BRUSSELS (MNI) - New rules to regulate the E2 trillion hedge funds and alternative investment industry are set to be thrashed out at a meeting of European Union finance ministers here Tuesday.

An agreement is likely, EU diplomats said, because the proposals will be decided by a qualified majority and no country has power of veto over the final decision. But there is likely to be a heated debate over the rules, which some countries say contravene the EU's single market principles.

"The Spanish presidency have more of an appetite for reaching an agreement than for following an approach that everyone will agree to," a diplomatic source said.

"We are very close to having the conditions to have a general approach," a Spanish diplomatic source said on Friday. Spain currently holds the rotating presidency of the European Union. "It's a decision that has been discussed for almost a year now."

The European Commission proposed its Directive on Alternative Investment Fund Managers last April in a bid to regulate the industry better, chiefly by restricting the marketing and selling of alternative funds within the European Union.

The current proposals are not acceptable to the UK, diplomats said, as they fear that too strict regulations will drive London's thriving hedge fund industry to territories not bound by the rules, for example, Switzerland.

Earlier this week US Treasury Secretary Timothy Geithner waded in to the debate, warning in a letter to EU Internal Markets Commissioner Michel Barnier that the proposals could be considered protectionist.

"It is very clear, and it is in Commissioner Barnier's mind, that these measures would not take the form of something protectionist," a European Commission spokesman told reporters Friday, rejecting Geithner's claims.

But the UK delegation is said to share the US concerns that the current proposals "go against single market principles."

The main sticking point is the terms under which fund managers and funds based outside the European Union are able to market themselves within the 27-member state bloc.

Under the current proposal these funds and fund managers would require a "passport" which allows them to market within the EU.

The UK is concerned that fund managers and funds based outside the EU will not be able to access the EU's single market because they will not be able to get a passport, and therefore will not be able to market to EU investors.

Proponents of the legislation say it allows fund managers based outside the EU to market their funds within the bloc, provided they comply with the minimum rules.

French diplomats said Friday that they are supporting the legislation because they want to prevent potentially risky and unregulated products from non-EU territories, for example the Cayman Islands, being marketed and sold to their investors.

"It's not protectionist because there is a passport," a French diplomat said.

"There are still issues which are under discussion," a Spanish diplomat said on Friday. "It is a sensitive area."

But he added that agreement was likely on Tuesday. If agreement is reached the new rules are likely to come into force in 2012.

"We have been working on all sorts of compromises," another EU diplomat said.