City of London

I entirely agree. That is an important point. Power is shifting eastwards to India and China. They have two and half billion people between them, and they will be the two big economic superpowers of our lifetimes—certainly by the middle of the century. That shift has undoubtedly been accelerated by recent events, and nothing would be more catastrophic for Europe—whether within the confines of the EU or as a time zone—to relinquish what should be and has been one of its traditional advantages. The importance that should be attached to the financial services business as a whole cannot be overstated, given the propensity of the 20 million or 30 million people a year who are added to the Chinese and Indian middle classes to save, which means that there will be a great reliance on what should be a great industry for us. To the directive's opponents, the European Commissioners' attention on these issues seems to have been promoted all too often by an unholy alliance of continental bankers and politicians who are concerned in part to effect something of a power grab. Eighty per cent. of the hedge funds managed in Europe are accounted for by London, while fewer than 20 per cent. originate in Paris. The plain truth is, as my hon. Friend the Member for West Suffolk pointed out in an intervention, that the asset management business has not been directly implicated in the global financial crisis, so one must ask why the EU is suddenly giving such priority to its regulation. Typically, hedge funds are small start-up businesses—a far cry from the large international banking institutions whose antics, in part, jeopardised the entire global financial system last autumn. Their offshore domicility often owes much to the need for simplicity in tax and regulation, as places such as the Cayman Islands are not beset by double taxation treaties and reclaim bureaucracy. The impetus for a European directive derives from panic in response to the economic crisis, alongside a partisan vision of hedge funds and private equity as a wild west show of amoral speculators and asset-strippers. Even one or two people in the Labour party have been known to espouse such views. However, there has been no crisis of asset management. Unlike banks, hedge funds neither leveraged themselves to the hilt—of course, they lacked the balance sheets to do so even if they had been so inclined—nor ran down from adequate levels of liquidity. Indeed, those that have failed—several have—have not threatened the entire financial system. In truth, one of the unsung successes of the Financial Services Authority—I hope that I am not too far out of line with my party's views on this matter—has been its ability to keep the hedge funds sector ticking along relatively nicely in recent years. It cannot make sense for a European directive to insist on onerous hedge fund registration requirements by giving Commission officials the right of veto over their investment strategies. That will simply result in the drying up of investment from outside the EU to hedge funds here, which is, as my hon. Friend the Member for West Suffolk pointed out, against not only UK interests but French and German interests and those of the other 24 nations of the EU. All that investors in the global market ask is to be given free rein to choose their investment managers. Instead, the proposed brave new world for hedge funds and private equity risks forcing EU-based investors to abide by a system of rules whereby they will have to instruct EU-based managers and place their assets in EU funds. A more sensible approach would be to examine how and why hedge funds became so powerful so rapidly. Perhaps the homogenising of mainstream institutions in the financial sector as a result of interdependencies and the converging effect of regulatory creep gave rise to the demand for a new diversity of off-balance-sheet methods to manage assets and credit. In particular, in the aftermath of the Enron scandal a decade ago, stricter regulations that were introduced to control off-balance-sheet activity simply resulted in an explosion in special purpose vehicles, which were created to bypass a culture where stifling regulation presented a massive competitive advantage to those institutions able to reap the benefits of economies of scale. I am not here to bury hedge funds, but equally I would not give them untrammelled praise. There is little doubt that the emergence, in reaction to regulatory overkill, of a largely unpoliced, unsupervised hedge fund sector had significant distorting effects on the entire financial system. Additionally the huge, largely unregulated profits derived from the most successful hedge funds had a perverse effect on the strategies employed by investment banks whose profits could never emulate those obtained in the tax-free, "regulation-lite" regimes enjoyed by the funds. As those profit margins became ever more the talk of the City half a decade or so ago, unrealistic expectations of compensation were ratcheted up. By 2004, senior banking executives watched enviously as hedge funds' profits soared and the brightest and best of their junior staff were poached to make their fortunes in those funds. In retaliation, many leading investment banks elected to allow the emergence internally of "virtual fund" teams specialising in the riskiest but potentially highest-return sectors. More often than not, such star teams negotiated and were granted special shadow profit-sharing status internally. I must accept that that proved to be the worst of all worlds, giving those teams the green light to indulge in relatively unprecedented risk-taking, all the time underwritten by the banks' colossal balance sheet. That seemingly safe umbrella encouraged ever greater leverage and the spectacle, even in the good times, of such a small proportion of banks' profits being retained. Naturally, that strategy was questioned only after the credit crisis exposed the folly of allowing an inherently riskier culture of hedge funds to pollute the banking system. I am glad that I have had the opportunity to speak at some length, and want to conclude with this thought on hedge funds: it is right for policy-makers to engage intellectually with the proposition that the rewards and super-profits should be justified only in return for exceptional performance, rather than as an arbitrage for tax and regulatory breaks; but that requires a much more systematic analysis than the European Commission has provided of the structure of the financial services sector. Scapegoating hedge funds and the private equity industry cannot be a sensible first step on that path.