Disharmony hits EU

Fighting back

Hedge funds prepare to battle Brussels

“Far better it is to dare mighty things, to win glorious triumphs, even though checked by failure, than to rank with those poor spirits who neither enjoy nor suffer much because they live in the grey twilight that knows neither victory nor defeat.”
Theodore Roosevelt (1858-1919)

As Croatia contemplates membership of the European Union this month, many citizens in the 27 other member states are wondering why they ever joined. While the UK’s ambivalence with the EU is well known, the fact that others in the exclusive club are less enamoured of the European goals is only now becoming apparent.

One cause of the disharmony has been the prolonged and stubborn insistence of EU leaders to push for austerity rather than prosperity (or at least a bit of growth stimulus). The EU leadership should realise something is going horribly wrong when both the German and French populations start questioning the wisdom of the club.

This is not good. The EU may be a flawed concept but it is one worth pursuing, if only for the benefits of a single market, the one idea that even sceptics in the UK cherish. European leaders need to start taking the dissent seriously and address some of the issues that could in the long term tear the group apart.

Having successfully averted full-scale meltdown with the various eurozone bailouts, it would be very silly of Europe’s politicians to fail to read the signs of revolt.

At the heart of the problem are two things: a lack of democratic accountability and an overzealous love of rulemaking unmatched by expertise in those areas. The challenge of making the union more responsive and accountable to its collective population is a tricky one that has bedevilled the organisation from the start. The problem of making rules that are ill thought-out, if not plain silly, should be one the politicians and bureaucrats should be able to tackle relatively easily. Or so one would hope.

Ever since the concept of harmonisation was first aired, the EU has been in trouble. The idealists want a homogenous Europe. The truth is that the EU is a collection not only of 27 individual countries with distinct histories and cultures but within those countries are even more traditions, disagreements, prejudices and pride.

The latest folly of this desire to impose uniformity on even just a subset of members is, thankfully, about to backfire. The financial transaction tax (FTT) aka Tobin tax, is causing a lot of consternation. The tax, which even James Tobin (if he were still alive), would certainly condemn, is a prime example of how wrong-headed policies can quickly get out of hand.

Tobin’s original idea was a tax to penalise short-term currency speculation. The EU’s FTT, also sometimes known as ‘Robin Hood tax’, intends to impose a fee every time a person or business buys or sells a share, bond, futures contract, options contract or any of commonly traded financial instruments in any of the 11 eurozone countries that intend to impose the tax. France and Italy have already done so. Italy’s implementation was particularly damaging.

Sanity may yet prevail. While Brussels argues, with typical wrong-headedness, that the UK has its own version of the tax and so should not be complaining, it has missed the point. The stamp duty, imposed first in England in 1694, has been absorbed by the market and is a fairly logical and easy to collect tax. The EU’s FTT extends extraterritoriality limits that make even the US government’s eyes water.

Talk of the tax has so far failed to cause too much of a stir in the hedge funds community. One can only assume this is because the industry is still shell-shocked by the total chaos the alternative investment fund managers (AIFM) directive has caused and is continuing to cause. (Another great example of a political idea expressed through law without anyone writing the law having the least idea of what they were trying to regulate.)

The FTT could be disastrous for European-focused strategies. Judging by the fiasco caused by Italy’s imposition of the tax and fears that widespread taxation could simply dry up the fairly anaemic liquidity in markets, hedge funds may be right to adopt a more wait-and-see attitude than plunge into the fray, demanding total withdrawal of the tax.

The European hedge fund community is also preoccupied with the impending AIFM directive’s implementation, even though many crucial parts of the legislation are unclear and confusing not only to the industry but to the regulators.

All this comes as Europe’s hedge funds are just getting back to a semblance of prosperity following 2008. There is a growing optimism within the sector, born of improved performance in 2012 and a fairly benign start to 2013. Although launches are still down, there continue to be a few brave souls willing to risk their fortunes. Many believe it is only a matter of time before Europe’s pension fund community wakes up and sees the return potential of hedge funds. The more optimistic think the AIFM directive will give institutional investors a particular push in the direction of alternatives.

Nevertheless, despite the EU’s attempts to beat the industry into submission, it continues to thrive. While the AIFM directive may in the short term make funds based outside the EU pause before committing themselves to a European base or even push them out of the region, the unlocking of pension fund money could eventually bring them back.

It is still too early to tell what will happen in the long term, but it is clear that no matter what is thrown at it, the hedge fund community is determined to continue to prosper and grow.

Humankind cannot stand very much reality.
TS Eliot (1888–1965)

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