George Osborne heads for defeat on EU hedge funds regulation

George Osborne will tomorrow be forced to accept tougher regulations on the UK's highly profitable hedge fund industry as European leaders press ahead with plans to crack down on the sector. On his first visit to Brussels as chancellor, Osborne had hoped to resist plans which he and his predecessor Alistair Darling were strongly against. But after months of threats and deliberations, French, German and Spanish leaders within the EU are expected to push ahead with a directive which is aimed at clamping down on speculators who they believe contributed to the global credit crunch and more recently pushed Greece to the brink of collapse. In another attempt to stop market jitters, financial services commissioner Michel Barnier promised to deal "very severely" with the use of credit default swaps, the instruments that investors buy to protect themselves against a potential default, but were used to bet against a country's ability to pay its debts. Barnier said: "These people don't like to come out in the light of day. We are going to flood them with light." This regulation will be proposed in October – after the hedge fund and private equity directive has been agreed by finance ministers, the European parliament and the commission, a process that may take three months. Under the new rules, hedge funds will be forced to hold more capital and non-European hedge funds will have to gain a "passport" to operate within the EU. "We will approve regulation on hedge funds – I think this will all contribute to more stability," Spain's finance minister Elena Salgado said . Britain has strongly opposed the plans as it hosts about 80% of the European hedge fund industry, which contributes £5.3bn in tax revenues to the UK economy every year, according to the thinktank Open Europe. "Forcing through the directive could cause serious damage to the UK's economy and jeopardise billions in funding to developing countries," the thinktank said. The move would also be a blow to Osborne and his colleagues in the coalition government, Open Europe said. "The decision is being taken by the bloc's finance ministers only one week after the new UK government has taken office, leaving it virtually no room to prepare for the negotiations," the think tank said. Former prime minister Gordon Brown managed to persuade Spanish prime minister José Luis Rodríguez Zapatero to withdraw the vote at the last Ecofin meeting , but a similar plea, on Friday, by George Osborne, the new chancellor, was to no avail. European Union leaders, facing the worst crisis in the EU since the euro was created a decade ago, are now in a rush. The new directive comes as the single currency dropped to its lowest level against the US dollar in four years as weaker economies in the zone continue to come under pressure on the markets. However, hedge funds deny any wrong-doing and say they only profit from volatility created by politicians' mishandling of the economy. "Markets are markets – hysterical, schizophrenic, paranoid, whatever you want – but politicians live in a dreamland," said a hedge fund manager. "Politicians have spent everything they wanted over the past few years, and now they can't spend less, when they need it – so they are prisoners of the markets." Hedge funds and other financial institutions have enjoyed a year of market volatility – and trading opportunities – while politicians were deliberating how to punish them. The axe is now out – and the first consequences are being felt. Man Group, the biggest publicly traded fund manager, based in London, agreed to buy rival hedge fund GLG Partners, also based in London, to expand its product offer.Although the merger had been planned for a long time, more consolidation is expected as the industry weathers the effects of tougher regulation and higher costs, said Peter Clarke, chief executive of MAN Group. "It makes the competitive environment quite tough," Clarke said in a conference call. "Some people will have to decide whether they're out of Europe or in -the barriers of entry will be much higher." European leaders also blame hedge funds for causing trouble for smaller companies: activist hedge funds, in the past, have bought the debt of a troubled company, only to boycott a debt restructuring deal in order to gain control of the assets and sell them at a hefty profit. Activist hedge funds argue they push beleaguered companies into efficiency and much-needed change. The global hedge fund industry, mostly based in London and New York, manages about $2tn in assets. In Britain, it employs 10,000 professionals directly and 30,000 service providers, such as lawyers and accountants, indirectly.