James Moore: Hedge funds and private equity are partly to blame for a bad, bad law

Outlook Pity the poor hedge fund managers. EU finance ministers yesterday backed controversial new rules that will impose the dead hand of Euro regulation on the industry and its counterparts in private equity.

There is still time for their champions to mitigate what are seen as some of the worst bits of a bad law: there remain significant differences between the texts agreed by member states' finance ministers and the European Parliament and the two will have to be reconciled before the directive is adopted. So there is haggling room. But the die is now cast.

Britain is less than delighted with the new rules, and it's easy enough to see why. Something like 80 per cent of the European hedge fund industry is located within the City of London. And even though hedge fund managers like to route their funds through offshore territories such as Jersey and Guernsey, thus mitigating their tax liabilities, they still pay quite a lot into the coffers of HM Revenue & Customs. As much as £5bn by some estimates. Then there is the substantial infrastructure in and around Mayfair that supports them, provides employment, and generates more tax.

So you might have expected George Osborne to be hammering his fist on the table, Ian Paisley style, with a rousing chorus of "Britain says no". What better way to placate the substantial band of backbenchers who see the coalition with all those nasty pro-Europe Liberal Democrats as a betrayal?

And yet the directive passed without intervention from Britain. Mr Osborne has realised that he is going to have to pick his battles with the EU, which looks like commendable pragmatism from one of the leaders of a party which is aligned with, in the words of the leader of its coalition partner, a bunch of "nutters" in the European Parliament. But there are political calculations at work here that go beyond relations between the odd couple. Mr Osborne has probably realised that going in to bat for hedge fund and private equity managers would be politically suicidal at a time when you're preparing to impose the most swingeing cuts in public expenditure this country has yet seen.

He knows that this is a bad law. A law that could have a number of damaging consequences beyond the fate of a handful of overpaid casino capitalists in a plush part of west London. It will, for example, cover venture capital. At a time when small and medium-sized enterprises across Europe are being starved of funds because of the unwillingness of banks to lend on anything like sensible terms, putting the squeeze on this sector of the financial services industry is the height of stupidity. It's a measure that could further squeeze the economic prospects of the entire continent.

But its main targets – the hedge fund and private equity industries – have an appalling public image and that makes them very difficult to defend. They have displayed an arrogant disregard for their stakeholders. Decisions such as employing Andy Hornby to run Alliance Boots after driving HBOS off a cliff, or the callous treatment of workers made redundant as a result of leveraged buyouts, or the speculative attacks that hedge funds have launched against vulnerable companies, or the continual threats to run off to Switzerland if they don't get their way. They cast a very poor light on both industries and, as a result, the reaction of the general public to the Alternative Investment Fund Directive is "serve 'em right". Unless the industries work this out, there is likely to be more of this sort of trouble coming their way.