SOMMARIO:

Executive summary - 1. - 2. - 3. - 4. - 5. - NOTE

Executive summary

The UCITS IV proposal recasting the 1985 UCITS Directive (85/611/EC) does represent a significant and necessary regulatory improvement of the existing harmonized UCITS regime to foster the construction of a truly pan-European competitive market for European UCITS. The proposal tackles at least some of the regulatory obstacles to a deeper market integration and it should prove effective especially in its new provisions on (national and cross border) mergers and asset pooling. I  also welcome the proposals of reform concerning, on one hand, the simplification of the notification procedure to be followed in order to market UCITS units in one or more host Member States and, on the other hand,  the shift in the disclosure philosophy, as regards the information to be given to retail investors, from prospectus to “key investor information” (KII). In the legislative debate attention must be paid, however, to the adequacy of the safeguards provided for by the proposal in the interest of unit holders and potential investors at large. Nonetheless, despite the remarkable efforts of the UCITS IV proposal, it seems quite dubious that these major amendments to the UCITS Directive shall suffice to create a truly single market platform. On one hand, the current (provisional) decision of the Commission not to implement a well functioning management companies’ passport due to concerns on their proper cross-border supervision, clearly restrains competition on a pan-European scale and limits the efficiency and flexibility gains  expected by the industry from UCITS IV. It remains to be seen, therefore, the position which CESR shall take on the Commission request for assistance. On the other hand, it seems that the persisting lack of harmonization of advertisement and marketing rules, albeit partially cured by KII innovation, still makes it difficult for a fund to follow a one single pan-European marketing strategy. The same can be said of the “multitude of ways national tax laws discriminate against foreign funds” (as it has been said in the literature), so as to raise additional barriers to the sale of foreign UCITS funds in their territory. But in my view a major (and perhaps still the major) obstacle to the establishment of a truly pan-European competitive market for UCITS funds remains outside the scope of the Directive and is represented by existing distribution channels. Based on market forces alone, an open [continua ..]

1.

The Committee has requested an opinion on the following question: “UCITS is a European invention and has been very successful since its inception. It now threatens to fall back if European regulation is not flexible enough in order to create a true single market platform. Is the current UCITS IV proposal sufficient in your opinion?”. This briefing paper endeavours to answer this (complex) question in the few pages requested and is organized as follows. Paragraph 2 provides a brief survey of the development of European investment fund regulation from UCITS I to UCITS III and shows its impact on the market. Paragraph 3 describes the recognized weaknesses of the existing UCITS regulation and the main features of the UCITS IV proposal of reform also in the light of its impact assessment. Paragraph 4 evaluates the UCITS IV proposal, it comments on its rationale and considers in detail a few new provisions which, in my opinion, should deserve close scrutiny from the EP. Paragraph 5 briefly tries to look ahead, and in particular to assess UCITS IV against the backdrop of the policy goal to establish a truly effective pan-European competitive market for UCITS.    

2.

The UCITS Directive was designed, from the outset, to promote the free movement of (harmonized) collective investment schemes and in particular to make it easier for a collective investment scheme established in one Member State to market its units in another Member State (recital 2, directive 85/611/EEC). To attain this goal the directive primarily focused on the UCITS as a product and on the cross border marketability of their units, rather than on the market access and regulation of those who manage the UCITS: a feature which, however, was subsequently covered in some detail by the UCITS III amendment (directive 2001/107/EC). As it has been correctly said in the literature [1], “the UCITS I Directive, for the most part, concerns an investment product (and), to a limited extent, regulates investment services providers in the more traditional sense. It stands, as a result, on the cusp between the official listing/public offer regime, which focuses on the capital raising process and trade in securities and the investment service regime which would follow. Its harmonization technique places it with the later investment services regime, however. Its market-integration mechanism of mutual recognition, home country control and the conferment of a regulatory passport is sharply different from the detailed harmonization mechanism used by the official listing regime in the initial phase of harmonization. Indeed, the UCITS Directive serv(ed) as a template in the securities regulation field for the regulatory passport which would come to dominate the regulation of investment services”. The legislative history of the directive confirms that the primary goal of this piece of European legislation was the promotion of a single market for these financial products: in fact, albeit the Segrè Report had already advocated community action in 1966 to stimulate, through collective investment schemes, the emergence of a European equity capital market capable to attract the saving of the public at large, by 1976 (at the time of the first Commission proposal) and by 1985 (at the time at the adoption of the UCITS I Directive) collective investment schemes were still subject to quite different regulatory regimes in many Member States and, for this reason, were excluded from the two early free movement of capital directives. Collective investment was therefore fragmented along national boundaries. The UCITS I defined, therefore, a set of requirements which [continua ..]

3.

The Commission, following  the research and consultation process  launched with the Green Paper on Investment Funds (COM 2005 314 final, 12 July 2005) and developed  with the White Paper on Investment Funds (COM 2006 686 final, 15 November 2006) and its first Impact Assessment, identified a series of problems and regulatory bottlenecks to industry efficiency. It concluded that EU action in recasting the UCITS Directive would be justified on five issues: a) notification procedures to the host Member State supervisory authority; b) fund mergers; c) asset pooling; d) management company passport and e) a simplified prospectus. Indeed, the Commission identified as problems requiring a change in the UCITS Directive the following: a) First, the existing barriers to marketing funds in other Member States represented by the notification procedure introduced by the 1985 UCITS Directive. This proved in practice “often long and cumbersome”. According to the Commission, “host regulator’s requirements often exceeds those in the Directive and the two month limit is not always respected. As a result the procedure has been compared to a second authorisation of the fund” b) Second, the proliferation of funds of a sub-optimal size. According to the Commission “the European fund market landscape is characterised by a high number of small funds. At the end of 2006, 54% of European funds managed less than € 50 million in assets. The average European fund is more than five times smaller than its American counterpart[6]. Managing large ranges of small funds is costly. It impedes the exploitation of economies of scale and increases costs”. c) Third, the lack of flexibility in organising the industry value chain. The Commission finds that despite UCITS III “it is currently not possible for management companies to manage a UCITS in anotherMemberState. Ambiguities in the Directive text and split supervision concerns have deprived the relevant 2001 provisions of their effect. As a result fund groups are obliged to establish a fully fledged management company in each Member State where they wish to base a fund range”. d) Fourth, an ineffective simplified prospectus. The Commission finds that “despite the clarification provided by the Commission Recommendation in 2004 (2004/384/EC of27 April 2004) the simplified prospectus has failed in its mission to [continua ..]

4.

 In my view the UCITS IV proposal does represent a substantial step forward in the right direction. It tackles indeed at least some of the regulatory obstacles to a deeper market integration and it should prove effective especially in its new provisions on mergers and asset pooling. As anticipated, on fund scale and connected cost efficiency there is a major delay of the European industry if compared to the US industry [7]; a strive towards consolidation and asset pooling seems therefore justified and should normally improve the current situation. Attention should be paid however, in the legislative debate, on the safeguards for investors. In particular, the proposal on UCITS mergers relies on disclosure (Article 40), exit (Article 42) and, to a limited extent, voice for unit holders (Article 41). The (self)-protection of unit holders is complemented, moreover, by the authorisation procedure set out by Article 36, whereby “mergers shall be subject to the prior authorisation by the competent authorities of the merging UCITS home Member State” and “the competent authorities shall consider the potential impact of the proposed merger on unit holders of both the merging UCITS”. As recognized also by the Commission, there is here a clear need of protection for investors; this stems from the very fact that the merger by itself affects the portfolio composition of the merging UCITS, necessarily encompassing a change in the risk profile of the investment: a change which varies depending on the degree of homogeneity of the pre-merger portfolio composition but can be very substantial where the merging UNITS follow very different investment policies. The remedy for dissatisfied unit holders provided for by the proposal is exit: “the laws of Member States shall provide that unit holders of both the merging UCITS and the receiving UCITS have the right to request the repurchase or redemption of their units, or where possible, to convert them into units in another UCITS with similar investment policies, without charge”. It might be questioned, however, if an adequate level of investor protection does not require also that, in similar exceptional circumstances, unit holders be given on an harmonized EC basis extraordinary voice rights; that, in other terms, the Directive mandates that the merger be approved by a set percentage of unit holders. A solution which, in fact, the proposal envisages under Article 41 but leaves [continua ..]

5.

It remains to be considered, however, if these major amendments to the UCITS Directive shall suffice to create a truly single market platform. This seems to me quite doubtful. On one hand, the current (provisional) decision of the Commission not to implement a well functioning management companies passport (due to concerns on their proper cross-border supervision) clearly restrains competition on a pan-European scale. It limits the efficiency and flexibility gains to be expected by the industry from UCITS IV; moreover, it discriminates  the regime of UCITS managers in respect to the full passport regime already applied by MiFID to investment companies. It remains to be seen, therefore, the position which CESR shall take on the Commission request for assistance and in particular if CESR will not be able, as it should be, to devise, also in this respect, a well functioning system of supervisory cooperation (as it was possible, albeit in a different context, with the Supplementary Supervision of Financial Conglomerates) capable to remove the risk, envisaged by the Commission, “to gamble with regulatory failure that could have huge effects on ordinary savers”. On the other hand, it seems to me that the persisting lack of harmonization of advertisement and marketing rules, albeit partially mended by KII innovation, still makes it difficult for a fund to follow a single pan-European marketing strategy, with an increase in fixed cost which diminishes the incentive for a fund to access host Member States unless there is a significant business potential. The same can be said of the “multitude of ways national tax laws discriminate against foreign funds” [10], so as to raise additional barriers to the sale of foreign UCITS funds in their territory. Moreover, in my view, a major (and perhaps still the major) obstacle to the establishment of a truly pan-European competitive market for UCITS funds remains outside the scope of the Directive and is represented by existing distribution channels. This is an issue already identified as requiring some kind of corrective action both in the literature [11] and in the regulatory setting (the Commission acknowledges in its impact assessment that, as things stand now, “at the distribution level the move towards the open architecture – i.e. the fact for a distributor of offering third party funds instead or in addition to its “in house” fund range – [continua ..]

NOTE