In the 20 years to 2008 the UK’s exports of financial services rose over 17 times, at an astonishing compound annual rate of over 15%. In 2008 they totalled almost £53 billion, about 4% of our national output and more than 20% of our trade receipts from abroad. The surge in international financial services was basic to the economic dynamism of London and the south-east of England in this 20-year period.
Part of this boom in financial services reflected the emergence of private equity funds using innovative financing and management methods to extract the best return from unquoted company assets. Hedge funds with more diverse investments have also prospered using similar leveraged funding.
But since 2008 the UK’s exports of financial services are down by over 25 per cent. Part of the explanation is of course a cyclical weakening in activity due to the Great Recession. But also important have been new regulations and restrictions imposed by the European Union. While the challenges to prosperity from the Great Recession will fade over time, the threat from new EU regulations is long-term, radical and dangerous.
For private equity funds and hedge funds the most immediate new regulatory threat is the EU’s Alternative Investment Fund Management Directive. It will impose severe constraints on normal business, impracticable investment consultation obligations and restrictions on remuneration. Worse, it imposes limits on leveraging relative to funds’ equity share capital, regardless of the quality of assets acquired.
The financial crisis may be laid at many doors, but not at those of private equity and hedge funds. It was imposed without any genuine impact or costs assessments. Teams of top professionals in these fields, with outstanding records of management success, have left the UK for a non-EU location in Europe (Zurich or Geneva) or to a non-European centre altogether. The UK and the EU have lost well-paid jobs and valuable expertise. Other continents, notably Asia and North America, are the winners.
The pernicious AIFM Directive is to be administered by the newly-created European Securities and Markets Authority (ESMA) based in Paris. ESMA controls will include powers to determine the jurisdictions in which funds may deposit cash and assets on grounds of “prudential supervision”, so restoring a kind of exchange control and firms will be subjected to more than 20 EU laws.
With 80% of all European hedge fund business being conducted in the City of London the impact of the Directive on the UK is grotesquely disproportionate. The EU seems determined to penalise the most successful part of the British economy.
It is fantasy to imagine that the powers of the ESMA over our financial sector can be contained. The UK has only 8.7% of the votes on decisions under the new regime. Michael Barnier, the EU’s Commissioner for internal market and services warned in July 2011 “…we are moving towards a single European rulebook, with more directly applicable legislation.” And yet, astonishingly, Conservative MEPs voted to support this regime. Only UKIP offers release from these shackles.