European Union finance ministers backed stricter controls for hedge funds and private equity groups today, handing a defeat to Britain's new coalition government at its first EU meeting.
The draft rules will control pay and borrowing at hedge funds as well as forcing them to disclose extensive information to watchdogs about how they are investing or short-selling, breaking a taboo for the secretive industry.
The regime, which puts hedge funds under the eye of a pan-European watchdog for the first time, is part of a wider set of pledges by world leaders to create a more stable financial system after the global economic crisis.
"We are determined to accelerate the pace of regulation," Wolfgang Schäuble, Germany's finance minister, told reporters after the meeting. "Up until now this was not regulated," he said of the hedge fund and private equity industry. "This hole will now be closed."
Britain had fought hard to water down the law and was still hoping to overturn a provision that refuses a single licence for foreign funds to do business across Europe, something US Treasury Secretary Timothy Geithner has also objected to.
But London's objections were overruled in a rare break with an unwritten rule of Brussels diplomacy that says no country should be bullied into accepting a law it does not want.
British diplomats put a positive gloss on developments, described by hedge fund lobbyists as disappointing, saying they had reached the "best possible" outcome with a footnote to the ministers' statement that flagged their worries.
But experts see the new rules - likely to take effect around 2012 - as a decisive political victory given the symbolic importance of the industry for London.
Other political leaders played down any impression that Britain might have come off badly in the negotiations. "Today, with goodwill and agreement from Britain and after very hard struggle in recent weeks, we have succeeded ... to rein in hedge funds," said Austrian finance minister Josef Proell.
Britain is worried the new law will drive its financial services elite out of London's West End, home to eight out of ten European hedge funds, to cities like Geneva.
But it is isolated. Only the Czech Republic backed it in opposing the approval of the new rules by the finance ministers, a weak alliance in the face of heavyweights France and Germany, who pushed for rigid restrictions.
Chancellor George Osborne blamed Britain's previous, Labour government for giving the new government a "hospital pass".
"I came here given a challenging position bequeathed to me by the previous government," Mr Osborne told reporters after being outvoted at the first meeting with his peers. Officials said he did not speak during the deliberations on the issue.
Mr Osborne now hopes to win a last-minute concession in negotiations with parliament. Last night, its economic affairs committee approved its version of the draft law, backing the idea of a passport or EU license for foreign funds.
Hedge funds have been accused of exacerbating Greece's borrowing difficulties by betting against its debt, although there are few trading records to prove that how much such betting took place.
The planned legislation would change that, proponents say, making it easier for supervisors to see what is happening as well as intervene by curbing short-selling, for example.
The hedge fund clampdown is part of a broader revamp of financial services in Europe, spanning curbs on banker pay to demanding lenders put aside more for unpaid loans.
Mr Schäuble also flagged a possible financial transaction tax today. "Agreement on a European initiative would come at the earliest if there were to be no such agreement at the G20," he said, referring to the meeting of developing and industrialised nations in Toronto in June.