Hedge funds will be required to disclose more information about their operations to investors under plans by the European Securities and Markets Authority (Esma).
Exchange traded funds (ETFs) can also expect more scrutiny on collateral and securities lending.
Speaking at the International Capital Market Association's annual general meeting in Paris on May 26, Esma chairman Steven Maijoor said the Authority will launch a consultation in July looking at proposals to ensure availability of information to investors that will allow them to better assess the risk profile of the fund.
Alternative investment fund managers will also need to provide regulators with "sufficient information" on their activities.
The consultation will be part of Esma's work providing technical advice to the EC on the Alternative Investment Funds Directive.
However he acknowledged the effect such requirements can have on funds. "We should be careful not to require information just for the sake of it and should focus on those elements that help regulators carry out their supervisory tasks," he said.
Unsurprisingly, a hedge fund counsel criticised the proposal, describing it as "unnecessary".
The counsel told IFLR that sophisticated investors already demand extensive information from hedge funds before investing.
Hedge funds already provide details to investors with regards to what they buy and sell, and their internal risk guidelines are in the private placement memorandum, he said. It also includes information about risk management, liquidity of assets and duration.
No investor commits a cent, he said, unless they really understand what the fund does.
"If a guy says 'I'm not going to invest unless you tell me this', we usually tell them," he said. "Mandating some type of risk disclosure to all investors strikes me as unnecessary if it's from an investor protection point of view."
On ETFs, Maijoor said that Esma has enlarged its focus to include not only investor protection issues and possible additional disclosure but also ETF practices in regards to collateral and securities lending.
"These practices can potentially give rise to systemic risk if they are not properly managed," he said.
He noted that the discussions do not exist in a vacuum, and that ETFs structured as undertakings for collective investment in transferable securities (Ucits) are already subject to requirements on risk, liquidity management, investment limits and investor disclosure.
Temporary product bans
Maijoor also welcomed the EC's adoption of temporary product prohibition rules, hailing them as a key weapon against regulatory arbitrage.
He said that while certain EU member states had experience of banning short selling activities, the biggest achievement is that there will be consistent rules across the EU.
"Whatever the final details of the short selling regulation will be, it is important that the end result can avoid the possibility of regulatory arbitrage," he said.
Without the new powers, he said, a situation could emerge where short selling a particular sovereign bond is banned in one member state, but short selling the same bond is allowed in another.
"The financial markets in sovereign bonds are European, if not world-wide, and asymmetric treatment of similar situations would undermine the credibility of regulatory interventions," he said.
He also emphasised the importance of avoiding complex and unclear accountabilities. "This would risk slowing down the decision making while a decision to ban will typically require speed to be effective," he said.
The EC's Economic and Financial Affairs (Ecofin) Council adopted the short selling rules on May 17. Maijoor said the agreed rules are "broadly consistent" with the advice that Esma's predecessor, the Committee of European Securities Regulators (Cesr), provided to the Ecofin Council.
"The key elements of Cesr's advice 'survived' the test of the difficult negotiations on the content of the regulation," he said.
Non-European ratings face EU requirements
In his speech, Maijoor also signalled that European credit ratings issued by non-EU parties will face EU regulatory requirements.
Maijoor said Esma has decided that a voluntary regime based on the commitments of the rating agencies themselves would not be sufficient.
"I strongly believe that in this area we should not return to the pre-crisis model of self-regulation," he said.
Maijoor said it is important to centralise decision-making on third-country market infrastructure issues in order to streamline international coordination.