The article’s main concern is to determine the extent to which European regulation
can fulﬁl what is allegedly its main purpose, namely, ensuring that HFs are managed
so that they do not become sources of instability for the ﬁnancial system as a whole,
that is, systemic instability. HFs operate on the basis of leverage, that is, their invest-
ments are ﬁnanced not only by the capital contributed by their investors but also by
borrowed money that supplements that capital. Depending on the strategy pursued
by individual HF managers, those borrowings can range from one or two times to many
multiples of the fund’s capital.
The instruments discussed in this article recognise that HFs’use of leverage can result
in ﬁnancial instability. In particular, the AIFM Directive explicitly justiﬁes its regula-
tion of HF managers by reference to ‘effective monitoring of systemic risk’
that HFs’use of leverage means that they may ‘under certain conditions…contribute to
the build-up of systemic risk or disorderly markets’.
Similarly, the SFT Regulation is
intended ‘to enhance ﬁnancial stability’through the imposition of uniform transparency
rules on the securities ﬁnancing transactions that, inter alia, provide HFs with much of
But does this acknowledgment of the risks inherent in the way HFs op-
erate translate into an effective regulatory framework?
Many argue that the two legal instruments considered in this article mark a paradig-
matic shift, a bold intervention that limits the economic freedom of HFs and that will
reduce the danger that HFs will pose a threat to systemic stability. In particular, it
has been claimed that there was ‘a genuine willingness on the part of British political
and regulatory chiefs to engage in a quite fundamental reappraisal of the State’s role’
and that the AIFM Directive is the product not only of political compromise but also
of ‘a principled, intellectually-grounded move away from formerly orthodox beliefs in
the self-correcting effects of markets’.
Other observers are more sceptical of whether
there has been a real change of heart on the part of the British authorities and instead
claim that the move away from the belief in self-regulating ﬁnancial markets results
from ‘market-shaping’Member States, such as France and Germany, prevailing over
‘market-making’Member States, such as the UK. This new balance of regulatory
power has ‘partly affected…national regulatory approaches and the prevailing para-
digm in the EU’, even though it does not amount to ‘a fully-ﬂedged paradigm shift’.
This article takes a rather different position. It shows that the assumption shared by
ﬁnancial economists and ﬁnancial regulators before the crisis, namely, that ﬁnancial
markets can, for the most part, be left to regulate themselves, still casts a long shadow
AIFM Directive, above n. 2, preamble, §88.
Ibid., preamble, §49.
See above n. 2, §§5 and 6.
E. Ferran, ‘The Regulation of Hedge Funds and Private Equity: A Case Study in the Development of the
EU’s Regulatory Response to the Financial Crisis’,University of Cambridge Faculty of Law Working Paper
No 10/2011 (February 2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1762119,
at 17. Fioretos offers a similar appraisal of the regulatory regime drawn up by the G20 in 2009, which,
as will be shown next, strongly inﬂuenced the AIFM Directive, claiming that it ‘represents an important
shift in how the world’s large economies regulate the prudential risks associated with hedge funds’. See
O. Fioretos, ‘Capitalist Diversity and the International Regulation of Hedge Funds’(2010) 17 Review of In-
ternational Political Economy 696–723, at 700.
L. Quaglia, ‘The “Old”and “New”Political Economy of Hedge Fund Regulation in the European Union’
(2011) 34(4) West European Politics 665–82, at 678
Regulating Hedge Funds for Systemic StabilityNovember 2015
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