Hedge funds and private equity firms based in Asia face tough new rules on pay and leverage from a regulatory overhaul set to pass in Europe this week.   

The European Union's Alternative Investment Fund Managers Directive, which goes before the European Parliament on Thursday, will apply to all fund managers with EU-based clients, regardless of where they are domiciled.   

That means Asian hedge fund and private equity managers, which previously enjoyed broader regulatory freedom than their Western counterparts, may get roped into the reforms.  

While Singapore and Hong Kong are home to a growing Asia-focused alternative investment industry, it's estimated that around 50 percent of their investor base comes from Europe.   

It's the connection with European investors that could make them subject to strict new rules on pay and leverage.    

"There remains concern that non-EU managers will have to comply with the full text of the directive if they want to access EU investors," said Han Ming Ho, a partner at law firm Clifford Chance and chairman of Singapore's Alternative Investment Management Association    

"They will effectively have to follow EU law and an EU pay code in their respective local jurisdictions,- this obviously creates multiple challenges for the industry," he added.   

Under the directive, any fund manager who has clients in the EU will have to obtain a "passport" to operate across the 27-nation block from 2015 onwards. The passports will be granted if the manager's home jurisdiction has a similar regulatory structure to rules in the directive.   

While it is still unclear what a "similar structure" will entail in practice, hedge funds fear that they will have to comply with EU rules which impose curbs on pay in the sector and receive supervisor approval on how much leverage they can use.

"Larger asset gathering managers are very concerned - they will have to put in quite substantial and expensive structures for their European operations," said Peter Douglas, principal of Singapore-based hedge fund consultancy GFIA.   

The curbs on pay mean funds are likely to be forced to stagger 40 percent of bonus payments over a number of years. The hedge fund industry has complained that this is a tougher requirement than that facing bankers, since most fund managers have no base salary, instead drawing all their income from performance fees - which would be classed as bonuses.   

Alternative investment managers are also likely to face higher costs due to tighter controls on the custodians they use to safeguard investors' assets. Custodians are likely to be subject to a greater degree of liability if a fund gets in to trouble, meaning they would charge managers more for their services.

Lobbying from the industry and the UK, the EU's biggest hedge fund centre, means that earlier proposals for a fixed cap on leverage have been scrapped. But funds will still need to receive approval from European supervisors on their degree of risk-taking.   

Until 2015, Asian fund managers will continue to obtain national authorisation to operate in the EU on a country-by-country basis.   

Fund managers say this does bring them some breathing space but hinders them from making longer-term business decisions. "Immediately there is a small sigh of relief but at the moment I don't see that we can really plan anything because it will be all about how the detailed rules are drafted over the next year," said Philip Tye, chief operating officer of DragonBack Capital, a hedge fund platform based in Hong Kong. 

Asia's hedge fund industry is still in a relatively nascent stage. Funds in Hong Kong and Singapore had assets of $45.4 billion as of July, according to Singapore-based consultancy Eurekahedge, just 2.7 percent of the $1.7 trillion industry total. - Reuters