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France defends hedge fund line under U.S. fire

By Jean-Baptiste Vey

PARIS (Reuters) - France's stand on European plans for hedge fund regulation does not discriminate against funds from outside the EU, Paris has told the United States, and offshore funds should be subject to supervision by a European watchdog.

France, citing fears of insufficient regulation, refused with German backing a few weeks ago to back adoption of new hedge fund rules that would give funds outside of the EU area a license or passport to do business across all 27 EU states.

In a letter to U.S. counterpart Timothy Geithner, dated October 8 and obtained by Reuters from French sources, French Economy Minister Christine Lagarde responds to recent U.S. grievances, saying the system France supported was "neither protectionist ... nor discriminatory."

But by also referring in the letter to a potential phasing-in of EU licenses for foreign funds to work across Europe, Lagarde could have been leaving the door open to a deal addressing Washington's chief concern about the new EU rules.

"We believe that awarding a passport to offshore funds is not satisfactory as they would not be subject to the same regulatory provisions as EU funds on many issues ranging from the governing law and competent court, the capacity to obtain enforcement or a judgment, the professional requirements and financial liability of auditors to valuation rules," it says.

"If however a passport for offshore funds was to be adopted, France believes that such a passport should be truly European," Lagarde says in the letter, adding it was important such funds register with and be supervised by a European body.

"This would also parallel the approach adopted under the Dodd-Frank act which requires funds advisers to be registered by the SEC (U.S. watchdog)," Lagarde says in the letter.

France had so far opposed any such scheme because of fears that controls on foreign funds would not be strict enough.

It remains unclear whether Britain would accept Lagarde's conditions for any deal, namely that a new EU watchdog rather than national supervisors should police the bloc's hedge funds.

Despite being one of the EU's more modest financial reforms, attempts to change European Union rules for hedge funds, chiefly by putting them under the watch of a new pan-European body, has taken what one industry expert called a totemic significance.

It put French President Nicolas Sarkozy at loggerheads with Britain, which has fiercely defended an industry London sees as important for its status as Europe's financial capital but which one German politician dismissed as "swarms of locusts."

The officials said the French challenge could undermine relations with Washington as Sarkozy prepares to chair meetings of the G20 from November. Such gatherings are an important forum for tackling the global economic crisis and deciding financial reform.

(Additional reporting by John O'Donnell in Brussels; Writing by Brian Love)