Britain in final push to tone down EU hedge fund rules

British diplomats will today begin the final stage of a desperate rearguard action against new European legislation that London-based hedge funds and private equity firms warn could drive them out of business.

While Britain has been fighting for some time for a significant watering down of the reforms proposed by the Alternative Investment Fund Management (AIFM) directive, time is running out to secure concessions on behalf of the City, where much of Europe's hedge fund and private equity sector is based. A source close to the talks warned "the UK is not going to get everything it wants".

Britain has spent much of the weekend trying to win the support of smaller European countries. This Wednesday, the directive will move to the European Commission's Committee of Permanent Representatives for consideration. Britain's representative, the diplomat Kim Darroch, will have a final chance to persuade colleagues that amendments are necessary, but only small changes will be possible.

The legislation will then be rubber-stamped by the EC's Economic and Financial Affairs Council (Ecofin) on 16 March, before being presented to the European Parliament for a vote, which is expected to be a formality.

The immediacy of the deadlines has seen British representatives at the EC engaged in frantic lobbying and negotiations over the past few days. It is now believed that the fate of the directive lies in the hands of a number of Eastern European member states that have yet to finalise their positions.

A powerful alliance that includes France, Germany, Italy and Luxembourg is pushing for the AIFM directive to proceed unamended, while the UK can depend on the support of Sweden, Finland, Ireland and the Czech Republic. The Spanish, who currently chair the EC, are thought to be sympathetic to the French and German position, while the UK believes it is supported by Estonia. The votes of Hungary, Romania and Bulgaria are being keenly sought by both sides.

Negotiations are continuing on three key features of the directive. The UK expects to get its way on the issue of thresholds, securing exemptions for investment managers with the smallest assets under management. On deposits and custody, the French are continuing to push for the strictest rules possible, though there is some room for flexibility. The third and most important issue, however, remains unresolved, with the French and Germans determined that the directive should apply to investment managers based outside the EU if they want to market their services within the bloc.

It is this rule Britain is most opposed to, because many of the hedge funds and private equity firms operating in London but headquartered in territories such as the US or Switzerland could be forced out of the City. Britain also fears other countries would retaliate against the EU, insisting that European businesses selling alternative investment management services in their territories sign up to equally proscriptive regulation. That would have a disproportionate effect on the City, where so much of Europe's industry is based.

City ministers, lead by Lord Myners, are concerned that the directive is the first of several reforms of financial regulation that the EU is to consider, and that acceding to German and French demands now could set a dangerous precedent for the future.

But Michel Barnier, the new EU Commissioner responsible for financial services, made it clear on a visit to London last week that he is determined to see AIFM go through. After meeting him, Simon Walker, chief executive of the British Private Equity Association, described the situation as "extraordinarily serious".