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Brussels, 16 July 2008
Improved EU framework for investment funds - Frequently Asked Questions (see IP/08/1161)
What does the UCITS Directive regulate?
UCITS (Undertakings for Collective Investment in Transferable Securities) are investment funds established and authorised in conformity with the requirements of Directive 85/611/EEC. In order to keep pace with growing financial innovation in financial markets the Directive was amended in 2001.
The UCITS Directive lays down common requirements for the organisation, management and oversight of UCITS funds. The Directive defines a list of eligible assets in which a UCITS fund can invest. It also imposes rules relating to the diversification and liquidity of the fund's portfolio. Thanks to these strict requirements, UCITS funds enjoy world-wide reputation of a well supervised financial product.
UCITS are an important long-term savings product widely used by European households. It gives small investors easy access to a professionally managed and diversified basket of financial instruments at affordable costs.
Are UCITS also successful outside Europe? How will the proposal impact on that situation?
UCITS legislation has been largely successful in delivering an effectively functioning market for retail funds in the EU. The success of the UCITS however does not stop in the EU. Third country regulators, in particular in Asia and Latin America, have allowed the sale of EU domiciled funds in their markets (subject to local registration). In recent years, third country sales have accounted for up to 40% of new sales of UCITS funds - primarily from Asia.
In 2007, the majority of the international UCITS were sold in Asia. Most fund managers believe that the proportion of UCITS held by investors in Asia, Middle East and Latin America will increase in the next three to five years.
In this context, any improvement introduced at EU level to the UCITS framework should directly and positively impact on the competitiveness of European funds on global markets.
Why do we need to propose changes to the current UCITS framework? What are the main problems?
Despite the global success of UCITS as the key retail-oriented investment, the operation of the current framework causes a number of efficiency bottlenecks that the new proposal aims to tackle.
The need to address those problems comes at the time when UCITS are facing an increased competition from other forms of financial products (unit linked insurance products, structured products). In addition, competition from other jurisdictions starts to build up as well. It is therefore essential to eliminate unnecessary cost and address challenges brought by fast moving innovation in financial markets.
How will the proposal improve the efficiency of the UCITS framework?
The new rules will allow UCITS managers to develop their cross-border activities and generate savings from economies of scale. Investors will benefit from a greater choice of investment funds operating at lower costs. The new rules aim at increasing the efficiency of the current legislative framework in a number of key areas:
How will the Commission simplify current rules governing cross-border distribution of UCITS?
The current practice of host Member States authorities often does not allow UCITS to be easily distributed on a cross-border basis. The current two-month granted to host authorities to check notifications is often not respected and additional requirements on foreign funds are imposed.
Emerging delays put UCITS in a disadvantaged position vis-à-vis other retail products that can be placed on the market in much shorter time. In addition, these restrictions significantly hamper competition between foreign and domestic funds. As a result, investors bear high fees and are deprived of a broader choice of investments.
The proposed changes aim at reducing costs and delays for the notification of foreign funds. They clarify the supervisors' responsibilities and ensure that a duly authorised UCITS has a right to access the market of another Member State, upon notification, without delay. The proposal removes the ex-ante control of host supervisor before marketing of units of UCITS can start. The new procedure is based on electronic exchange of information between regulators upon request of UCITS.
Improved procedural rules on funds' distribution will significantly improve cross-border market integration. This will force fund managers to improve their performance in order to be able to compete with top-class competitors and it will increase fund choice for investors. Most importantly, these measures will translate to a significant reduction of direct annual costs of notification and shorten time-to-market for foreign funds.
Why is it important to allow fund/mergers?
The proposal offers the possibility for UCITS to achieve greater economies of scale by introducing into the UCITS Directive a legal framework for fund mergers, which should ultimately also benefit the investors through lower costs and higher performance.
The basic principle provided for, is that all UCITS (and compartments thereof), irrespective of their legal form, are entitled to merge. This new merger regime, including its safeguards for investors, will cover both domestic and cross-border mergers. Domestic mergers may indeed have an impact on investors based in other Member States.
It is important though that investors and other third parties involved are adequately protected. A fund merger will therefore be subject to prior authorization by the competent authorities of the merging UCITS (i.e. the "disappearing" entity), before its presentation to the unit-holders. Additional measures to safeguard unit-holders' and other third parties' interests include (i) third party control (by depositaries and independent auditor); (ii) adequate disclosure to unit-holders (the proposal specifies the basic principles of investor disclosure to the unit-holders of all funds involved in the merger, details of which will be developed through implementing measures); (iii) other unit-holders' rights (voting rights, right to redeem without costs prior to the merger). Finally, the proposal also clarifies that the responsibility for the costs of the merger should not lie with the unit-holders, but with the manager/fund promoter which should further enhance investor protection.
What is a master/feeder structure and what benefits will it bring?
The proposed master/feeder structures enable a 'feeder' fund manager to invest between 85% and 100% of the fund's assets into one other fund (the so-called master fund). Instead of actively managing the assets of the feeder fund, the feeder fund manager de facto delegates the portfolio management to the manager of the master fund.
Master/feeder structures provide the following benefits: (i) investors of the feeder fund profit from economies of scale when pooling the assets of the feeder and the master funds; (ii) the centralisation of core investment management in a single high-performing team; (iii) the commingling of similar funds designed for different types of investors and with different fee structures in one entity; (iv) the local presence of the feeder funds providing advantages in terms of servicing client needs, and greater tax-efficiency for the end-investor; and (v) to enable merged financial groups to pool similar funds of both groups in one master fund (and thereby reduce management costs) while preserving the different fund labels.
How will the Commission improve the provision of information to investors?
The simplified prospectus, which under the current rules has to be provided to investors prior to their subscription to the fund, is intended to provide the average retail investor with basic information about the fund. This enables him/her to make an informed investment choice. However, extensive consultation with industry, consumers and regulators showed that it is not meeting these objectives: it is too long, too complex and does not allow for useful comparisons.
The Commission proposal therefore aims to develop a very short and easily readable disclosure document that helps the investor to understand the key features of the proposed fund investment (i.e. strategy and objectives, risk/reward, performance and charges) and to select the fund investment that best corresponds to his/her expectations. This information will be provided in the local language of the country where the fund is sold to the investor.
This implies principles-based changes to the UCITS Directive as it will replace the 'simplified prospectus' concept by a new concept of 'key investor information' (KII). Detailed rules on the exact content and format of the KII will be laid down in implementing measures. This is done in close association with national authorities and other stakeholders. The Commission also decided to test this concept with representative consumers before adopting detailed rules. The results of the testing will feed into the detailed rules, to be adopted by the Commission, on the content and presentation of the key investor information.
Why did the Commission not pursue the idea of allowing UCITS to be managed by companies established in a different Member States (so-called management company passport)?
The in-depth consultation process, including positions expressed by several national supervisors, revealed the existence of serious supervisory and investor protection concerns in respect of the establishment of a well-functioning management company passport. The split of supervisory responsibilities between the authority responsible for the supervision of the fund and the authority responsible for the supervision of its management company poses a real challenge.
There are uncertainties, in particular, regarding the allocation of responsibilities between these two supervisors and on the information flows that would need to be established between the different actors concerned (supervisors, fund, management company, depositary) to ensure effective on-going supervision. Another key issue would be to define effective cross-border enforcement mechanisms to deal with breaches of the rules governing the fund. In the context of the current financial turmoil, it is all the more important not to gamble with regulatory failure that could have huge effects on ordinary savers.
The Commission also considered that any new mechanism that would be required to ensure the proper supervision of funds managed on a cross-border basis should not lead to disproportionate compliance costs and complexity for business operators. If new management opportunities were accompanied by burdensome procedures or heavy regulatory requirements, they would bring little gain to fund managers and investors.
The Commission considers that the approach to deliver practical solutions to the concerns regarding the management company passport has not crystallised yet. Further work is needed to find the right balance between supervisory and investor protection needs, on one hand, and the benefits expected by the fund industry on the other. Since the UCITS reform package includes other improvements of the UCITS regulatory framework which are awaited by market participants, the Commission wants to avoid further delays in the adoption of the proposal. In parallel, the Commission will ask the Committee of European Securities Regulators (CESR) for advice, on robust and effective solutions to the identified supervisory challenges.
What will be the content and timing of the Commission's request for assistance to CESR in respect of the management company passport?
The Commission believes that CESR can provide valuable technical advice on the arrangements that are needed to ensure effective oversight of UCITS funds which are managed on cross-border basis. The Commission seeks answers to questions on the division of supervisory responsibilities and the design efficient mechanisms for cross-border enforcement. The Commission believes the practical experience of CESR will help define the conditions needed for a well-functioning passport. Particular attention should be paid to cross-border supervision of contractual funds, which have no legal personality. In many Member States UCITS are indeed only established in this contractual form.
The Commission has asked CESR to deliver its advice by the 1st of November 2008.
Has the Commission carried out a cost-benefit analysis of its proposal?
In conformity with the Better Regulation principles, the Commission has undertaken an extensive stakeholder consultation and contracted an external expertise to gather sufficient input into its cost-benefit analysis of a potential EU level intervention. This analysis in the form of an Impact Assessment is published with the current proposal. It is the fruit of a four-year intensive preparatory process. It concludes that there is a need to amend the UCITS Directive in order to introduce the most far-reaching changes in the current framework, both in terms of substance and procedure. The binding nature of these changes will ensure a proper and harmonised implementation within a given period of time (two years and half after the adoption of the Directive).
Will the proposal contribute to the general policy of the Commission to simplify administrative procedures and cut red tape?
The proposal removes administrative requirements and procedures that proved to add little to investor protection. It provides for solutions that optimise disclosure to investors as well as information flows between supervisors and fund managers. Where possible the electronic exchange of data is foreseen, in particular for cross-border notification of UCITS. Strict deadlines for supervisors are introduced to transmit the notification file (one month), approve mergers of UCITS or certain master/feeder structures. This will significantly cut the current red tape, improve decision-making processes, help fund managers to better plan and implement their business strategies.
The fact that the proposal is presented in the form of a recast of the existing UCITS Directive - which has been modified 10 times since its adoption in 1985 – is another source of simplification. These successive texts will be compiled into a single document putting together existing rules that will not change (the 'codified part' of the text), with the new provisions described above. This will significantly improve the readability of the UCITS legislative framework making it easier for stakeholders and national supervisors to implement on a daily basis.
How did the commission consult the stakeholders when preparing its proposal?
The proposal to amend the current UCITS framework is a result of a long and extensive consultation process dating back to 2004, when a new strategy for the post-Financial Services Action Plan was being developed.
In the area of asset management an expert group was set up in 2004 of whose subsequent recommendations served as a starting point of an extensive process of reflection on ways to improve the functioning of the European market for investment funds.
After the publication the Green Paper on the enhancement of the framework for investment funds in July 2005, the Commission launched two fact finding studies. The first one, mapping current trends in the European Asset Management industry was complemented by another study looking at potential cost savings in a fully integrated European investment fund market. By the end of 2005 the consultation of the Green Paper was finalised preparing the ground to feed to the next steps in the consultation process.
The year 2006 further deepened the preparatory process. Early on in the year, the Commission established two expert groups to further explore the need and form of possible measures with regards to market efficiency and alternative investments. Their final conclusions were then subject to an open hearing organised in July 2006. In parallel, the Commission has organised two workshops on Simplified prospectus. The variety of inputs and analysis undertaken up to that date has culminated in the adoption of the White Paper on investment funds in November 2006.
In order to reinforce the input of investors (their responses are usually less numerous than industry's ones) into the process, Commission services have worked closely with several groups representing investors' interest. In particular, the Financial Services Consumer Group and input of FIN-USE (the forum of user experts in the area of financial services) provided views as to the essentials of the proposal to safeguard interests of consumers.
On the basis of the extensive input received, main focus of the Commission's work in 2007 was to present and publicly consult via an open hearing its initial orientations on changes to the UCITS Directive, to which is also referred to as 'exposure draft'. This step in the process is relatively unique and further confirms the Commission's commitment to openness and transparency in all stages of the proposal's preparation. This has been frequently highlighted and acknowledged by stakeholders.
Is the new UCITS Directive a 'Lamfalussy' Directive? Will additional implementing measures be based upon it?
The substantial changes that the Commission proposes to make to the UCITS Directive are designed in accordance with the 'Lamfalussy' format. The amendments foreseen in this Directive, introduce principles-based provisions that will be complemented by implementing measures adopted by the Commission. Implementing measures will deal with the more technical requirements and will be prepared on the basis of advice provided by CESR.
The Commission considers that this is the most efficient approach to ensure that the new rules will benefit from the input and experience of the national supervisors. It will also allow for regular updates of these technical requirements as they will not have to be adopted through the co-decision procedure (adoption by the European Parliament and Council).
For example, the new principles-based provisions according to which key investor information should be provided to investors in good time prior to their proposed investment will be introduced by the present proposal. However, rules governing the precise content and presentation of this information will be determined by implementing measures.
When will the new UCITS Directive be in force?
The Commission proposal will now be discussed with the European Parliament and Council. Once adopted, Member States will have to implement the new provisions and adapt their national rules. The new provisions will become applicable two years and half after their adoption. This suggests a realistic timeframe for the entry into force of the measures (assuming political approval on the Commission's proposal in the second quarter of 2009) will be mid 2011. At that time, both the present Directive and its implementing measures will be applicable.