EU Regulation 101
Guide to European Oversight of the Hedge Fund Industry
Hedge Fund Fundamentals | March 2014
Hedge funds play a vital role in helping a wide range of institutions – from
pensions to endowments to non-profits – meet their financial obligations.
In Europe, hedge funds oversee roughly $549 billion in assets, according
to a recent report by Preqin1.
In 2011 a new financial services regulatory structure took effect, which
included the creation of the three new European Supervisory Authorities.
This guide provides a brief overview of the European policymaking and
new regulatory structure, and provides information on several issues of
specific concern to hedges funds – and the institutions that invest in them.
1Source: Preqin, February 2013
About the European Union
The European Union (EU) is an economic and
political union of 28 Member States. The EU was
established in its current form in 1993 by the
Maastricht Treaty. The Treaty of Lisbon, the latest
amendment to the constitutional basis of the EU,
came into force in 2009.
The EU operates through a system of
supranational independent institutions.
These include the European Commission,
the Council of the European Union, the European
Council, the Court of Justice of the European
Union, and the European Central Bank. The
European Parliament is elected every five years.
According to the EU, its policy making is focused
on ensuring the free movement of people, goods,
services, and capital.
Important Institutions of the EU
The European Commission is the executive body of the European Union. The body is
responsible for proposing legislation, implementing decisions, upholding the Union’s
treaties, and the general day-to-day running of the Union.
The Council of the European Union (sometimes called the Council or the Council of
Ministers) is the legislative institution that represents the executives of member
states (the other legislative body being the European Parliament).
The European Parliament is the directly elected parliamentary institution of the EU.
Together with the Council of the European Union and the European Commission, it
exercises the legislative function of the EU.
The European Council is comprised the EU heads of state, the President of the
European Commission, and the President of the European Council. The European
Council has no formal legislative power. However, under the Treaty of Lisbon, it
defines “the general political directions and priorities" of the Union.
The European Central Bank is the EU institution that administers the monetary
policy of the 17 EU Eurozone member states. The bank was established by the Treaty
of Amsterdam in 1998, and is headquartered in Frankfurt, Germany.
Council of the
In 2009, in response to the financial crisis, the European Commission proposed a new
framework for financial supervision: The European System of Financial Supervisors
The ESFS is an institutional architecture of the EU's framework of financial supervision.
It is composed of three authorities: the European Banking Authority, the European
Insurance and Occupational Pensions Authority, and the European Securities and
European System of Financial Supervisors
European System of Financial
In January 2011, the new framework was implemented, with the EBA,
EIOPA, and ESMA taking on the responsibilities of previously existing
New Regulatory Framework
To complement this framework, there is also a European Systemic Risk
Board (ESRB). The ESRB is an independent body within the EU,
responsible for the macro-prudential oversight of the financial system
within the Union. Board Members of the ESRB include members of the
European Central Bank, National Bank Governors, and Chairs of
European Supervisory Authorities (ESAs).
European Systemic Risk Board
European Systemic Risk Board
Headquartered in Paris, ESMA is responsible for safeguarding the stability of the European Union’s
financial system by ensuring the integrity, transparency, efficiency, and orderly functioning of securities
markets, as well as enhancing investor protection. It coordinates the work of securities regulators, and
across financial sectors by working closely with the other authorities, in particular the EBA and EIOPA.
ESMA is part of the European System of Financial Supervisors (ESFS).
Headquartered in Frankfurt, EIOPA regulates certain activities of credit institutions, financial
conglomerates, investment firms, insurance and reinsurance companies, and payment institutions. It is
responsible for supporting the stability of the financial system, transparency of markets and financial
products, as well as the protection of insurance policy holders and pension members and beneficiaries.
EIOPA is part of the ESFS.
Headquartered in London, the EBA regulates European banks. The EBA has the power to overrule
national regulators, prevent regulatory arbitrage, and promote fair competition throughout the EU
Common Reporting (COREP) is the standardized reporting framework covering: credit risk, market risk,
operational risk, own fund and capital adequacy ratios. EBA is part of the ESFS.
Headquartered in Frankfurt, the ESRB is responsible for the macro-prudential oversight of the financial
system within the EU to help mitigate or prevent systemic risks to financial stability. It is charged with
contributing to the smooth functioning of the EU’s internal market and ensuring a sustainable
contribution of the financial sector to economic growth.
The New EU Regulatory Framework
ESMA is the coordinating body for EU
Member State financial regulators.
European Securities and Markets
Role and Responsibilities
ESMA is responsible for coordinating actions of securities supervisors or adopting
emergency measures when a crisis situation arises.
ESMA is responsible for helping establish and implement a single set of
financial rules across Europe. ESMA has two primary goals:
• Ensure consistent treatment of investors across the EU, providing adequate
investor protection through effective regulation and supervision.
• Promote fair and equal competition among financial service providers and
ensure effective and cost-efficient supervision of supervised companies.
According to ESMA, the organization “contributes to the financial stability of the
European Union, in the short, medium and long-term, through its contribution to the
work of the European Systemic Risk Board, which identifies potential risks to the
financial system and provides advice to diminish possible threats to the financial
stability of the Union.”
While ESMA is independent, there is full accountability to the European Parliament,
Council of the EU and European Commission.
More About ESMA’s Role
Financial regulation in the EU is governed by the Lamfalussy Framework which
established the legislative approach to securities law.
It was adopted by the EU in the final report of the Committee of Wise Men on the
Regulation of European Securities Markets (an expert committee chaired by Baron
The Lamfalussy Framework proposed a four-level approach to European securities
It first applied to the securities sector and was later extended to banking, insurance, and
The framework has been brought into compliance with the Treaty of Lisbon, which entered
into force in 2009, and the ESA and ESRB Regulations, which entered into force in 2010
and 2011, respectively.
Baron Alexandre Lamfalussy
EU Regulatory Process
There are a number of regulations currently under consideration in the EU that are
of specific interest to hedge funds. These include:
1. Alternative Investment Fund Managers Directive (AIFMD)
2. European Market Infrastructure Regulation (EMIR)
3. Short Selling Regulation
4. Review of Markets in Financial Instruments Directive (MiFID II)
5. Market Abuse Directive (MAD)
EU Regulations of Interest to
In April 2009, the European Commission proposed a Directive on Alternative Investment
Fund Managers (AIFMs) with the objective of creating a comprehensive regulatory
framework for European Alternative Investment Fund Managers.
The proposed Directive was developed to help create common regulatory standards for all
AIFMs that met specific criteria. The final agreement on the framework Directive (Level I)
was achieved in November 2010 and the text entered into force in July 2011.
The Commission asked the European Securities and Markets Authority (ESMA) to provide
technical advice on the implementing measures of the AIFMD (Level 2).
ESMA and the European Commission have continued to develop implementation
measures throughout 2013.
Member States were to have transposed the Directive and its implementing measures by
July 2013, however, at the time of publication less than half of the 28 EU Member States
have done so.
ESMA continues to develop guidelines on the AIFMD in a number of areas.
The final text of the AIFM Directive (July 2011) is here. More information on AIFMD here.
Alternative Investment Fund Managers
In September 2010, the European Commission published a proposal for a
Regulation on OTC derivatives, central counterparties (CCPs), and trade
repositories, now commonly referred to as the European Markets Infrastructure
Regulation or “EMIR.” EMIR entered into force on August 16, 2012. ESMA and
the European Commission continue to develop technical standards on
implementation. EMIR is currently in its Level 2 implementation phase, with
recent consultations coming from ESMA and other ESAs.
Notably, EMIR calls for:
• All OTC derivative contracts considered ‘eligible’, entered into between any
financial and certain non-financial counterparties (subject to conditions), will
be required to be cleared by a CCP;
• All OTC derivative contracts not considered ‘eligible’ shall be subject to risk
mitigation requirements, including the exchange of collateral or a
proportionate holding of capital;
• Counterparties to an OTC derivatives trade (cleared or not) shall report
details of that trade to a trade repository;
• CCPs shall be subject to registration and prudential and conduct of business
• Trade repositories shall be subject to conduct of business regulation.
European Market Infrastructure
In November 2011, European negotiators reached an agreement on an EU
Regulation on Short Selling and certain aspects of credit default swaps. The
regulation, which entered into force on November 1, 2012, was designed to
establish a common regulatory framework and ensure greater coordination and
consistency between Member States. Among other items, the new regulation:
1. Requires public disclosure of short positions over a certain threshold
2. Requires parties entering into a short sale to have borrowed the instruments,
entered into an agreement to borrow them, or made other arrangements to
ensure they can be borrowed in time to cover the deal.
3. Requires notification of significant positions in credit default swaps that relate to
EU sovereign debt issuers.
4. Provides competent authorities with temporary power to require greater
transparency or impose certain restrictions on short selling and credit default
Both ESMA and the European Commission were to conduct a review of the Short
Selling Regulation by the end of June 2013. ESMA released its findings on June
3, 2013; ultimately, it did not recommend significant changes to the regulation.
As of publication, the European Commission has yet to release its review of the
Short Selling Regulation. More information on EU short selling regulation can be
Short Selling Regulation
The Markets in Financial Instruments Directive (MiFID) came into force in November 2007. It
replaced and expanded the Investment Services Directive. Its objective was to increase the integration
and efficiency of EU financial markets.
MiFID established a common regulatory framework for investment services in financial instruments
across the EU and for the operation of regulated markets by market operators.
The European Commission is currently reviewing the MiFID framework. In October 2011, the European
Commission adopted proposals for (i) a revised Directive and (ii) a new Regulation (MiFIR). Both the
European Parliament and Council of the EU have approved their respective reports on the MiFID
proposal and are currently (September 2013) engaged in trialogue with the European Commission.
Between them, these proposals:
• Extend the existing regulatory framework both in terms of instruments and firms covered, so that,
for example, certain commodity trading firms will fall within scope of the regime;
• Impose regulatory requirements on firms undertaking algorithmic trading (including HFT);
• Impose position limits on the trading of commodity derivatives;
• Impose restrictions on third country firms providing services in the EU;
• Introduce enhanced corporate governance requirements for investment firms; and
• Introduce enhanced pre- and post-trade transparency provisions in respect of both equities and
More information about MiFID and MiFIR is available here.
Markets in Financial Instruments Directive
In May 2001, the European Commission proposed a directive to
address insider dealing and market manipulation within the EU. The
Market Abuse Directive (MAD) aimed to enhance the integrity of
European markets by implementing common standards throughout all
Currently (September 2013), negotiations among the European
Parliament, Council of the EU, and the European Commission are
close to finishing.
More information on MAD available here.
Market Abuse Directive (MAD)
Council of the European Union
European Securities and Market
European Banking Authority (EBA)
European Insurance and Occupational
Pensions Authority (EIOPA)
European Systemic Risk Board
European Central Bank
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