AIFMD Impact on European Hedge Fund Industry

Abstract

Hedge funds have emerged as prominent players in the global financial markets during past few decades. Their trading has a sizeable impact on markets, as they trade more actively than mutual funds and constantly seek profit opportunities in less liquid markets. They have, however, faced significant headwinds since the financial crisis, as their returns have deteriorated and new regulatory measures have been introduced, even though no study directly linked the cause of the crisis to hedge funds. In Europe, the answer was the Alternative Investment Fund Managers' Directive (AIFMD).

Although the directive targets alternative investment fund (AIF) industry as whole, it was originally designed to regulate hedge funds and private equity. The directive is a comprehensive regulatory overhaul, which brings the previously lightly regulated AIF-industry under strict supervision. It seeks to harmonize alternative investment regulation across Europe, with the objectives of enhancing investor protection, mitigating systemic risk and facilitating cross-border distribution of funds.

The purpose of this study is to assess the impact of AIFMD on European hedge fund industry. The impact assessment is conducted by qualitatively assessing some of the latest industry surveys on the topic. The results are interpreted alongside a thorough examination of the content of the directive. The study takes a pragmatic approach to the subject, and practical consequences of the most important provisions are provided.

Some of the key findings of this research are following. The directive has a overwhelmingly negative impact on smaller hedge funds, as the borders of entry to the industry are substantially increased, and due to increased costs, the directive is almost an existential threat to some funds. Larger funds, however, may stand to benefit from the directive as they have the infrastructure in place accommodate the costs and take advantage of the benefits such as the AIFMD passport. As the directive has been in force for only a short period of time, it's impact on systemic risk and investor protection remains ambiguous. As such, the hedge fund industry as whole, also remains skeptical on the directive.