By Ellen Kelleher in London, Financial Times

Radical reforms from Brussels that recast the way alternative funds are sold across Europe are catching hedge fund and private equity managers off balance.

Starting as early as July, the Alternative Investment Fund Managers Directive (known in industry argot as the AIFMD) will disrupt how most alternative investment funds work in the EU by subjecting them to a diet of regulations and streamlining the way they are distributed across 27 countries.

The hope is that the AIFMD will curb the buccaneering ways in which hedge funds, private equity funds and real estate funds operate in Europe.

The arrival of the rules puts the alternatives fund industry in a tight spot. European managers must rush to meet detailed regulations and name a depositary that will assume responsibility for the loss of their funds’ assets while non-European rivals in the Cayman Islands and New York weigh whether setting up a European base is worth the cost.

“If you’re the manager of an unregulated fund, you’re going to have a depositary for the fund. You’re also going to have to comply with all of these detailed policies and procedures, some of which aren’t new,” says John Everett, a principal with Bovill, a regulatory consultancy.

“You’d have to comply with a lot of regulatory reporting you don’t have to at the moment.”

On the list of requirements are procedures to reduce malpractice, remuneration restrictions, strict due diligence in the monitoring of investments, and rules on settling trades.

And the paperwork required to meet the regulations is daunting. “There’s a mass of practical work involved, simply on the narrow point of regulatory reporting,” says Julie Patterson, director of funds at the Investment Management Association (IMA), the UK fund body.

The rules will be stricter for European managers, with more than €100m in assets, than for those in the US or the Caymans scouting for investors in the UK or on the continent. And until at least 2015, non-EU fund managers will not be able to sign up for the AIFMD and must keep dealing with private placement regimes. But industry watchers warn that establishing parallel sets of requirements is confusing and unfair.

“When one starts talking about a non-EU fund manager or an EU fund manager, the question of who is the alternative investment fund manager makes a major difference both in terms of the manner of distribution but also for things like regulatory reporting,” says Ms Patterson.

Tellingly, the push to encourage alternative funds to embrace transparency is taking place the world over, even in certain offshore havens. And the introduction of the AIFMD coincides with the Cayman Islands breaking with decades of secrecy by opening thousands of companies and hedge funds domiciled there to greater scrutiny. Whether this levelling of the playing field spurs offshore managers to come onshore remains to be seen.

The AIFMD also kicks off another battle between the domiciles, with Luxembourg and Ireland, the two biggest fund centres, fighting it out to gain business in its wake.

These days, Ireland positions itself as a sponsor of a liberal regime where non-Ucits funds face fewer requirements. And the Central Bank of Ireland will accept applications for alternative fund managers seeking authorisation under the AIFM directive from the start of the second quarter.

Luxembourg is also eager to draw business from alternatives managers looking to establish a presence in Europe, and industry types there say the domicile is keen to exploit its expertise in passporting gleaned from its experiences with Ucits passports – introduced in 1988.

“We see this as a big opportunity,” says Anouk Agnes, director of business development with the Association of the Luxembourg Fund Industry. “Europe has always been more of a Ucits fund business than an alternative funds business.

“But the AIFMD gives us the opportunity to develop the alternatives sphere.”

Ms Agnes adds: “The AIFMD brings the advantage that it’s now much clearer what regulation of these funds will mean. It gives the alternatives industry the necessary confidence and clarity to develop their business.”

One revolutionary change to come with the AIFMD is the phasing in of “passports”, permitting asset management houses to market funds across the EU. In theory, this alteration will strip out a layer of red tape for fund houses, allowing them to market funds to Spaniards in the same way they do to Germans.

In practice, however, any delay in the introduction of these passports presents possible pitfalls, as other countries follow Germany’s lead in looking to limit their private placement regimes earlier than expected. “Suddenly firms might have to stop the marketing they have been doing for years because countries have changed private placement regimes. That could be a real problem,” says Ms Patterson.

John Donohoe, chief executive with Carne Global Financial Services, a regulatory advisory group, agrees: “What some people fail to grasp is that as part of the process, private placements will be tied up considerably.”

Another interesting development is that a flurry of tie-ups between EU regulators and foreign ones are due as well. The Brazilian Comissão de Valores Mobiliários, for example, recently agreed a deal with the European Securities and Markets Authority (Esma) to jointly oversee the regulation of Brazilian hedge funds, private equity and real estate funds marketed in the European Union.

“The reality is that many of these funds are engaged in cross-border business,” says Reemt Seibel, a spokesman for Esma.

“So regulators have to agree to work together. We need to insure that players coming from outside of Europe are fulfilling the same rules as those coming from Europe.”

Fund managers based in some countries have been granted a stay of execution from the regulations. In the UK, for example, the Treasury proposes that UK managers will not have to comply with the new rules until July 22 2014.

The reprieve in the UK may be mimicked by other EU countries. “We need to see how other EU member states approach the deadline,” says Mr Everett of Bovill. “This is a welcome move by the Treasury … Firms would have had to comply with all this extra red tape within just seven months of seeing the detail.”

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