The Alternative Investment Management Association, which represents hedge funds around the world, says EU regulators imposing the directive could, contrary to previous hopes, prevent investors from putting money into non-EU funds. Funds based in the US, Canada, Hong Kong, Australia and Switzerland could be hit. Hedge funds collectively hold around $2 trillion of assets.

Under rules known as the Alternative Investment Fund Managers Directive – approved into law last year – hedge funds, private equity funds and some other vehicles are being placed under tougher supervisory controls. The AIFMD was ostensibly introduced to protect investors from fund blowups and bolster the stability of global markets in the wake of the 2008 financial crash. When the directive was originally rolled out, it prompted concerns that it would throw up a protectionist wall against non-EU firms, although some of the most controversial elements were removed or watered down after negotiations.

However, AIMA claims that in the “Level 2” process on how the directive will work in practice, the old protectionist threat has resurfaced. The European Securities and Markets Authority is advising participants on how the rules will work.

Many passages of the ESMA’s consultation paper reintroduced the concept of “equivalence” - requiring the same regulatory controls and standards in non-EU as in EU countries, which the industry regards as impossible, AIMA said in a statement.

“AIMA has significant concerns in relation to ESMA’s proposals for 'equivalence' standards to apply in relation to the regulation and supervision of third-country risk managers, portfolio managers and depositaries and the specific tasks to be performed by third country depositaries,” it said.

Jurisdictions such as the Cayman Islands, Jersey, Guernsey and elsewhere have been concerned that some of their lucrative hedge fund business could lose out if these places are not deemed up to standard by EU regulators. A number of these offshore financial centres have told this publication they are confident their business will not suffer from AIFMD.

AIMA said these equivalence standards should not be introduced at Level 2 where no such standard is required under the text of original legislation now signed into law. It is “absolutely clear on the face of the Level 1 text that no equivalence assessment is required under Article 20(1)(c) in relation to delegated third-country portfolio or risk managers”, the group said.

“The concept of equivalence was thoroughly considered, discussed, and, importantly, dismissed during the legislative process in a number of areas, as it was apparent that it would be unworkable.” AIMA chief executive Andrew Baker said in a statement yesterday.

“The practical implication of the proposals is that some investments into non-EU jurisdictions would become very difficult, if not impossible. Furthermore, it is difficult to imagine how the equivalence of dozens of jurisdictions could be assessed within the implementation deadline. In some parts of the proposal it's not even clear who would be responsible for such an assessment,” he added.

AIMA has 1,250 corporate members.