Hedge funds may have to provide information about their short selling activities if the latest recommendations in the European alternative investment fund managers (AIFM) directive are implemented.

A  positive development comes in a report by the directive's rapporteur, Jean-Paul Gauzès. He recommends easing the original proposals on the marketing of funds domiciled outside the European Union (EU) to investors based in the member states.

These proposals, which make it clear that institutional investors should be able to choose where they wish to put their money, would put a restriction on funds of hedge funds investing more than 30% in funds domiciled outside the EU.

In his report Gauzès made a number of amendments to the draft directive, which was first published in April 2009 by the European commission.

He suggested removing entirely the exemption from regulation for fund managers managing funds with less than €100 million in assets under management (AUM). Gauzès said a principle of proportionality should be imposed instead and the rules needed to ensure more transparency in fund management.

The recommendations would align remuneration within the alternative investment industry with the recent G20 proposals governing remuneration in other financial services sectors. Remuneration policies would have to be "consistent with effective risk management, counter short-term profit motives and [be] in line with the business objectives and the long-term interests of the AIFM and investors."

Gauzès's report expands on the commission's proposals to set leverage limits on funds, adding that "competent authorities" should pass information collected from fund managers about their leverage use to the planned European Systemic Risk Board. He said the board's views should be taken into account should the commission decide, "in exceptional circumstances" to impose limits on leverage used by managers.

The report suggested a new clause on short selling. It acknowledged that shorting is a "legitimate investment technique. Nevertheless, there is a concern that, notably in extreme market conditions, short selling may contribute to market disorder. Therefore, short selling should operate in a harmonised regulatory framework to reduce the potential destabilising effect that it may cause."

Gauzès said fund managers would have to  disclose information regularly on "significant short positions" to the authorities.

Controversial clauses in the original proposals requiring fund managers to appoint independent third-party valuators are refined in Gauzès's amendments. Under his revisions management companies would be able to carry out valuations providing there were sufficient Chinese walls in place to ensure the independence of the process.

Depositaries and fund managers would be jointly responsible for the proper valuation of the fund's net asset value.

Gauzès's amendments would bring the ceiling on own funds into line with the Ucits IV directive and the Basel II agreement. Managers would have to invest own funds in "liquid assets or assets readily convertible to cash in the short term" and not speculative positions.

The report was welcomed with caution by the industry. Alternative Investment Management Association (AIMA) chief executive Andrew Baker said it contained "some helpful proposals".

Baker said AIMA agreed with the removal of AUM thresholds as well as the alignment of the AIFM directive with existing European regulations.

But Baker said measures relating to short-selling should not be included in the directive. AIMA was also concerned that there was lack of clarity about provisions concerning leverage and depositaries.

The "substantial revisions" proposed by Gauzès and the Swedish EU presidency underlined that the original draft was "deeply flawed", concluded Baker.