the legislation wouldn't pass because the EU would be sensible on this issue. He also thought the 50% tax rate in Britain would be dropped after the election because it will not raise that much money. How lovely to have faith in the good sense of politicians!