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Higher costs, less capital
 The EU wants to keep a tighter rein on financial investors – and in the process could hurt the very financiers who are being sought.

Frankfurt Allgemeine Zeitung, December 15, 2009

Unity across all parties is seldom achieved in politics. But when the issue is how to foster technology companies, practically everyone agrees: Germany needs young creative types to secure its future. “Innovative processes are the key to the future”, declared German Chancellor Angela Merkel in the run-up to the recent IT summit in Stuttgart. At the conference, Merkel then openly subscribed to the view that the information technology will propel Germany forward and that the government bears some responsibility for it, as evidenced in particular by rising education expenditure.

But precisely those investors that the government is counting on to promote young technology firms now fear that politicians are about to set up insurmountable hurdles to investment elsewhere. For months now, in response to the reorganization of the financial markets, the regulation of alternative forms of investment has been under debate in Brussels. In the process, it is becoming apparent that the Directive on Alternative Investment Fund Managers does not bode well for smaller investment companies and risk financiers (venture capitalists). In one fell swoop, the EU member states and the Parliament want to regulate more strictly investment firms of the most varied sizes as well as hedge funds and real estate funds. “Everyone is being lumped together, even though we’re talking about very different investors and accordingly, very different needs for protection”, says Cristoph Schalast, professor of economic law from Frankfurt. “For this reason, and rightly so, the approach of the AIFM Directive is being criticized.”

Whether the planned regulation can really make the financial markets more stable is hotly debated, but it is certain the costs for investment companies and their financial backers will rise considerably. And that is where the protests of venture capitalists come in. The added expenses that large private equity firms specialized in multi-billion dollar takeovers can afford may be prohibitive for smaller financial investors. “Existing funds will be endangered by the looming extra costs, and it will be much harder to come up with new capital for future funds”, says Ulrike Fricke, founder and Managing Partner of Triangle Venture Capital Group in St. Leon-Rot.

Fricke is among those investors who acquire small technology and software companies in particular and try to develop them. Her criticism of the AIFM Directive hinges on three specific points. In the future, the balance sheets of all portfolio companies are to be examined additionally by an independent auditor. According to Fricke’s calculations, that would mean annual costs of between €20,000 and €100,000 per company – quickly totaling in the millions. “And those costs must be assumed by our investors, which makes the whole venture capital business less appealing to them.” And that audit would be required although these investors – all of them institutional types – need neither additional protection nor additional information.

Add to that the planned requirement to make the portfolio companies’ strategically important figures available not only to the funds’ own investors but also to the public. Fricke considers this to be unjustifiable discrimination vis-à-vis competitors. “Some of our companies have very few competitors who still will not have to publish such sensitive information. That will be a noticeable competitive disadvantage for us.” Finally, the Triangle manager and the entire investment industry are bothered by the intention within the EU to permit only those private equity funds that submit to the new regulation. Their concern is that America will come up with similar barriers for European funds, while at the same time American investors might largely pull out of the European market. “Other countries are not simply going to roll over take it if Europe puts up a fence”, warns Fricke.

This last argument is just a threat at the moment, which in Schalast’s opinion by no means needs to occur (“Europe is an exciting market and will continue to draw investors.”). Yet the finance expert does consider the AIFM Directive’s approach to be flawed. “Sensible regulation of the investment industry in Europe would create uniform framework conditions and uniform transparency, especially for institutional investors”, he says.

But to Schalast, the basic principle that appears to run through the Directive, which is to force all financial investors to engage in less risky behavior, is erroneous. “You cannot obligate investors to create greater sustainability and common good by law, that would be wrong” says Schalast. “Politicians feel they have a mandate to become regulatory in an effort to prevent future financial crises. And conversely they believe that they cannot afford to exempt private equity from additional regulation”, adds Jan Wildberger, Partner and private equity expert at the international law firm Simmons & Simmons. “When it comes down to it, the AIFM Directive is fraught with regulatory excess, which in many areas will result in senseless bureaucratic red tape that will hurt small investment companies above all” he concludes.

The German Private Equity and Venture Capital Association (BVK) is counting on still being able to make significant changes to the Directive during the negotiations in the coming months. The contentious points for the private equity sector are to be eliminated entirely, they say. At the very least the subject of proportionality already raised by the EU Parliament is to be addressed. Accordingly, smaller investment and venture capital firms would be subject to less stringent requirements. “The formulation of this idea, however, is still very nebulous” complains Dörte Höppner, Managing Director of the Association. In any event, past experience with retroactive amendments has not been very good: The Venture Capital Promotion Act (Gesetz zur Förderung von Wagniskapital), which was passed in the summer of 2007 after a long period of wrangling, also resulted in a lot of bureaucracy for the industry – but not so much as a single new investor for young technology companies.

@ All rights reserved. Frankfurter Allgemeine Zeitung GmbH, Frankfurt.

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