By Louise Armitstead, Chief Business Correspondent Published: 4:46PM BST 04 Aug 2009  The directive could have an 'enormous impact' investor returns, AIMA said Photo: Steve Caplin  The trade body warned that the cost of leverage restrictions, increased compliance costs and the impact of being restricted to European funds would hit investor returns in hedge funds and private equity by an estimated 2.5pc. It is thought that the €5 trillion European pension fund industry has nearly €1 trillion allocated to alternative investments at the moment  Andrew Baker, CEO of AIMA, said: "This is an estimated figure but it shows the potentially enormous impact that the directive could have on Europe's pension funds and in the longer term, Europe's pensioners.  He added: "The directive will result in a major reduction in choice for Europe's institutional investors and a big increase in costs and hence a significant reduction in returns. None of this is good for the competitiveness of the European financial services sector or indeed the economies of Europe as whole."  Kathryn Graham, director of Hermes Pension Fund Management, the executive arm of the BT pension fund, said: "It is our view that there are unintended consequences that would directly impact investments. We have two big concerns. First that the directive's passport system will restrict our choice of funds we can invest in. It seems we could only be able to invest in European based funds, for the first three years at least. The second concern is that regulatory costs will increase sharply and will be passed directly onto us."  Ms Graham said investors were not against regulation in principle but just the directive in practice. She said: "We want managers to be registered and we want to see improvements in corporate governance - we want a directive to exist. But as investors we want to be included in the process and see a proper consultation to achieve a directive without unintended consequences."  In April the EU unveiled proposals to introduce radical new restrictions on hedge funds and private equity that it said was necessary to address the concerns following the financial crisis. The directive is particularly tough on non-European fund operators. It stipulates that only funds domiciled in Europe can be marketed in the EU. An estimated 90pc of hedge funds are domiciled off-shore while the industry is also dominated by American players.  The UK has led the criticism of the directive as London is home to 450 hedge funds, or about 80pc of the European total, managing a combined £250bn.  Simon Walker, head of the BVCA, has called the directive "crass and unnecessary'' but warned that unless the Government and industry engaged, the current directive could be the "best-case scenario''.
The European Union's proposals to regulate hedge funds could cost pension    funds as much as &euro;25bn (&pound;21.3bn) a year, according to research by the    Alternative Investment Management Association (AIMA).