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Faustian dilemma

The Tragical History of the Life and Death of Doctor Faustus, commonly referred to simply as Doctor Faustus, is a play by Christopher Marlowe, based on the German story Faust, in which a man sells his soul to the devil for power and knowledge and contains aspects that should be heeded by every country within the EU.

You may ask what this has to do with the investment community and particularly AIFMD. Will becoming AIFMDcompliant bring riches and fame?

Yes, maybe in the short term, for a few big companies, but at the expense of others. In the end there is the danger of a wasteland.

The politicians of smaller countries make a Faustian pact with the EU on joining. There is instant access to lovely cash and loans and the promise of access to big markets. But the pact is handing the country’s soul to the Brussels based bureaucrats, non- elected and not held to account for what they do.

The money given is squandered by politicians on grandiose projects, new parliament buildings, enormous bridges and roads and is of little benefit for the general population except maybe to those in the construction industry that is cozy with the politicians.

Then the bite comes, all the rules and regulations designed to create bland uniformity in products and services oblivious to those wonderful differences that existed in products of a local nature.

Latvian farmers cannot meet the EU agricultural standards and are stopping farming; their local skills are centuries old. Their farming conditions totally different from the farmlands of Britain and France.

The hedge fund industry is faced with the same issues as the Latvian farmer. There are many “cottage industry” hedge funds and if they do not meet the AIFMD requirements they will have to close shop or find other ways to manage money. Many of these fund managers are startups and future leaders in the industry.

Yes, there is the option of having a “lite” AIFMD licence if the assets are under $100m. But over that amount and the costs of complying rise dramatically. Staffing becomes a big issue especially if you do not want to set up in a big financial centre. Do all hedge fund managers want to be in London, Paris or Frankfurt? These are all big costly locations.

AIFMD favours those large well established companies situated in big financial centres. Hedge funds are forced to become larger and larger to cover costs. The danger is that large hedge funds tend to become bland, homogenized financial products. Something precisely in line with the bureaucrats’ thinking and completely opposed to the real purpose of hedge funds.

But the danger of this approach is increasing the risk of the failure of a large hedge fund manager- a lesson clearly not learnt from the bankingindustry pre 2007.

The excuse for all this regulation is the issue of systemic risk to financial markets. This is despite research showing that after LTCM this has never been a hedge fund issue. LTCM should be a lesson in itself- creating bigger and bigger hedge funds creates systemic risk.

A question I have asked Regulators many times is how they will deal with systemic risk if it is identified. One gets no answer as they have no idea as to what it really is and have no means of dealing with it if it was to develop. Rather like having a fire detection system, it can detect a fire, but there are no extinguishers.

The European hedge fund industry will have to live with AIFMD, a directive full of inconsistencies and in some instances promoting practices that are not in line with global best practices.

The sad thing is what it can do to the future. Investors will have their choice of investment products reduced as innovators are stifled. Just like the shopper who instead of a choice of fifty local cheeses will only have a couple of sanitized, tasteless and mass produced gunk approved by a non-farming faceless, over-paid bureaucrat sitting in Brussels.