UPDATE 1-EU considers law to clamp down on hedge fund pay
* Hedge funds could be told to justify pay
* Draft law discourages golden handcuffs for high fliers
* Code wants at least 40 percent of bonus payout deferred
* Hedge funds, private equity say pay different from banks
By John O'Donnell
BRUSSELS, Nov 13 (Reuters) - Hedge fund managers may be told to justify their pay and prove it does not encourage excessive risk-taking, according to a document that could be a cornerstone of new European Union rules for the industry.
The EU is scrutinising a raft of regulations for hedge funds and other niche financial organisations that includes imposing tough borrowing limits on the secretive industry, which has provoked increasing suspicion among politicians.
On Friday, Reuters obtained the draft law, which outlines a pay code for hedge funds that discourages golden-handcuff payouts to retain high-fliers and demands that more than 40 percent of bonus payouts be deferred for at least three years.
The pay code, which is similar to that proposed for bankers, also demands a balance between the amount hedge funds or private equity managers get paid in salary and bonus.
It makes a new pan-European watchdog for markets -- due to be set up in an overhaul of financial supervision -- responsible for the pay guidelines for the fund managers best known for making reverse bets on company stocks rising or falling.
"Member states shall require Alternative Investment Fund Managers to have remuneration policies ... that do not encourage excessive risk-taking," officials write in the draft, which is the result of weeks of talks between European countries.
The European Parliament has joint say with EU states on the proposal and it is expected to publish its draft position later this month though lawmakers on the left are likely to welcome the new annex to crackdown on potentially risky pay structures.
Industry officials were dismayed by the new annex.
"The draft directive's proposals on remuneration for alternative investment funds don't fit the private equity model and could leave investors worse off," said Simon Walker, chief executive of the British Private Equity and Venture Capital Association.
Florence Lombard, executive director of the Alternative Investment Management Association, a global hedge fund industry body, was also concerned.
"Our industry has not been consulted on this and is structured differently in terms of remuneration to that of the banking industry," Lombard said.
Although the funds, which one politician dubbed locusts, did not play a central role in the financial crisis, long-standing suspicion of the industry prompted the EU's executive European Commission to draft rules to keep close tabs on it.
Since the crisis, there has been a drive towards a broad clampdown on financial services.
The G20 group of leading countries, which includes the European Commission and several EU states, agreed to guidelines on banker pay that are similar to the ones for hedge funds.
The Swedish draft also seeks to kick into the long grass the divisive issue of whether third country funds can be marketed in the EU and also tones down restrictions on leverage, and the valuation and custody of funds.
A "passport" to allow a fund to be marketed unhindered across the 27-nation bloc should only be granted to a manager of a fund that is located within the EU, the draft said.
However, member states can continue to allow the marketing of third country funds on their own territory to professional investors, the draft says.
Britain, home to the EU's biggest hedge fund and private equity sector, has already signalled it would accept such a compromise to avoid the risk of new restrictions that would limit the number of funds available to investors locally.
"The Commission is called upon to assess, three years after the entering into force of this directive, whether to come forward with proposals to allow for a passport to market alternative investment funds established in third countries in the Community," the draft said.
The ability of the European Commission to set limits on the levels of leverage fund managers employ -- a proposal that has angered many in an industry where borrowing is commonplace and in some strategies necessary to generate attractive returns -- has been removed.
Meanwhile, a requirement for an independent valuer of a fund's assets has also been scrapped, and instead replaced with a need to ensure "the proper valuation of the assets" is established.
Proposals to restrict valuers and administrators to EU countries, unless certain conditions are met, have also been loosened. (Additional reporting by Huw Jones and Laurence Fletcher in London, Editing by Luke Baker and Andy Bruce)
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