Eva Pakla^* Introduction
The 2008 financial crisis brought about a frenzy of financial regulation that has not passed over the hedge fund sector. This article assesses whether the instances of regulation implemented after the 2008 financial crisis, and in particular the 2009 European Union (EU)'s Alternative Investment Fund Managers Directive (AIFMD) and the 2010 United States (US) Dodd-Frank Act, could lead to an improvement or to a deterioration of hedge funds markets in the EU and the US. In order to do so, it analyses the new regulation in the light of history of the regulation of hedge funds in the EU, with a particular focus on the United Kingdom as this country hosts 80 per cent of hedge funds in the EU, and the US.¹

Hedge funds, arguably, were originally designed to circumvent regulation. In the first decade of the 21^st century hedge funds have taken steps towards regulating themselves. In the UK and the US (where over 80 per cent of global hedge fund activity takes place) serious self-regulatory proposals were developed by the US President's Working Group and the UK Hedge Fund Working Group in the UK in 2008. ² Were the regulations to expect any efficiency gains or any other benefits - such as international scope and flexibility? The objectives of the regulations vary: they are aimed at investor protection, systemic risk prevention and corporate governance. In effect, both of the American and the EU regulation are now based on the results of the 2009 London G20 Summit, where the parties agreed on the need to focus on regulation of hedge funds in four main areas, namely: disclosure, diversification, redemption and fund fee structures.³ This article shall analyse the regulation in the EU and in the US before the financial crisis and the legislative changes in both jurisdictions in each of the four areas after the crisis. Alleged disadvantages such as the probability of hedge fund managers avoiding the UK and/or the EU market for the reason of new laws governing them and possible advantages of the new legislation shall be discussed. Through my research I will argue that no exodus of hedge funds from UK and Europe is to be expected for reasons I discuss in the following.

At the EU level, the AIFMD⁴ is intended to fulfil the commitments made by the EU at the 2009 London G20 summit.⁵ The Directive is aimed at establishing a harmonised framework for monitoring and supervising the risks that alternative fund managers pose to their investors, to other market participants and to the stability of the financial system. According to the AIFMD, alternative funds manager shall be allowed to provide services and market funds throughout the EU single market, subject to compliance with strict requirements.⁶ The procedure of passing the recent regulation in Europe however has been very controversial. Whilst three big EU countries were in favour of stricter rules for hedge funds, the UK and the fund industry were mostly opposed to the proposed solution.⁷ Furthermore, the draft directive when approved by the EU Council of Ministers has been criticised by the media and by hedge funds lobbyists. According to some opinions the new regulations would spur hedge funds to move from the EU to non EU countries such as Switzerland.⁸

Based on the provisions of the draft directive, this article explores whether these critics and prognostics have legal and factual fundaments, and whether the new regulations could lead the deterioration of the EU hedge funds market. Similar questions are asked relating to the allegations of overregulation in the US. In order to do so, this article will first provide an overview of the essence of hedge funds, illustrating their possible beneficial and adverse effects on the financial and economic systems and thereby highlighting the need for investor protection. Next, it will critically examine the history and latest developments of the hedge fund regulation in the EU - with a focus on the UK - and the US.

Background on hedge funds
In the European context the term hedge fund does not always identify homogenous financial institutions. In some legal systems, it is used to identify investment vehicles in which the managers are allowed to operate "without limits". Such systems counter-balance this freedom by a ban on offering to the public. In other systems the term hedge fund refers to a set of investment instruments which can be offered to the public. In those cases, the manager's freedom to determine the content of the investment is very limited.

Hedge funds are defined as 'collective investment undertakings' and they, therefore, clearly differ from other types of financial investments.⁹ They can be set up both as single hedge funds and funds of hedge funds. The structural options of hedge funds in Europe are given by the Undertakings for Collective Investments in Transferable Securities (UCITS) Directive.¹⁰ The so called open-ended funds as opposed to closed-end funds allow the investors to liquidate shares on demand.¹¹ Not all legal systems within the EU allow hedge funds to act both in open-ended and closed-ended form.¹² It is commonly recognised in all EU Member States that hedge funds allow the use of sophisticated management techniques such as short selling, leverage and derivatives contracts (swaps, forwards, options, futures, etc.). ¹³

US commentators define hedge funds broadly as professionally managed pools of assets which are used to invest and trade in equity securities, fixed-income securities, derivatives, futures and other financial instruments.¹⁴ Some commentators generally suggest defining hedge funds by common traits, such as that most of them do not show versatility or by distinction from other institutional investors. Further common characteristics are:

- Short selling: Hedge funds take long and short positions in stocks in order to mitigate market risk, allowing absolute returns independently from the market moves. In effect, Alfred Winslow Jones - who attributes to himself the invention of hedge funds - created the novel idea which consists in taking as many short positions as long positions. This allows the fund to make money in any case, as long as it has chosen the correct stocks.¹⁵

- Leverage: Hedge funds often buy securities using borrowed money or purchase derivatives in which not the full economic position, but only the margin is supported.

- Activity level: Hedge funds show a higher level of activity than other funds.¹⁶ They are typically short term investors. For many funds, a "long-term" investment is keeping securities for a whole day. ¹⁷

- Fee structure: most hedge funds compensate their portfolio managers by periodic fees calculated as a percentage of assets managed and by performance or incentive fees or allocations. The asset-based fee is calculated at an annual rate of one to two percent of the assets managed. The performance or incentive fee or allocation is usually calculated as 20 per cent of profits above a high water mark.¹⁸

In the past decades various bodies identified advantageous effects of hedge funds on the economies. The former UK Economic Secretary to the Treasury, Ed Balls, mentioned the following beneficial effects of hedge funds: providing liquidity to companies and markets, helping markets to price assets more accurately and driving financial innovation.¹⁹ In the opinion of the former Chairman of the Federal Reserve, Alan Greenspan,²⁰ the beneficial effect of providing liquidity by the hedge funds could be negatively influenced by the over-regulation of hedge funds. This would have a large negative effect on the markets.²¹

Surveys conducted at EU level have demonstrated that private equity firms, such as hedge funds, invested billions of Euros in renewable energy projects across the continent in the second half of the first decade of the 21^st century, helping in this way the EU to meet its environmental targets. In 2008 alone, private equity firms in the EU invested €51 billion in European companies providing so liquidity to the markets. In 2009 the private equity industry was estimated to hold worldwide over US$1trillion of not invested capital. Such figures constitute a huge potential to provide companies with the capital they need (especially since the credit crunch).²²

The US and UK regulations require the investors to be in some way sophisticated.²³ It's both a legal term and a commonly used description, both of which are subject to interpretation. A sophisticated investor is one of several categories of investors the Securities and Exchange Commission established to limit access to certain harder-to-understand products in the US. The equivalent terms created by the UK regulator FSA are eligible counterparties or professional clients,²⁴ the latter defined as 'individuals with financial expertise, and high net worth'.²⁵ Sophisticated investors, according the SEC's definition, have enough understanding and experience in business matters to evaluate the risks and merits of an investment. The SEC exempts small companies from notifying of sales of certain securities to these investors. Some investment vehicles, including certain types of hedge funds, require investors to meet a still higher threshold for the SEC investor category of qualified purchasers. According to SEC rules, this category includes individuals who own investments valued at US$5 million or more.²⁶ The expectation is that a sophisticated investor can afford the high fees that must be paid and is able to understand the riskiness and complexity of his investment.

The recently increased retailization of hedge funds makes the notion of a sophisticated investor less clear. Regulators are concerned about the increasing cases of individual unsophisticated investors to be exposed to investors in hedge funds, sometimes without their knowledge. Thus, pension funds which invest in the hedge funds are not unsophisticated but their beneficiaries are likely to be unsophisticated.²⁷

The US legislation also applies the definition of an accredited investor.²⁸ Under the Securities Exchange Act 1933 investors whose net worth was bigger than US$1 million or whose income exceeds US$200,000 qualify as accredited investors. The new US Non-admitted and Reinsurance Reform Act 2010²⁹ upholds these limits but prohibits including a primary residence in net worth calculations.³⁰ The definition is not linked to inflation, and has not been adjusted since 1982. This means that millions of individuals could now qualify as an accredited investor.³¹

One of the objectives of hedge fund regulation is, therefore, investor protection.³² That might have gained importance because the proportion of investments by institutional investors has increased substantially. Between 1996 and 2004 pension funds increased their share of capital in hedge funds from 5% to 15%. In 2006 the San Diego Country Employees Retirement Association had US$175 million of its US$7.7 billion of assets invested in the hedge fund Amaranth,³³ which collapsed causing a loss of a billion of dollars.³⁴ The San Diego pension fund then brought a suit against Amaranth, claiming that it incurred unexpected 'excessive and unbridled speculation in natural gas futures'.³⁵ Up to 2008 the hedge funds in the US and in the UK developed proposals for self regulatory measures.

1. Historical overview of the EU regulations of hedge funds
In the past a fragmented regulatory panorama of hedge funds was the case in Europe as hedge fund legislation was made by the Member States at the national level. In the pre-crisis period, however, various institutions and organisations launched various non-binding documents aiming to regulate hedge funds:

• the European Parliament's Purvis Report³⁶
• the post-FSAP³⁷ Report on Asset Management³⁸
• the CESR³⁹ 's mandate for the Asset Management Experts Group⁴⁰
• the IOSCO report on 'Issues Arising from the Participation of Retail Investors in Hedge Funds'⁴¹
• Article 2 of Directive 2001/108/EC (amending the UCITS directive 85/611 on investments) requires the European Commission to prepare a report aimed, inter alia, at 'review(ing) the scope of the Directive in terms of how it applies to different types of products', including hedge funds.

Indeed, a survey published in 2005 revealed a certain level of a 'de facto harmonisation' between various EU states.⁴² Remaining inconsistencies detected at that stage were: a minimum level of underwriting for purchasing shares in the hedge fund was not always specified; the maximum number of participants in the fund was not always set, some countries allowed hedge funds to deal directly with the retail sector, other prohibited distribution amongst the general public.⁴³ Some of the activities of hedge funds were subject to EU legislation, notably to the Markets in Financial Instruments Directive (MiFID), the Transparency directive and to the Market Abuse Directive. Besides, according to the Regulation ECB/2007/8 of 27 July 2007 concerning statistics on the assets and liabilities of investment funds, the European Central Bank (ECB) was entitled to collect some prudential reporting from fund supervisors.⁴⁴ The Regulation set out that all investment funds in the EU, including hedge funds, had to notify certain information to national central banks.⁴⁵ In some Member States hedge fund managers as such were subject to regulation.⁴⁶ Other member states, such as France, Italy, Spain and Germany, regulated the fund itself as an onshore vehicle, even though it was domiciled in a third country.⁴⁷

The private equity sector and the hedge fund industry contributed around €9 billion in tax revenues to the EU economy in 2008.⁴⁸ After the credit crunch, at the G20 summit in London on April 2, 2009, the Heads of State and Government affirmed their commitment to strengthen the regulation and transparency of the financial sector, as well as the accountability of the players that compose it. The High-Level Group on EU Financial Supervision launched the the Larosière Report which attributed the systemic failure to the lack of regulation.⁴⁹ The Heads of State and Government announced that all financial institutions, products and markets of systemic importance shall be subject to an appropriate level of supervision and regulation. The first measures to meet this objective were developed by the end of 2009.⁵⁰
The EU Commission, inter alia, launched proposals for the regulation of hedge funds.⁵¹ On April 28 2009 the European Commission published the draft of a Directive on 'alternative' fund managers (Alternative Investment Fund Managers, or AIFM). The draft reflected the Commission's wish to implement a device for regulating and supervising the activities of these funds.

The Commission proposed to regulate managers rather than funds, although the Directive would have an impact on both. The draft directive provided for only AIFMs established in the EU being able to provide their services and sell their funds to investors within the EU. Accordingly, it would be irrelevant whether the fund is established in the EU or not. Hedge funds managers would have to be authorised by the regulatory body of the EU country where they are based. Once a manager would be authorised by his home regulator, he could trade his funds in all EU countries ('passporting provision'). Managers established outside the EU would be prohibited from selling their funds throughout the EU. Managers who are established in the EU, but run funds based outside the EU would be subject to additional restrictions. The Directive would be mandatory only for AIFMs whose funds hold €100 million or above. AIFMs whose funds hold less than this threshold can still voluntarily 'opt in' and become subject to the Directive. This means that they could take advantage of the passporting provision but at the same time be subject to all the other rules of the Directive.

The draft set out that managers will be required to provide more detailed information about their activities and their organisation to both investors and regulators. A range of rules also set out how AIFMs should operate and be organised. In particular it provided for all funds marketed in Europe to deposit their cash and assets with an EU based bank; for an obligation of the manager to hold a permanent capital reserve; and, as another example, for limitations for the managers outsourcing certain responsibilities to other companies. It also proposed to regulate certain investment strategies and techniques that managers employ. Furthermore, the European Commission would be allowed to dictate limits on how much fund managers would be allowed to borrow.

In its final version, the AIFMD empowers the Member States to set out and ensure leverage limits on each AIF managed under its jurisdiction.⁵² For corporate governance activities of hedge fund managers, such as buying up companies, a series of disclosure and reporting requirements would apply.⁵³ The final version of the EU AIFMD was published on 1 July 2011. The AIFMD particularly provides for a harmonised regime for the authorisation of EU AIFM.⁵⁴ The scope of the Directive is broad; it captures the management of alternative investment funds or AIF, ie most vehicles that would be regarded as funds, as well as vehicles that would usually not be described as a fund.⁵⁵ The Directive, further, sets out common transparency requirements to regulators and investors - common operational requirements (delegation, valuation and custody of fund assets) and a new marketing regime for EU and non-EU AIF, whether marketed by EU AIFM or non EU AIFM.⁵⁶ Non-EU AIFM shall obtain an appropriate authorisation and nominate a representative in the Member State of reference⁵⁷ .

Exemptions from the authorisation cover: holding companies, securitisation special purpose vehicles (SPVs), supranational organisations, public bodies and employee participation schemes. Partial exemptions exist under the Directive for AIFMs who manage AIF with assets of €100 million or less, or with assets of €500 million or less, where AIF are not leveraged and no redemption rights exist within first five years following first investment in the AIF. Investment firms and banks are not required to seek additional authorisations to manage AIF. The Directive sets out capital requirements: external AIFM need an initial capital of at least €125,000; internally appointed AIFM would need an initial capital of at least €300,000. Where assets managed by the AIFM exceed €250 million, the capital requirement is €125,000 plus 0.02% of assets under management (AUM) in excess of €250 million.⁵⁸ The capital requirement cannot exceed €10 million in total.⁵⁹ Another area covered by the AIFMD is the AIFM conduct of business. The Directive prohibits a preferential treatment of investors, unless it is disclosed.⁶⁰

The remuneration policy of an AIF is required to be consistent with the effective risk management. Its assessment of performance must be linked to life-cycle of the AIF in question. Guaranteed bonuses are only permitted for new staff and only for one year period. Furthermore, an appropriate balance between fixed and variable remuneration is required: at least 50% of variable remuneration must consist in shares in the AIF in question and at least 40% of the variable remuneration must be deferred for an appropriate period.⁶¹ The risk management functions must be functionally separate from other activities. The risk monitoring process is required to be documented. The Directive also provides for a documented due diligence process when investing on behalf of the AIF and an AIFM is required to set a maximum leverage per AIF managed.⁶² The Directive sets out requirements of consistent investment strategy, liquidity profile and redemption policy. Procedure requirements are introduced to enable monitoring of the liquidity risk per each AIF managed.⁶³

The AIFMD has been criticised under several points of view. To begin with, in order to accomplish the provisions of the Directive AIFMs will have to face high costs. This might cause a decrease of investment in European firms and make Europe less attractive place for investors and talent from around the world and so reduce EU's competitiveness. Furthermore, investors would no longer be able to select freely the best performing funds and managers around the world. The above mentioned survey from 2009 has shown that more than 84 per cent of all hedge fund managed by EU-based managers are domiciled outside the EU. Furthermore, 80 per cent of hedge fund managers worldwide are based in non-EU countries. Those were alleged to be banned by the new Directive from the European market by the draft directive's provisions.⁶⁴ The final version of the Directive, nevertheless, allows non EU managers to trade EU and non EU funds within the EU under certain requirements. The Funds' activism under the AIFMD lacks any kind of surprise effect, necessary for the funds effectiveness, due to the disclosure requirements. This is likely to protect the companies but also to deteriorate the aspect of fund activism in the EU. The role of depositories, intended to protect investors, is likely to make hedge fund services more expensive, as they will pay fees to the depositaries for their services.

In the UK the primary regulatory body for hedge funds is the Financial Services Authority (FSA). It was found in 1997 resulting from a merger of various previously independent regulatory groups. The FSA moved from a very positive stance towards hedge funds to a precautious position. In some occasions it has, nevertheless, stressed the benefits that hedge funds bring to the UK economy.⁶⁵ The hedge fund products are classified in the UK as unregulated collective investment schemes. It means that they may not be marketed to the general public and that they can be traded to private customers in certain restricted circumstances. Hedge funds may only trade with persons that are classified by the FSA as eligible counterparties or professional clients,⁶⁶ the latter defined as 'individuals with financial expertise, and high net worth'.⁶⁷

The FSA also acts as a regulatory body for UK-based hedge fund managers themselves. According to the Financial Services and Markets Act 2000, UK based hedge fund managers activities are 'regulated activities' and must see authorisation to do so. The FSA admits that it is not territorially able to regulate the 'systems and controls of the underlying hedge funds' and that it rather intends to direct its regulation at the managers of hedge funds. It therefore focuses on the resources and competence to manage the assets of funds in line with its mandates from the operators of the underlying fund. That requires adequate interfaces with the Prime Broker and Administrator of the fund for reconciliation purposes, and appropriate information systems for pricing and other market information. A hedge fund also needs an adequate internal accounting system to ensure ongoing compliance with its financial resources requirement.⁶⁸

In its 2002 publication with the title 'FSA and the Hedge Funds' FSA recognised that the low regulatory burden, coupled with the fact that so many 'wholesale investors' are based in London, attracted managers to be based in the UK, and that their presence contributed to the strength of the UK markets.⁶⁹ FSA at that stage classified hedge funds as 'low impact' actors in its risk-based approach to regulation.⁷⁰ Even though the FSA noted at that occasion that apart from regular monitoring there was no need of regulation, it for the first time admitted the need of a global "industry-led...Code of Conduct".⁷¹ Every entity regulated by the FSA must follow its Principles for Business. In 2006 the application of the Principles to hedge fund managers was discussed for the first time.⁷² Since 2006 the FSA has supported the International Organisation of Securities Commissions (IOSCO) in developing Principles for the Valuation of Hedge Fund Portfolios.

In 2007 the FSA visited a number of hedge fund managers to review the control measures they implemented to mitigate the risk of market abuse.⁷³ It also launched a 'formal assessment of the systems hedge fund managers use to prevent market abuse after being disappointed by the quality of controls at some firms it visited.⁷⁴ In the same year, furthermore, it also initiated a consultation entitled Disclosure of Contracts for Difference.⁷⁵ A contract for difference is a 'derivative product that gives the holder an economic exposure...to the change in price of a specific share'.⁷⁶ These kinds of contract enable hedge funds to gain large economic exposure to the price of stock without having to disclose their interest. The disclosure laws in the UK are related to the voting interests, but hedge funds have proven to be able to exert power over investee companies without such voting interests.⁷⁷

When the credit crunch hit the global financial markets in 2007, the FSA did not see hedge funds as a part of the problem. As the former FSA's Chief Executive Hector Sants stated, hedge funds were not 'the catalyst or the drivers' of the credit crunch events.⁷⁸ As a continuation of its development of self-regulation policies for hedge funds and, independently from the ongoing crisis, in July 2007 a group of 14 UK-based hedge funds named the Hedge Fund Working Group (HFWG) committed itself to establish a set of best practice standards for the hedge fund industry.⁷⁹ In 2007, the HFWG published a Consultation Document seeking input from the industry. Based on the comments to the Consultation Document, the Final Report of the HFWG was published in January 2008. It established the Hedge Fund Standards Board (HFSB). The Board was meant to be responsible for maintaining and updating the standards as well as enabling hedge funds to sign up to the standards. The final report recognised the growing importance of hedge funds and the necessity, them to assume responsibilities consistent with their standing.⁸⁰

The FSA Principles apply to the 21 per cent of global hedge fund managers who are located in the UK. The FSA principles comprise 11 very general points. They are not specifically designed for hedge funds, but rather for any entity regulated by the FSA. The Final Report contains 28 Standards which cover different areas of hedge fund regulation. The HFWG Standards are the best-practice standards for hedge fund managers. Hedge fund managers can sign-up and become signatories to the Standards. If they do so, they must adopt a 'comply or explain approach'.⁸¹ None of the Standards is mandatory for any of the signatories. The Standards are intended to encourage disclosure and the explain option does not discourage from disclosure, even if the manager cannot follow the particular Standard precisely. The explain option allows firms to adapt without needing constantly to change the Standards.⁸² The same option also enables managers to enjoy the prestigious status of a signatory (a voluntary selfregulatory organisation (SRO), while not having to follow all or indeed any of the Standards in their totality. ⁸³ HFWG states that managers would be incentivized to conform as all the 'Standards are based on enlightened self-interest'.⁸⁴ Conformity by the managers would, therefore, add value to them and cause the potential investors to have more confidence in them and in the hedge funds as a whole. The market would at the same time put pressure on those managers who have not yet become SROs to sign the HFWG Standards. Full compliance with the Standards does not guarantee the FSA would find no violation of its Principles. The FSA Principles can be seen as 'minimum standards' and the HFWG Standards are best-practice policies.⁸⁵ As mentioned above, the new AIFMD should be implemented in UK by 2013.

Historical overview on the regulation governing hedge funds in the US
Prior to the introduction of the Dodd'Frank Act, there were four key pieces of legislation which might have been applicable to hedge funds.⁸⁶ The requirements of the pieces of legislation were overlapping. They primarily covered the number of investors, the type of investors, and the way investors are solicited.⁸⁷ Thus, under the previous legislation, hedge funds in many cases fell into various exceptions. Hedge funds also intentionally used specific structures to avoid the more stringent regulation under each piece of legislation. ⁸⁸ The relevant pieces of legislation are listed as follows:

Securities Act of 1933
The objectives of the regulation under the 1933 Act are to ensure that investors receive material information concerning securities that are available for public sale, and to avoid fraud and deceit in the sale of securities.⁸⁹ Hedge funds are structured to fall within section 4(2) of the Act. This section exempts the highly detailed disclosure requirements for 'transactions by an issuer not involving any public offering'.⁹⁰ Rule 506 of Regulation D defines the safe harbour requirements to fall within this exemption for transactions not involving any public offering. Hedge funds must not sell to more than 35 investors who are not accredited.⁹¹ Hedge funds also must not advertise or solicit the purchase of interests in the fund and must take reasonable steps to ensure that their investors do not plan to sell their interests.⁹²

Securities Exchange Act of 1934
The 1934 Act provides for strict registration and disclosure requirements for dealers in securities.⁹³ Hedge fund managers sought, therefore, to avoid being registered as broker-dealers under Section 15 of the Act. Their objective was to be deemed to trade securities for their own account (not as part of a business) and this way to fall within the trader exception. In order to avoid regulation under Section 15 hedge funds had to ensure they have less than 500 interest holders or less than US$10 million of assets.

Investment Company Act of 1940
The Investment Company Act requires entities which fall within the scope of its regulation to register with the Securities and Exchange Commission (SEC) and comply with the regulatory and its disclosure requirements. Two exceptions were previously applicable with hedge funds. Under section 3(c) of the Act, an entity is exempt from the rule if it either has less than 100 private investors or the investments are owned by qualified purchasers. A qualified purchaser is an individual person with more than US$5 million of investments.

Investment Advisers Act of 1940
Under this Act, the SEC may conduct unannounced searches with investment advisers acceding their books and records, limits on the performance fees that may be charged and further filings and disclosure. Hedge fund managers fall within the broad scope of the Act, due to the fact that they advise clients regarding investment opportunities. However, the Act provides for a private advisor exemption.⁹⁴ Hedge fund managers did not fall into its regulation if they 'had fewer than fifteen clients' in the proceeding 12 months, did 'not hold themselves out generally to the public as an investment adviser' and did not act as an 'investment adviser to any registered investment company'.⁹⁵ For purposes of this act, the clients of the investment manager were deemed to be the individual hedge funds. The funds were organized as a limited partnership, with each investor investing as limited partners, and the fund manager serving as the general partner.⁹⁶

The Dodd-Frank Act 2010 has generated the greatest impact within the recent developments related to hedge funds in the US.⁹⁷ To begin with the Act changes the registration policies of the hedge funds. The registered advisors are also subject to a strict disclosure and reporting regime. Both strategies and portfolios are required to be disclosed to the government. The Act confers on the Federal Reserve and the Financial Stability Oversight Council (FSOC) the power to regulate systematically financial institutions which could also be hedge funds.⁹⁸ The new regulation eliminates the above-mentioned fewer than 15 clients exemption.⁹⁹ The Act introduces a definition of a private fund, a term that is meant to include hedge fund. At the same time the Act distinguishes between the investment advisors and the fund they manage. Such arbitrary use of the terminology needs to be clarified.¹⁰⁰ According to the Dodd-Frank Act, investment advisers are required to register as investment advisers with the SEC. Larger fund managers, previously not required to register, will now have to register and smaller fund managers that are registered may need to de-register (subjecting them in most instances to a patchwork of state investment adviser regulation).¹⁰¹

The new regime also provides for periodic reporting on proprietary information requirements to the government. The Act also confers broad powers upon the Federal Reserve and FSOC to regulate 'significant financial firms', a term that could include certain large hedge funds. The powers include the ability to impose capital requirements and even to intercede in the actual business affairs. Hedge funds that enter into a significant volume of swaps may be required to register with either or both - the SEC and the CFTC¹⁰² as 'major swap participants (Swaps)'. Furthermore the Dodd-Frank Act's treatment of many Swaps as futures will cause many funds to be considered commodity pools, and thus they may be required to register with the CFTC as 'commodity pool operators' or 'commodity trading advisors'.¹⁰³

Conclusion
The present period is apparently an age of overregulation. Legislators prefer to have overlapping and unclear rules (as it might be in the US) than no rules at all. At the same time it is the age of complexity. Such comments could tend to give a simplified view of the situation. The race to the bottom - i.e. to the US standards - which was feared by the UK during the negotiations on the AIFMD was unwarranted. In fact, by passing the 2010 Dodd-frank Act the US has also introduced stringent measures to regulate hedge funds.

In Europe, it is arguable that the AIFM Directive could make life easier to non-EU funds in future. If ESMA¹⁰⁴ reports favourably on the functioning of this passporting system (the report is expected during 2015), it may be extended to non-EU fund managers to passport their non-EU AIFs throughout the European Union.¹⁰⁵ The extension of the passporting system on the non-EU AIFM would mean that they would have to seek approval only once to market to European investors, rather than from each different country.

In view of the improvements mentioned above such as the reinforced disclosure to investors and to the regulators in both core markets of the hedge funds the EU (and UK) and the US and possible future advantages to non-EU hedge funds, it is argued that no exodus of non EU funds managers is to be expected in Europe. As long as Europe remains an interesting market it is to be expected that hedge funds will continue to trade within Europe regardless of the new regulation. The cost of the implementation of new laws would of course throw its shadow on the attractiveness of the European market. Further overregulation, therefore might effectively endanger the liquidity supply by the hedge funds to the European markets. While the hedge fund industry has not yet been destroyed by the new rush of regulation, the balance which once was believed to be created by the markets themself (or by Adam Smith's invisible hand) is today believed to be secured by normative regulation.¹⁰⁶