Enhancing the framework for investment funds
The investment fund sector is undergoing constant change. It also contributes to the development of integrated and efficient European markets. This Green Paper launches a debate on possible improvements to the Directive on undertakings for collective investment in transferable securities (UCITS) which, due to a lack of precision and flexibility, is not keeping pace with developments in the market
Green Paper on the enhancement of the EU framework for investment funds [COM(2005) 314 final - Not published in the Official Journal]
Investment funds play a major role in European capital markets, and the most common form of these are Undertakings for Collective Investment in Transferable Securities (UCITS). This Green Paper seeks to enhance the legislative framework of the short and medium-term funds sector with a view to raising its performance and strengthening integrated and efficient European markets.
The funds sector has grown, and Europe's UCITS legislation - amended Directive 85/611/EEC - has not developed its full potential. The Green Paper (accompanied by an in-depth analysis) offers an initial assessment of its impact. In effect, new challenges which lie outside the scope of this Directive highlight its shortcomings:
- rapidly evolving financial markets and the lack of flexibility in the current legislation;
- the emergence of alternative and more sophisticated investment strategies, substitute products and new risks;
- market expectations and the need to protect investors - especially when confronted with changes in the range of products and distribution networks.
Even though cross-border UCITS are developing into significant players, this cross-border dimension to the UCITS directive is still unsatisfactory. As a result, European funds are significantly smaller than their US counterpart, which does not make it possible to achieve economies of scale. The Green Paper therefore proposes that maximum use be made of all the possibilities offered by the current framework.
The potential offered by existing legislation
The first step towards making the legislation on UCITS more effective is uniform application in all Member States.
Priority actions are therefore needed to clarify and consolidate the measures that already exist, some of which were intended to back up the UCITS Directive.
On the one hand, there is a need to explain the notion of product. The Directive on products extended the range of assets under management by UCITS. Products have, however, become more diversified and sophisticated, thus making it necessary to re-think the way in which UCITS are sold or promoted. More specifically, information on the products should be responsive to how they develop.
On the other hand, the changes made by Directive 2001/107/EC on management companies supplemented the UCITS product passport with a management company passport. Despite that, the management company passport has still not materialised. The framework for the passport should, in itself, be improved; the ambiguities arising from the Directive should be cleared up so that it can genuinely act as a passport.
The priority actions to make the current legislation work more effectively should focus mainly on:
- simplifying the notification procedure for passporting funds;
- promoting implementation of the Commission's Recommendations on the use of derivatives and the simplified prospectus;
- clarifying the concept of "assets" which can be acquired by UCITS.
It should also be possible to adapt the current legislation to long-term challenges. The rapidly evolving financial markets, greater product sophistication and diversification of investment strategies coupled with the emergence of alternative investment strategies, and the growing demand from investors do, in fact, make it essential to rationalise the existing legislation.
As a result, it is necessary to consider way of reducing costs. Consolidation of the sector would help make it more competitive given the number of small funds. The Green Paper proposes the following options to facilitate consolidation:
- cross-border fund mergers;
- fund pooling with collective management and administration;
- rationalisation of fund custody and depositary services by separating the management company from the depositary;
- improving the organisation of fund administration on account of the excessive fragmentation of the European infrastructure for processing subscription/ redemption orders.
At the same time, there is a need to consider the wider asset management landscape insofar as UCITS are competing with new products which replicate some UCITS features. These substitute products could therefore have a harmful effect on the smooth functioning of the market and investor protection insofar as they are also subject to different legislation. For example, these products may not face such tough obligations as regards transparency on fees and costs.
Likewise, the emergence of alternative and more sophisticated investment instruments may involve higher risks for investors, yet there is no united approach to them in national legislation.
The Green Paper takes up the idea that the legislation on UCITS should be modernised by adopting the Lamfalussy two-level approach: level 1 being framework legislation and level 2 detailed legislation to implement the framework legislation. The legislation would thus be more flexible and more responsive to change. This sort of approach should not, however, be taken lightly as it would constitute an upheaval of the current framework and would involve major changes. For the moment, there seems to be no justification for such an overhaul, as the necessary improvements can be made within the current legislative framework.
In 2006, the Commission presented the White Paper on enhancing the single market framework for investment funds [COM (2006) 686 final]. In this document, the Commission presented a number of measures intended to reform the current Community framework for investment funds (the UCITS Directive).
These changes are intended to simplify the regulatory and operational environment and to propose attractive and safe investment solutions to investors.