European Union finance ministers approved draft rules to tighten hedge fund regulations as the U.K.'s new chancellor of the exchequer, George Osborne, raised concerns about the law's impact on the industry.

The proposal, which would impose transparency standards on hedge fund managers based outside the European Union, was endorsed by a majority of ministers over U.K. objections at a meeting in Brussels on Tuesday.

Britain is home to 80% of European hedge fund and 60% of private-equity managers, according to the Financial Services Authority. It's also a hub for non-EU funds looking to market in Europe.

"It could be disastrous," Philip Keevil, senior partner at the investment bank Compass Advisers LLP in New York, said in an interview. "There are elements that will drive hedge funds offshore that will have a terrible effect on London. It's not going to put hedge funds out of business. They will move somewhere else."

Hedge funds and private-equity firms are under scrutiny worldwide, who say they are partly to blame for the financial crisis. Then-U.K. Prime Minister Gordon Brown warned in March that the Alternative Investment Fund Managers Directive may threaten the country's preeminence in the financial services industry. The U.S. has also opposed the draft law.

"We're a community and that means that there can be decisions against an individual member state," German Finance Minister Wolfgang Schaeuble told reporters in Brussels, referring to the U.K. stance.

The draft from the ministers requires managers to register in each EU country they want to market their funds. It also would set restrictions on investment managers' bonuses and on the use of debt.

"Ultimately it's really bad for investors," Ana Haurie, managing director of Dexion Capital PLC in London, which manages a $1.7 billion fund of hedge funds, said in an interview. "If you're limiting where you can invest there will be a consequence."

Final EU approval of any measures requires an accord between the Parliament and EU national governments in a process that could take another year or more.

The finance ministers "gave explicit recognition" of the U.K.'s criticism about the way fund managers from outside the EU are treated in the law, Osborne said in an interview with Bloomberg TV.

"The U.K. hasn't given up on its concerns," Luxembourg Finance Minister Luc Frieden said. "Osborne told us in bilateral talks they have a number of questions on this, but we'll take these questions with us into the discussions we'll have with the European Parliament."

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