Investment Funds - From UCITS III to UCITS IV
Undertakings for Collective Investment in Transferable Securities (UCITS III) were introduced by the law of 20 December 2002 (the “2002 Law”), and benefit from a European Passport enabling them to be freely marketable throughout the EU countries. However, unsatisfactory elements relating to the current state of the Law paved the way to discussions about a possible ‘mutation’ from UCITS III to UCITS IV.
Those include, inter alia, details in the cross border distribution, in the simplified prospectus, and in the management company passport. In this context, the European Commission on 16 July 2008 published proposals to enhance the efficiency of the current legislative framework for UCITS. This could create, more than 20 years after the enactment of the first UCITS Directive, a genuine pan-European single market for investment funds, which would improve market efficiency and investor protection. Two types of legislative changes are contemplated: some aiming to enhance the working of existing provisions (in particular in relation to the notification procedure, the management company passport and the simplified prospectus), and others intended to introduce new single market freedoms (by creating inter alia a facilitating framework for fund mergers).
Cross Border Distribution
The first proposal aims at simplifying the procedures enabling the cross-border distribution of UCITS. In the current regime, detailed documentation must be filed on behalf of the UCITS with the regulator in the host Member State, which has theoretically two months to confirm compliance with the host Member State’s advertising laws. However, in practice, this process usually takes much longer and it is therefore unnecessarily time-consuming and costly. Consequently, it impedes greatly cross-border distribution and calls into question the concept of a single market to its very roots.
To cope with this problematic deficiency, it is proposed to replace the current regime with a simple, electronic, regulator-to-regulator notification procedure by which a UCITS seeking to market its units in another Member State informs its own regulator of its intention to do so and sends to it the necessary notification documents. Those documents shall consist of a Key Investor Information Document (see below) - which the UCITS is in the obligation to translate into the local language of the host Member State -, the full prospectus, the constitutive documents and the latest annual and any subsequent half yearly reports. A consequence of the new regime is that the marketing of units in the funds will be possible within three days of the file’s transmission from home to host regulator.
The home regulator reviews that information, and, if complete, transmits them within one month of receipt of the documents to the host regulator with an attestation confirming that the UCITS fulfils its obligations, and the UCITS may commence inward marketing in the host Member State from the date of transmission. The transmission of that information should take place electronically (see point II of this newsletter).
Key Investor Information
The concept of simplified prospectus is deemed to be another failure of the UCITS III regime. Originally, it was intended to provide investors with all basic information relating to the UCITS, in order to enable them to make an informed investment choice. In practice, the simplified prospectus failed to meet those expectations, as it is often very lengthy, and implemented differently across the EU.
It is therefore suggested to replace this simplified prospectus by a ‘key investor information’ document, which will provide key facts to investors before the conclusion of a contract. It will have to be set out in a common format in all Member States, thereby allowing for effective comparison, and shall be presented in a brief manner and in non-technical language, likely to be understood by retail investors. Key information shall include a short description of the investment objectives and policies of the UCITS, past performance, costs and associated charges and risk/award profile of the investment including appropriate risk warnings. Investors should note that this document is considered as pre-contractual information and hence liability should not be imposed solely on the document itself unless it is misleading or inaccurate.
Fund Mergers
Pursuing its general aim of promoting a single market, the European Commission proposed to remove barriers to amalgamation of funds which would, inter alia, cope with the proliferation of small and inefficient funds.
In this context, the proposal provides a framework for domestic and cross-border mergers of UCITS, introducing a basic principle that all UCITS are entitled to merge, regardless of the structure (e.g. corporate, unit trust or contractual). It should be pointed out that approval by investors is only necessary if required by national law. However a maximum threshold ceiling of 75% of the votes cast by unit holders is envisaged and this will be especially significant in Luxembourg since 100% unit holder approval is currently required to merge a Luxembourg UCITS with another UCITS. The proposals are however silent as to whether merging funds must have similar investment objectives and policies.
Master-Feeder Structures
The European Commission also innovated by proposing to introduce the ability to establish limited master-feeder structures. This could result in significant economies of scale and a reduction of charges for investors. The feeder UCITS and the master UCITS must enter into a legally binding agreement in which the feeder fund will be required, inter alia, to have at least 85% of its assets in a single master fund. Additionally, the feeder fund will have to act in the best interests of its investors and to monitor effectively the master UCITS.
Management Company Passport
The most controversial element introduced by the UCITS III regulation was undoubtedly the management company passport, originally designed to enable a manager that managed UCITS in a number of jurisdictions to centralise its activities within a single jurisdiction. The rationale being that this would result in significant economies of scale and better control as all activities would be carried out in a single company. However, the lack of EU-wide consensus on what the passport entailed resulted in different opinions when it came to interpreting the meaning of the management company passport concept. Opponents to a full cross-border passport point out that the regulator of a UCITS having a management company not regulated in the same jurisdiction could deprive the UCITS regulator of the means to monitor and enforce compliance with regulatory provisions in force in the UCITS domicile. Others are concerned with the fact that such a measure would be likely to create problematic regulatory and tax issues. The Commission has therefore requested CESR to provide advice on how to operate by 1 November 2008. On 31 October 2008, CESR had completed their work on the management company passport issues and published their advice to the European Commission. For more information, we refer to the CESR advice that can be found at the following address: http://www.cesr.eu/popup2.php?id=5367. It mainly followed the draft paper that was issued in September 2008 containing advice on issues relating to definition of domicile, applicable law and supervisory responsibilities, authorisation procedures for UCITS funds whose management company is established in another Member State, on-going supervision of the management of the fund, and finally on how to deal with breaches of rules governing the management of the fund.
The controversy over the management company passport shows how much the mutation from UCITS III to UCITS IV is far from being achieved. The UCITS proposals will however be presented to the EU council of Ministers and the European Parliament for approval. If they are adopted by mid 2009, it is contemplated that these provisions will come into force in mid 2011.
