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Commission proposes first EU law on hedge funds and issues guidelines on bank pay practices.

The measures are part of a broader effort to plug regulatory holes that contributed to the financial crisis.

Hedge funds are high-risk private investment partnerships that make huge wagers on market movements and are suitable only for professional and institutional investors. At their meeting in April, leaders of the world’s 20 largest economies – the Group of 20 – declared their support for clamping down on large hedge funds.

Under the proposed law, managers of hedge funds and similar ‘alternative investment funds’ that handle at least €500m (€100m for those using borrowed money) would have to register with regulators. They would also have to disclose information about their business, for example the extent to which they use borrowed money or financial instruments to boost potential returns.

At these thresholds, the law would cover about 30% of hedge fund managers and 90% of the assets in EU-based hedge funds. At the end of 2008, the alternative investment industry was managing about €2tr in assets.

For now, the draft law applies only to managers, rather than funds, because many funds are based offshore. After three years, the rules will get tougher for funds based outside the EU.

Earlier this year, the commission introduced a plan for overhauling the financial system, saying the crisis had demonstrated the need for tighter regulation and greater oversight. The general approach was endorsed by EU leaders in March.

The commission also issued recommendations on how EU nations should regulate bankers' pay. Current pay practices often encourage directors to take excessive risks.

The commission is proposing that bonuses and stock options be linked to financial performance over a period of years. It also recommends banning severance pay for executives who fail at their job and capping such pay even when they do well.

Financial institutions should be able to get their money back if the bonus was based on bogus numbers.

The commission also announced plans to help consumers make informed decisions about investing in mutual funds and insurance policies, particularly with regard to their risks and costs. Many of these “packaged investment products” have lost much of their value during the crisis, often to the surprise of investors.

All proposals, an important part of the commission's response to the financial crisis, now they go to parliament and the council for consideration.

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