The European parliament is expected to toughen regulations for hedge funds and private equity despite UK and US opposition

The European parliament is expected tomorrow to approve a draft directive to toughen regulation of hedge funds and private equity firms despite a growing tide of opposition from leading politicians and lobby groups in the UK and America, where both industries are clustered.

Labour's City minister Lord Myners has described the proposed regulatory crackdown – being championed by France and Germany – as "fundamentally flawed and promot[ing] protectionism under the guise of protection". Both the Conservative party and Liberal Democrats have similar views. US treasury secretary Timothy Geithner has also been critical.

However, after months of deliberation members of the economic committee of the European parliament are expected to pass the text proposed by Jean-Paul Gauzès, the parliament's rapporteur on the proposed directive on alternative investment.

Directive rules on hedge funds would require non-European funds to have a "passport" to be able to trade in Europe, but they may not be able to earn one if their home country has different financial regulation. This would limit the presence of US-based hedge funds in Europe, which include some of the biggest firms, such as Paulson & Co.

Many hedge funds from both sides of the Atlantic operated registered operations from the Cayman Islands, the Caribbean tax haven. A passport blacklisting for the Cayman Islands could create huge problems for the industry.

The proposal has angered the financial industry, particularly in Britain, home to about 450 hedge funds, 80% of the European total. UK-based hedge funds employ 10,000 professionals directly and 30,000 others, such as lawyers and accountants, indirectly.

Andrew Baker, chief executive of the hedge fund lobby group the Alternative Investment Management Association, has written to Gauzès setting out concerns, saying: "We feel that the proposed text will result in Europe closing its borders to the detriment of its own investors, many of which are responsible for covering Europe's citizens' pension and insurance needs."

The CBI will tomorrowjoin calls for MEPs to vote against at least some parts of the directive, claiming it would increase costs and bureaucracy for businesses owned by private equity houses and discourage investment.

But many unions, including the GMB, disagree. They have argued for years that the high levels of debt involved in many buyout deals has had a material impact on the security of jobs.

Even some private equity barons have conceded that large-scale, aggressively financed deals, struck at the top of the buyout market, may have put employment at risk. Jon Moulton, of Better Capital, has described such deals as "betting jobs against shareholder returns".

The directive, though, is far from being ready to be turned into legislation – a process that may take two years.

In a parallel process, the Spanish presidency has produced another draft proposal, which is expected to be approved in the next meeting of European financial leaders on 18 May. Afterwards, commission and parliament will have to negotiate a final draft.

Hedge fund leaders remain hopeful that recent comments from France and Germany hint at possible concessions. In an article in the Wall Street Journal last month, the two countries' respective finance ministers, Christine Lagarde and Wolfgang Schauble, said: "France and Germany believe in open financial markets [and that] qualified investors should be free to invest in funds from all around the globe irrespective of quality standards set for state-of-the-art European hedge funds".The conflict between the industry and legislators about the directive generated a record 1,670 amendments submitted to the first proposal. The rapporteur has sided with France and Germany's tougher view on hedge funds, and recently said in London that the loss of up to 3,000 industry jobs in the City would be a price worth paying for better regulation in the sector.

Hedge funds claim that they did not cause the credit crunch, which is more often blamed on the widespread use of derivative contracts, a market more difficult to identify and legislate, as trades occur privately between parties.