Some of Britain’s biggest hedge funds have warned the UK Treasury they will be forced to leave the country unless a draft European directive is radically changed.

The move follows last minute changes to the draft directive on alternative investment fund managers to include a requirement for the European Commission to set a limit on borrowing.

As a consequence, some hedge funds have already begun back-up preparations to move to Switzerland in case the rules are not re-written 

Ian Wace, co-founder of hedge fund manager Marshall Wace, told the Treasury this week it should modify tax rules to allow the thousands of Cayman Islands-based funds to move to be fully regulated in London, rather than have much of the industry abandon Europe.

“If this directive goes through as drafted, large chunks of the industry will be leaving Europe, whereas we have the opportunity today to have large chunks of this industry coming to Europe,” he said.

At a recent meeting, Financial Services Authority (FSA) and Treasury representatives have reassured top managers that they would fight for changes.

People present said the FSA officials accepted that the “killer” rules limiting borrowing – and defined to include the implicit borrowing built in to derivatives – would make popular strategies such as global macro impossible. But the FSA and Treasury argued the definition of borrowing was so “obviously ridiculous” it was bound to be rewritten.

Lord Myners, City minister, accused the European Commission of producing “naive” proposals and said the draft directive “did not conform with the best practice of consultation”. He was confident it could be improved.