UCITS IV – A critical analysis and impact on Europe and...

Faculty of Law, Economics and Finance

UCITS IV – A critical analysis and impact on Europe and Luxembourg

—

ERASMUS INTENSIVE PROGRAM 2012

Illustration: the University of Luxembourg

Sara Ndou & Guillaume Kardjoe Tutor: Jean Marc Goy

Erasmus IP -‐ 2012 Topic 1

University of Luxembourg Sara NDOU Guillaume KARDJOE

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Abstract This paper aims to present a critical analysis of the UCITS IV Directive1 and its impact on Europe with a focus on Luxembourg. We begin with an overview of the past developments concerning the European legislative framework. Then we continue with a presentation of the European UCITS market providing also data concerning Luxembourg. These introductory presentations would set the scene and allow us to develop in more detail the objectives of the new directive by elaborating on the related topics. Finally we close with a critical analysis and a presentation of the impacts produced by this new legislative framework.

1 Directive 2009/65/EC



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Table of contents Abstract ................................................................................................................. - 2 - Introduction .......................................................................................................... - 4 -

1. INTRODUCTION TO UCITS IV ............................................................... - 5 -

1.1. UCITS: FROM ONE TO THREE TO FOUR ................................................ - 5 -

1.2. UCITS IV: ONE STEP CLOSER TO THE SINGLE MARKET DREAM ....... - 6 -

2. THE EUROPEAN UCITS MARKET......................................................... - 8 -

2.1. EUROPEAN FUNDS MARKET .................................................................. - 8 -

2.2. LUXEMBOURG FUNDS MARKET............................................................ - 9 -

3. THE UCITS IV DIRECTIVE ...................................................................... - 11 -

3.1. UCITS IV: THE NEED FOR CHANGE ....................................................... - 11 -

3.2. KEY PROVISIONS OF UCITS IV ............................................................... - 12 -

3.2.1. Strategic opportunities ..................................................................... - 12 -

3.2.1.1. Cross-border mergers .................................................................. - 12 - 3.2.1.2. Master-Feeder structure .............................................................. - 14 - 3.2.1.3. Management Company Passport................................................. - 16 -

3.2.2. Other changes.................................................................................... - 17 -

3.2.2.1. Notification procedure ................................................................ - 17 - 3.2.2.2. Key Investor Document .............................................................. - 18 -

3.2.3. Cooperation between supervisors authorities ................................ - 19 -

3.3. IMPLEMENTATION .................................................................................. - 20 -

4. UCITS IV DIRECTIVE: A TANGIBLE REALITY IN EUROPE .......... - 21 -

4.1. IMPACT ON THE EUROPEAN MARKET.................................................. - 22 -

4.2. IMPACT ON THE LUXEMBOURG MARKET............................................ - 24 - Conclusion............................................................................................................. - 25 - References ............................................................................................................. - 26 -



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Introduction The European Union is aiming to achieve a single market. To reach this goal, it is essential to set up a common legislative framework for the fund industry. This is the key to a harmonized market where the products issued in different countries would be fully harmonized. This requirement is important in that it provides a uniform protection within the European Union. Europe launched the first UCITS Directive in 1985. Undertakings for collective investment in transferable securities (UCITS) are investment funds which meet the criteria laid down by the EU Directive2. One of the principal innovations of this directive was permitting distribution to investors in any other EU Member State3. Unlike UCITS, non-UCITS are funds that comply with the national law but aren’t in line with the Directive. There have been three UCITS Directive during the last two decades. Our paper will focus on UCITS IV4, which is the last Directive. Luxembourg was the first EU Member State to transpose UCITS IV into national law by the “Law of 17 December 2010” relating to undertakings for collective investment.5 UCITS is well accepted outside Europe as a high quality, well-regulated investment product providing significant levels of investor protection. And Luxembourg has successfully positioned itself as the global leader for cross-border distribution of investment funds, with the result that today more than 75% of UCITS funds distributed internationally are based in Luxembourg.6 The success of Luxembourg is based primarily on political and social conditions and a modern legal and regulatory framework constantly adapted to changing market through an ongoing dialogue between government, the legislature and the private sector.7

2 Luxembourg for Finance 3 Ernst and Young June 2009 4 Directive 85/611/EEC relating to undertakings for collective investment in transferable securities (UCITS), as amended

5 Association of the Luxembourg Fund Industry 6 Ernst and Young 2009 7 Luxembourg for Finance



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1. Introduction to UCITS IV

1.1. UCITS: from one to three to four UCITS is the acronym for “Undertakings for Collective Investment in Transferable Securities”. It appears in to the first directive adopted in 1985, which aimed to create a single market for funds in Europe and to ensure investor protection.8 However, the different marketing rules in each Member State was an obstacle to cross-border distribution. Furthermore the limited permissible investments hampered the possibilities of the vehicle’s growth and acceptance.9 During in the following century, discussions led to a draft UCITS II directive. This proposal was abandoned in 1997, because it was too ambitious to reach a common position from the Member States.10 It was not until 2001 that UCITS I was amended by a new directive, UCITS III, which consists of two main elements11: -‐ The Product Directive expanded the type and range of investments that a UCITS could

hold; -‐ The Management Company Directive sought to give a European passport to management

companies of a UCITS fund to enable them to operate throughout the EU as well as tightening up risk management framework and increasing managers’ capitalisation requirements.

The combined Directive was intended to widen consumer choice and consumer protection. The entities called by managers “UCITS-III-compliant” are funds that take advantage of the key benefits of the Directive as a wider investment power. The Management Directive developed the existing concept of “product passport” and introduced the “Simplified Prospectus” as a marketing document throughout the EEA12. UCITS III also was a further

8 Association of the Luxembourg Fund Industry 9 Bank of New York Mellon June 2010 10 Wikipedia 11 BlackRock September 2010 12 European Economic Area



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step to allow management companies to operate funds domiciled in other countries (the “Management Passport”).13 However the management company passport wasn’t a complete success at this time. The European Commission pointed out that more could be done as new challenges lie ahead and set out its vision for the modernisation of the UCITS directive in a White Paper14 in 2006. As a follow up, the Commission adopted on 16 July 2008 a legislative proposal for a recast of the 1985 Directive that led to the adoption of the new UCITS IV Directive in July 2009.15

1.2. UCITS IV: One step closer to the single market dream The funds landscape has changed inexorably over the past 25 years and Europe is a global leader in the international funds industry.16 UCITS is a success and a brand renowned worldwide. Despite its recognition, there were a number of weaknesses and failures. Back in 2007, the European Commission stated in a press release of the 16 June: “EU funds are on average five times smaller than US funds and the cost of managing them is twice as high”.17 After years of work and discussions as the EU White Paper issued in 2006, those points have been addressed. Indeed, a review of UCITS III by enhancing European framework for investment funds led to the adoption of the UCITS IV Directive in June 2009. Those latest amendments to the legislation had to be implemented into national law by 1 July 2011. The aim of the directive as proposed by the Commission was to simplify the UCITS directive and modernise the regulatory framework in order to ensure that investors receive useful cost and performance disclosures when selecting funds and also make it easier for the industry to achieve cost savings and specialisation benefit across the single market.18

13 BlackRock September 2010 14 European Commission « White Paper on enhancing the Single Market framework for investment funds », COM (2006) 686 final, 15 November 2006. 15 European Commission 16 Alfi – Symbiosis in the evolution of UCITS 17 Deloite 2012 18 European Commission



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To enhance its competitiveness by improving the quality of its services and reducing costs, the UCITS IV Directive aimed at fulfilling the following objectives:19

-‐ Improve investor information by creating a standardised summary information document: “Key Investors Information Document” (KIID) that would replace the Simplified Prospectus;

-‐ Create a genuine European passport for UCITS management companies;

-‐ Facilitate cross border marketing of UCITS by simplifying the administrative

notification procedures;

-‐ Facilitate cross border mergers of UCITS, which will make it possible to increase the average size of European funds;

-‐ Facilitate asset pooling by creating a framework for the system of “master-feeder”

arrangements whereby a fund invests more than 85% of its assets in another fund;

-‐ Strengthen the supervision of UCITS and of the companies that manage them, by means of enhanced cooperation between supervisors.

UCITS IV main measures:

BNP Paribas Securities Services – White paper UCITS IV

19 ucits-‐iv-‐directive.com

UCITS IV main measures

UCITSUCITS UCITS

Increase industry ef!ciency

Increase cross-border distribution

Increase investor protection

Absorption New Fund

Fund mergers

Management Company Passport

Master-feeder

Noti!cation procedure

Key Investor Document Co

oper

atio

n be

twee

n su

perv

isor

s

1 2

The transfer of all assets and liabilities of one or several UCITS funds/compartments to another existing UCITS fund/compartment

Creation of a new UCITS fundby dissolving previously existing funds

Assets and liabilities

These priorities translate into !ve main measures, with an over-riding provision to reinforce cooperation between market regulators, as shown in the !gure below:

Cross-border fund mergers

As part of the plan to increase industry ef!ciency, the Directive creates a legal framework to rationalise fund offering — facilitating both domestic and cross-border mergers of UCITS funds or fund compartments.

This can be effected by one of three techniques:

UCITS

UCITS



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The challenge of our paper is to present the provisions of UCITS IV in order to propose an analysis of their impact on the European market and put the emphasis on the situation of the Luxemburg fund industry. Before doing so, we would like to present the data for the European UCITS and the Luxembourg UCITS markets.

2. The European UCITS Market

2.1. European Funds Market

The European funds Market is part of a worldwide market of 20,85 trillions of euros in the end of the first quarter of 201220. With a total of 5,961 billions of euros, the European Market is the second worldwide market behind the USA that counts around the double of Assets under management on the same period21. The European Fund and Asset Management Association notes in its press release of the 25th May 2012 that the increased investor confidence sees UCITS sales up in the first quarter of 2012. Also in this first quarter of 2012, the European market for UCITS and non-UCITS have seen an increase of 5,3 percent to stand at EUR 8,362 billion at the end March 2012.22 At this period, UCITS account for 71 percent of the total investment fund market in Europe, with non-UCITS accounting for the remaining 29 percent.23

20 EFAMA -‐ International Statistical Release 2012 Q1, page 1 21 EFAMA -‐ International Statistical Release 2012 Q1, page 2 22 EFAMA -‐ Quarterly Statistical Press release Q1 2012 23 EFAMA -‐ Quarterly Statistical Press release Q1 2012



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In billions of euros

Illustration of Assets under management in the European investment fund industry, Alfi March 2012.

According to EFAMA’s Asset Management report dated of May 2012, The total employment in the European asset management industry in 2010 is around 85,000 Direct Jobs plus an estimation of 4.6 time this number for Indirect Jobs. Luxembourg as one of the leaders with Ireland in cross-border distribution of funds employed 10,500 people in 2008.24 These statistics show that Luxembourg is an attractive financial centre for investment funds, we would now present you the particularities of the Luxemburgish Funds Market.

2.2. Luxembourg Funds Market As mentioned in the introduction, Luxembourg offers a flexible legislative framework, a stable political and social environment with a multilingual and high-qualified work force.

24 EFAMA – Asset Management report, May 2012

Net Assets of European Investment Funds MARCH 2012

692

961

1 01

1

1 00

0

950

1 05

0

1 16

1

1 42

4

1 66

5

1 84

7

1 63

5

1847

2140

2303

24012

349 3

195

3 54

9

3 61

7

3 34

4

3 78

5

4 21

2 5 19

1 5 95

6

6 16

0

4 53

6 5306 6

010

5634 59

61

3 042

4 156 4 560 4 6174 294

4 8355 373

6 615

7 6218 007

6 171

7154

8150 79378362

0

1 500

3 000

4 500

6 000

7 500

9 000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Q12012

Non-UCITS UCITS

Assets under management in the European investment fund industry

Source: EFAMA

In billions of euros



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The country also offers a wide range of investment funds and a simple straightforward process for the authorisation of investment funds.

Illustration of Investment fund assets by country of domicile at end 2010 (EUR billion) As the illustration above shows, Luxembourg is the European leader in terms of investment funds. It represents 31,3 percent of the European net assets under management.25 From the 1990’ to nowadays, the number of funds / units and the net assets related as presented on the illustration bellow have been constantly growing in Luxembourg. In May 2012, the net asset under management in Luxembourg were around 2 212.027 billions of euros. It represents an increase of 5.51 percent since December 2011.26

25 EFAMA – Asset Management report, May 2012 26 Association of the Luxembourg Fund Industry

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11/26

Luxembourg was the first EU Member State to implement the UCITS Directive in its national legislation in 1988. Luxembourg was also the first EU Member State to implement the UCITS III and the UCITS IV Directives in its national legislation, in 2002 and 2010 respectively.27 In the next pages of this paper we would like to present you the major enhancements of the UCITS IV Directive.

3. The UCITS IV Directive

It is in a context of economic turmoil that the so-called UCITS IV Directive introduces crucial requirements to enhance the European legislative framework.

3.1. UCITS IV: the need for change The European investment fund industry is fragmented, some barriers remain in the cross-border distribution and there is a competitive need for change in the structure of the market. The new Directive proposes efficiency solutions through a package of measures that are hoped to provide strategic opportunities and create synergies in the market. New procedures as a shorter “regulator to regulator” notification procedure have the purpose to facilitate in 27 Association of the Luxembourg Fund Industry

End of period

Number of Funds (1)

Number of Fund Units

(4)

Net Assets(millions of

euros)

Number of Umbrella Funds (2)

Number of Sub-Funds

(3)

Net Assets of Umbrella

Funds(millions of

euros)

1990 805 1 727 72 244 264 1 186 26 051

1991 898 1 984 103 049 312 1 398 46 869

1992 1 041 2 337 167 442 364 1 660 76 852

1993 1 175 2 775 247 078 437 2 037 130 181

1994 1 283 3 262 247 502 511 2 490 151 639

1995 1 329 3 597 261 798 573 2 841 174 423

1996 1 384 3 939 308 605 632 3 187 221 981

1997 1 426 4 618 391 766 711 3 903 296 124

1998 1 521 5 178 486 843 797 4 454 384 292

1999 1 630 5 836 734 518 913 5 119 604 875

2000 1 785 6 995 874 586 1 028 6 238 739 072

2001 1 908 7 519 928 447 1 129 6 740 797 800

2002 1 941 7 806 844 508 1 190 7 055 724 800

2003 1 870 7 509 953 302 1 180 6 819 820 893

2004 1 968 7 876 1 106 222 1 226 7 134 962 799

2005 2 060 8 497 1 525 208 1 298 7 735 1 341 411

2006 2 238 9 473 1 844 850 1 387 8 622 1 639 559

2007 2 868 11 115 2 059 395 1 688 9 935 1 812 442

2008 3 371 12 325 1 559 653 2 019 10 973 1 349 898

2009 3 463 12 232 1 840 993 2 108 10 877 1 628 125

2010 3 667 12 937 2 198 994 2 302 11 572 1 979 5242011 3 845 13 294 2 096 512 2 427 11 876 1 881 506

Jan. 12 3 837 13 273 2 157 081 2 421 11 857 1 937 212Feb. 12 3 847 13 334 2 203 159 2 430 11 917 1 979 935Mar. 12 3 866 13 343 2 217 206 2 441 11 918 1 994 007Apr. 12 3 872 13 368 2 225 600 2 447 11 943 2 002 674May 12 3 874 13 412 2 212 027 2 452 11 990 1 990 816

(4)=(1) - (2) + (3) Source: CSSF

TOTAL OF WHICH

Funds, sub-funds and net assets

0

500 000

1 000 000

1 500 000

2 000 000

2 500 000

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

16 000

funds units net assets

! millionsnr. of funds / units

!"#$%&' (!!)



12/26

combination with an effective Management Company Passport, the cross-border marketing and distribution and contribute to the development of centres of expertise.28 The Directive would create a reorganisation of the market, some places like Luxembourg and Ireland would increase their activities based on cross-border distribution, some managers would centralise around their Management Company or their Headquarter. The downside would be that tax is a significant barrier to successful implementation of UCITS IV.29 We will present in the following pages the major provisions of the Directive and for each, a concise observation of the operational impacts. In the last part of the paper we will focus on the market more generally and provide an overview of the expected changes.

3.2. Key provisions of UCITS IV

3.2.1. Strategic opportunities

The European Market is fragmented and UCITS as mentioned before are smaller and more expensive to market compared to funds of the US market. To address these aspects that limits the competitiveness of UCITS, the new legislation framework provides fund promoters with a helpful toolbox.

3.2.1.1. Cross-border mergers The European legal framework for cross-border and domestic mergers of UCITS is now harmonised with the new Directive. This measure is part of the plan to increase the industry efficiency by lowering the number of funds and rationalise the offer.

28 RBC DEXIA Investor services, 2011 publication 29 RBC DEXIA Investor services, 2011 publication and Luxembourg for Finance



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The Directive propose three types of merger techniques30:

-‐ Merger by way of absorption Transfer of all assets and liabilities of one or several UCITS funds/compartments to another existing UCITS fund/compartment.

-‐ Merger by creation of a new entity Creation of a new UCITS fund by dissolving previously existing funds.

-‐ Scheme of amalgamation Amalgamation of UCITS funds’ assets into: o The compartment of the same UCITS fund, o A new UCITS fund, o Another existing UCITS fund.

Source: RBC DEXIA Investor services, 2010 publication

30 BNP Paribas Securities Services – White paper UCITS IV

September 2010 | 28

MergersPoints to consider

Tax impacts

At fund level risk that tax neutrality of cross-border mergers at the discretion of local tax authorities At investor level risk that capital gain taxation applies if no local tax relieves available

Operational impacts

Investors to be informed individually Risk of saturating big receiving flagship fund investors and distribution partners with non material info; costs? ; beneficial owners?KIID of receiving UCITS to be provided to shareholders of merging UCITS

Financial impacts

Costs should not be borne by investorsat charge of promoters and/or

Managers

ManCo

Merging UCITS

France Ireland/Luxembourg

United Kingdom

Contributionin kind

Merging UCITS

Receiving UCITS

ManCo ManCo

Domestic distribution

Cross border/ Domestic

Distribution

Domestic distribution



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Some new requirements arise, as the need to analyse fund mergers according to various criteria including regulatory, operational, cross-border tax issues and time to market.31 The merger regime requires a high level of cooperation and trust between supervisory authorities and corporate national law that are able to accommodate with mergers rules.32 A survey led by EFAMA and KPMG shows that the major barrier that face cross-border merger is doubtless the tax issue. The results show that for 90 percent of the respondents, tax is a significant factor when deciding which fund to merge. UCITS IV is a regulatory and not a tax Directive, this is the reason why this point isn’t addressed.33 At the question, “Where would you intend to consolidate assets from cross-border fund mergers?” RBC DEXIA and KPMG note that all the respondents would choose Luxembourg and Ireland or their EU Group headquarters. The decision lays on many factors such as having already a fund established in the location, the reputation of the financial centre.

3.2.1.2. Master-Feeder structure UCITS IV introduce a new form of assets pooling, the so-called “master-feeder” structure. These UCITS have been designed to boost industry efficiency through economies of scales and it also enables groups to focus investment management in one location.34 The concept allows a feeder UCITS vehicle to invest a least 85% of its assets in a master UCITS, and a maximum of 15% in other liquid assets or derivatives. Managers may choose to convert existing UCITS into Feeders or to establish new Feeders when entering new markets.35

31 Deloitte, 2011 32 Clifford Chance, April 2010 33 EFAMA/KPMG Analysis of the Tax Implications of UCITS IV 34 RBC DEXIA Investor services, 2011 publication 35 Clifford Chance, April 2010



15/26


The key benefits are the cost efficiency through the pooling of assets in a single UCITS fund and the centralisation of core management resources. The product can be tailored according to the needs and this is an efficient way to test new markets or distribution channels.36 There are a number of tax considerations to take in account when one decides to establish a Master-Feeder structure. Investing through a Master UCITS has to remain more interesting than investing directly in the underlying. Some Member States rise tax on distribution from a Master to a Feeder or if a Feeder disposes of shares in the Master. In these cases the investment won’t be popular.37 In conclusion, the two main factors in deciding on the domicile of Master Fund are the legal and regulatory framework and the tax regime. These criteria place Luxembourg as the favourite financial centre for cross-border distribution.38

36 RBC DEXIA Investor services, 2011 publication 37 RBC DEXIA Investor services, 2011 publication 38 RBC Dexia and KPMG

What!are!the!authorisation!andregulatory!requirements?

! The!investment!of!a!Feeder!into!a!Master!fund!is!subject!to!permission!by!the!competent!authorities!of!the!Feeder"

! Supervisory!authorities!should!allow!existing!UCITS!funds! to!be!converted!into!Feeders#!subject!to!requirements!to!inform!investors!of!the!pending!change!in!investment!policy!and!offering!them!the!right!to!redeem!free! of!charge"

! Masters!would!only!need!to! be!authorised!as!a!normal!UCITS!fund$!no!specific!authorisation!is!required!to!assume!the!role! of!a!Master"

! Competent!authorities!of! the!Master!should!communicate!without!delay!any!decision!or!measure!taken!with!regard!to!the!Master!to!each!of!the!Feeders’!competent!authorities"

What!is!the!impact!on!investors?

! Both!Master!and!Feeder!can!receive!(subject!to!applicable!limitations!at!fund!level!and!the!required!authorisations!for!public!distribution)!investments!from!institutional!or!retail!investors"

! Offering!documents!and! Key!Investor!Information!of! the!Feeder!must!clearly!replicate!the!investment!policy!of!the!Master!they!are!investing!in#! and!furthermore#!explain! the!implications!of!investing!into!the!Master!through!the!Feeder! in!relation!to!investment!policy!and!fees"

The!key!benefits

Cost!efficiencies!through!the!pooling!of!assets!in!a!single!UCITS!fund!and!the!centralisation!of!core!management!resources

Products!can!be!tailored!to!domestic!constraints!or!client!segment!needs

! Cost!efficient!way!to!test! new!markets!or!distribution!channels

UCITS UCITS

ManCo

Country!A

Domestic!distribution!

Country!B

Cross-border%!Domestic

distribution!

Country!C


ManCo ManCo

UCITS

UCITS UCITSFeeder

ManCo

Country!A



Country!B Country!C Country!D


distribution!


Domestic!distribution

ManCo ManCo

UCITSMaster

Notification UCITSFeeder

UCITS!III UCITS!IV

Master-Feeder!structures



16/26

3.2.1.3. Management Company Passport

The European legal framework for management companies has known some changes. The Level 2 Directive 2010/43/EU set additional rules regarding organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company.39 Our paper will focus only on the Management Company Passport (MCP). A survey conducted by Deloitte about the use of the MCP shows that nearly two thirds of the respondents have a Management Company in two or more Member States. This fact allows us to emphasise that one of the key aims of UCITS IV is to enable a UCITS located in one EU Member State to be managed, distributed and administered by a management company located in another EU Member State via a management company passport.


Thereby, the market will see a decrease in the number of Management Companies as many cross-border organisations will use the MCP to consolidate the number of Management Companies that they operate in the EU.

39 Deloitte, 2011

What!are!the!capital!requirements?

Identical!to!those!set!out!already!under!UCITS!III"

What!are!the!local!requirements?

The!Management!Company!does!not!need!to!have!a!local!representative!in!other!Member!States!than!its!Home!Member!State"

For!UCITS!funds!located!in!another!Member!State!than!the!Management!Company#!an!agreement!must!be!drawn!up!between!the!Management!Company!and!the!UCITS!fund!depository"

Which!rules!apply?

It!will!be!necessary!for!the!Management!Company!to!comply!with$

! the!rules!of!the!Management!Company’s!Home!Member!State!in!relation!to!the!organisation!of!the!Management!Company#!including!delegation!arrangements#!risk!management!procedures#!financial!reporting#!prudential!rules!and!supervision

! the!rules!of!the!UCITS!fund’s!Home!Member!State!in!relation!to!constitution!and!functioning!of!the!UCITS!fund#!including!the!calculation!of!the!net!asset!value#!the!accounting!plan!and!applicable!standards#!and!the!regulatory!reporting

Which!new!policy!requirements!have!been!introduced?

Management!Companies!are!not!subject!to!MiFID#!but!will!under!UCITS!IV!be!required!to!implement!similar!policies!in!areas!such!as$

! conflicts!of!interest! compliance!function! internal!audit! rules!of!conduct! record!keeping! accounting! complaints!handling! personal!transactions! proxy!voting! due!diligence! best!execution#!placement!and!order!aggregation

! inducements

In!addition#!under!UCITS!IV!the!risk!management!scope!to!be!monitored!by!a!Management!Company!has!been!extended!to!liquidity!and!operational!risk"

Have!the!rules!changed!on!distribution!fees?

It!is!not!clear!whether!the!payment!of!distribution!fees!to!externally!appointed!distributors!falls!under!the!exemptions!quoted!in!the!“inducements”!section"!Our!understanding!is!that!payment!of!fees!is!allowed#!subject!to!meeting!the!conditions!of!enhancing!the!quality!of!relevant!services#!not!creating!conflicts!of!interest!and! of!being!disclosed!to!investors"

What!are!the!impacts! on!the!relationship!between! a!Management!Company! and!a!depository!bank?

The!content!of!the!agreement!to!be!concluded!between!a!Management!Company!and!a!depositary!bank!might!imply!some!conflicts!between!respective!national!laws!and!regulations!(e"g"#!anti-money!laundering!clauses#!liability!issues#!prescriptions!on!termination)"

The!requirement!that!the!agreement!will!be!governed! by!the!national!law!of!the!UCITS!fund!Home!Member!State!will!also!impact!Management!Companies"! A!Management!Company!located!in!a!different!Member!State!than!the!depository!will!need!to!be!aware!and!keep!itself!updated!of!all!the!relevant!laws!and!regulations!and!interpretations!of!the!UCITS!fund!Home!Member!State"!

The!key!benefits

Provides!more!flexibility!to!reorganise!business!models!geographically!with!a!centralised!administration

Achieves!better!cost!savings!through!economies!of!scale

Allows!for!the!centralised!monitoring!of!the!underlying!UCITS!fund!and!eliminates! the!need!for!different!delegation!and!operating!models

ManCo

Country!A


Country!A


Cross-border%Domestic

distribution!

Country!B


distribution!

Country!CCountry!B

Domesticdistribution!

Country!C

Domesticdistribution!

ManCo ManCo ManCo ManCo ManCo

UCITS UCITS UCITS UCITS UCITS UCITS

UCITS!III UCITS!IV

Management!Company!Passport



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Two years ago, many managers preferred to focus on the implementation of the mandatory requirements and adopted a “wait and see” position while tax complexity had discouraged them from taking immediate action. Tax is often a barrier when the decision makers have to consider options. The survey conducted by RBC DEXIA and KPMG in 2009 shows that it is the first factor in determining the location of the management company before the regulatory framework. This survey also points out that 60 percent of the participants planned to use the MCP to centralise their ManCo and that Luxembourg would be the first choice largely before Ireland or the Group headquarter.

3.2.2. Other changes

The fund industry has to comply with compulsory measures required by the UCITS IV Directive. We would present the notification procedure that has been adapted in order to speed up market entry. In line with the protection of investors, the KID would replace the simplified prospectus. We will describe how this short document aims at enhancing investment transparency.

3.2.2.1. Notification procedure The UCITS passport has been created to facilitate the cross-border marketing and distribution following appropriate notification to the respective competent authorities. Under UCITS III, the procedure was burdensome40, took too much time to market and the fact that the host Member State could ask additional requirements created disparities in the market.41 UCITS IV replaced the ex ante control of the host Member state with a “regulator to regulator” system.42 Now the current notification period is reduced from two months to ten days. Once the home regulator has transmitted the notification to the host country regulator, the marketing of the

40 Deloitte, 2011 41 Clifford Chance, April 2010 42 Clifford Chance, April 2010



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fund can begin immediately. The host Member State authority no longer has ex-ante power to oppose the marketing.43 The illustration below shows the new process.


These enhancements provide faster access to markets and will make the notification process smoother throughout the European Union after a period of adaptation from the regulators.44

3.2.2.2. Key Investor Information Document Under the UCITS IV Directive, the Key Investor Information Document also known as the “KIID” has replaced the simplified prospectus. The simplified prospectus was widely seen as having failed its objective. The document was known to be too technical, too complex and also sometimes too long. It was often incomprehensible for a retail investor and the production really costs were high.45 The KIID is an extremely short document (two A4 pages – one sheet) that contains pre-contractual information in a non-technical language. The document has to be provided free of charge to the investor before any subscription. The common format of the document allows comparisons, it is also translated into the local language.46

43 RBC DEXIA Investor services, 2011 publication 44 Clifford Chance, April 2010 45 Deloitte, 2011 46 Deloitte, 2011

How!long!will!it!take!for!approval?

No!later!than!"#!business!days!after!the!Home!Member!State!authority!receives!by!electronic!means$

! the!notification!letter

! the!complete!file

The!UCITS!fund!is!notified!about!the!transmission%

When!can!marketing!start?

It!can!start!immediately!after!the!transmission!of!the!notification!by!the!Home!Member!State!authority!to!the!Host!Member!State!authority%

What!powers!do!the!Host! Member!States!have?

Host!Member!States!have!no!power!to!ex-ante!oppose!the!marketing&!even!if!there!are!concerns!about!compliance!with!non-harmonised!marketing!provisions!of!domestic!law%!

Such!domestic!rules!will&!however&!have!to!be!respected!by!the!UCITS!fund!and!made!publicly!available!by!each!Member!State%

What!facilities!does!the!UCITS!fund!need!to!provide!in!the!Host!Member!State?

The!UCITS!fund!needs!to!ensure!that!facilities!are!available!in!the!Host!Member!State!for!making!payments!to!unitholders&!purchasing!or!redeeming!units!and!making!available!the!information!which!the!UCITS!fund!is!required!to!provide!(KII!and!legal!documentation)%

What!does!the!UCITS!fund!have! to!do!after!initial!notification?

The!UCITS!fund!has!to!notify! all!amendments!to!its!KII!and! legal!documentation!and!has!to!ensure!the!Host!Member!State!authority!can!electronically! access!these!documents%

The!key!benefits

Cost!efficiencies!through!the!pooling!of!assets!in!a!single!UCITS!fund!and!the!centralisation!of!core!management!resources

Products!can!be!tailored!to!domestic!constraints!or!client!segment!needs

! Cost!efficient!way!to!test! new!markets!or!distribution!channels

Notification!-!Points!to!consider

" Submission!of!the!notification!file! and!translations

' Checking!of!the!completeness!! of!the!notification!file

( Electronic!transmission!of!the!file!and!of!an!Attestation!Letter!that!the!UCITS!fund!complies!with!UCITS!IV!directive!(no!later!than!"#!business!days!after!the!receipt!of!the!complete!notification!documentation)

)a Notification!of!the!transmission!date! of!the!notification!file

)b UCITS!funds!can!be!marketed!in!Host! Member!State!as!of!the!date!of!the!notification!in!step!)a!

* Modification!+!update!of!the! notification!file

UCITS!Home!MS*

UCITS Regulator Regulator

UCITS!Host!MS*

"

' ( )b

)a

*

Domestic!marketingrules!apply

*MS$!Member!State



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The document contains in particular the following information:47

-‐ Identification of the UCITS, -‐ Investment objectives and policy, -‐ Past performance (or performance scenarios), -‐ Cost and associated charges, -‐ Risk/reward profile of the investment.

The KID is an interesting concept that seems simple is however at first sight. It reveals to be more complex in reality involving the implementation of a whole new system of data collection, production, translation and dissemination as well as ongoing data monitoring and updating. For many managers the complexity and specialised nature of this process has necessitated outsourcing part or all of the KID production.48

3.2.3. Cooperation between supervisors authorities

UCITS IV introduced many measures that require an increase of exchange of information between supervisory authorities. This is the reason why the Directive also defines the responsibilities of each authority in order to provide a minimum degree of harmonisation among Member States.49 In fact, each competent authority is bound by an obligation of professional secrecy and this obligation dictates how information of a confidential nature received by a competent authority may be used.50 The success of the new streamlined notification procedure, and the reduced regulatory and cost burden of such changes, depends largely on the level of confidence between EU regulators.51 In a recent interview, Simone Delcourt, Director of the CSSF52 since 2005 said that in order “to restore confidence, help to develop a single set of rules, resolve the problems linked to cross-border companies and avoid a build-up of risks liable to threaten the stability of the global financial system, a new European financial supervision system was set up in January

47 Deloitte, 2011 48 Deloitte, 2012 49 PricewaterhouseCoopers Luxembourg, 2012 50 Clifford Chance, April 2010 51 Clifford Chance, April 2010 52 “Financial Sector Supervisory Commission“ in Luxembourg



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2011, comprising a European Banking Authority (EBA), a European Securities and Markets Authority (ESMA) and a European Insurance and Occupational Pensions Authority (EIOPA).”53

3.3. Implementation On 17 December 2010, Luxembourg was the first EU Member State to enact the UCITS IV Directive and its implementation measures into national law. Other countries followed, including the Netherlands, Denmark, Germany, Sweden and the United Kingdom. Yet even though the deadline has passed, some Member States Counties have not fulfilled their obligations. These include Belgium, Cyprus, Greece and Portugal. As foreseen by the Directive, late transposition may entail practical issues where cross-border operations involve a Member State that has not transposed the UCITS IV Directive. This is why the “European Securities and Markets Authority” introduced practical arrangements to resolve these issues.

-‐ Management companies established in a transposing Member State should be able to create a fund via the management company passport in a Member State where the UCITS IV Directive has not been transposed.

-‐ Cross-border mergers involving a UCITS established in a Member state that has not transposed the Directive are not possible.

-‐ Master-feeder structures should not be permitted if one of the two Member States in which the UCITS are established has not transposed the Directive.

53 Web site – myofficialstory.com/businesswomen/article



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UCITS IV Implementation Timeline:

RBC DEXIA Investor services, 2010

As mentioned Ernst and Young Luxembourg in a release presenting the new Directive, the challenge for ESMA54 and the European Commission concerning the implementation is to come up with practical implementing measures to make the enhancement to UCITS IV a reality.

4. UCITS IV Directive: A tangible reality in Europe As presented in our paper, the UCITS IV Directive generates a wide level of interest and activity among the asset management community. Now that we have introduced the key provisions of the Directive and highlighted some operational changes, we will describe the excepted impact on the European and Luxembourg markets. Our analysis is a based on findings referenced in our paper and particularly on a survey led by KPMG and RBC DEXIA in 2009. At first, the industry has been focused mainly on the implementation of the mandatory requirements of the UCITS IV Directive which all UCITS have to comply with in all cases. Mandatory requirements such as the KIID, organisational rules, conduct of business and VaR model validation and testing have actually increased compliance costs. Attention is now gradually shifting back to the strategic and operational implications. In order to get an inside point of view on how the industry reacts to those implications, we contacted

54 European Securities and Markets Authority -‐ CESR non longer exists

September 2010 | 5

UCITS IV Implementation Timeline

N.B. In Luxembourg, draft law passed on to Parliament in July 2010 and is expected to be adopted prior to year end.

13 July 2009Adoption of

UCITS IV directiveby EU Parliament

& Council

Oct./Dec. 2009CESR’s advice

on level 2measures

1 July 2010EU Commissionadopts level 2

measures

30 June 2011Member States to implement

UCITS IV Directive and

Level 2 measures into their domestic

law

1 July 2011UCITS IV

Directive and Level 2

measures applicable in all Member

States

1 July 2012KIID will

replace the simplified

prospectus

July 2013EU Commission will report on

application of the UCITS IV

Directive



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the Association of the Luxembourg Fund Industry (ALFI). This inquiry allows us to confirm what we read in the press. According to the Association and its members, “the fund industry already makes or plans to make use of Master-Feeder structures and the MCP if they think they can reach economies of scale by doing so. They hesitate to make use of cross-border fund mergers as, depending on national law, this can result in a taxation at the level of the fund or the level of the investor.” The absence of a tax framework and natural obstacles such as national market preferences and existing distribution networks are key considerations while decision makers analyse the new opportunities provided by the UCITS IV Directive. Nevertheless, there are opportunities to maximise efficiencies under this new framework. The number of Management Companies is likely to decrease, existing fund administration models may be challenged and a new wave of fund mergers lies ahead. There are consequently expected impacts on the fund industry. We will present the main trends and put the emphasis on the Luxembourg market

4.1. Impact on the European market As UCITS IV entered in force in June 2009, the vast majority of UCITS managers took a proactive approach to UCITS IV and planned early how to leverage the new regulatory changes to gain competitive advantages. Three years later, the UCTIS Directive is mainly implemented and a majority of Member States adapted their legislation. The Management Company Passport is arguably the measure that brings about the most potential landscape changes under the new Directive. A majority of managers considers the MCP as an opportunity to centralise their UCITS Management Companies. Consequently, the market will see a decrease in the number of Management Company. At the time of the survey led by KPMG and RBC DEXIA in 2009, Paul Freeman, Head of Product Development for BlackRock in the United Kingdom believed that: “The choice of domicile will depend on several factors including the existence of local staff with the appropriate skills and expertise, the tax framework, the ability to outsource activities to centres of excellence and the level of operational costs.” His statement reflects the top factors cited by the survey respondents in determining the location of their Management Company.



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The fund administration under UCITS IV brings new challenges and opportunities that will lead some managers to rethink their administration model. In 2009, the survey showed that 48 percent of the respondents intended to concentrate the administration of their UCITS products. Asset managers are increasingly seeking to outsource non-core activities (such as back-office services) and sharpen their focus on investment management. The survey also emphasises the preference to outsource those services with a number of limited preferred providers. As mentioned KPMG and RBC DEXIA, ongoing consolidation of the fund administration business should lead to greater levels of standardisation and automation in the industry. With a highly fragmented sector composed of sub-optimal size funds especially compared to the US market and an average Total Expense Ratios (TER) that is too high, the competitiveness of the UCITS products is considerably impacted. Against this background, the UCITS IV Directive sets up measures to enable rationalisation of the European funds market. The new legislative framework will drive fund consolidation in the EU and will lead to an increase in cross-border fund mergers. Paul Freeman rightly mentioned: “Whether we see an overall reduction in the number of funds will depend on individual asset manager appetite to rationalise their product range”. As we mentioned earlier, some asset manager hesitate to make use of cross-border fund mergers because they fear double taxation. Furthermore, as Bill Lockwood & Diane Voss55 said: “It is still much easier to launch new products than to close existing funds for many investment managers”. Finally, under UCITS IV, some domestic mergers become more complex and demanding than before. This is the reason why a number of local mergers have been carried out before UCITS IV came into force. The Master-Feeder structures also have a significant impact on the European UCITS market as they permit a targeted distribution. The survey shows that 42 percent of the respondents of the study intended to create a Master-Feeder structure. The advantage of the concept is that it is quick to set up a Feeder fund when combined with the MCP. However, some investors often regard Feeder funds as expensive products given the double fees and costs structure they entail. When it comes to choose the domicile of the Master UCITS, most asset managers seek to use EU domiciles with fiscal stability, well-established local expertise, strong legal and regulatory frameworks, responsive regulators and competitive tax regimes. 55 Conducting Officers, Franklin Templeton Investment, Luxembourg.



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Three years on, the UCITS IV Directive is implemented and the efficiency package promises some changes that will affect the European UCITS market structure. Thereby, the industry favours the development of centres of expertise such as Luxembourg and Ireland, which are strong in cross-border retail UCITS and cash funds respectively. We will now put the emphasis on the expected impact of the UCITS IV Directive on the Luxembourg market.

4.2. Impact on the Luxembourg market One of the objectives set up by the UCITS VI Directive is to increase the market efficiency. In order to strengthen its competitiveness and reputation, the fund industry want to create or strengthen centres of excellence specialised in administrative services and capable of supporting complex and flexible UCITS structures.56 There is a new business environment for service providers, which creates new opportunities and threats for them. Their key challenge is to meet the quality of service requirements at a competitive price.57 This may lead to concentration and consolidation in the most attractive jurisdictions. Luxembourg has consistently demonstrated its expertise in the context of cross-border fund servicing issues and is clearly aiming to consolidate its pivotal position as a centre of expertise that combines a reputation for know-how with strong commitment to developing its human and technical capabilities. UCITS will drive an increase in assets under management in Luxembourg. The survey led by KPMG and RBC Dexia places Luxembourg as the most attractive centre for:

-‐ Centralising the UCITS Management Companies, -‐ Concentrating the administration, -‐ Consolidating assets from cross-border fund mergers, -‐ Consolidating assets in a Master-Feeder UCITS structure.

The stakes are considerable for Luxembourg. The financial centre has proven its value and will doubtless capitalise on its strengths. 56 Luxembourg for Finance 57 Ernst and Young 2010



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Conclusion The vast majority of UCITS managers have taken a proactive approach to UCITS IV, however, many managers adopted a “wait and see position” given tax uncertainties and the need to carefully consider and weigh up the advantages and disadvantages of such strategic moves. The high points of the Directive are mainly the cost savings expected, an easier access to new EU markets and the improved competitiveness of UCITS products. Marc Pictet58, stated in 2009: “From a global point of view we consider UCITS IV as an evolution, but not a revolution, whose global outcome should lead to more transparency and reduced cost.” The UCITS IV Directive has increased the level of regulatory requirements and consequently of the compliance burden on management companies. The main drawback of the Directive is undoubtedly the absence of a tax framework. Bill Lockwood & Denise Voss rightly mentioned:59 “Tax remains the elephant in the room and, in our view, there will be no rush to rationalise existing structures until the tax impact is clarified.” The UCITS IV Directive only entered in force on 1 July 2011 and the European Commission actively published its UCITS V proposal. We would like to emphasise the fact that some EU and many non-EU jurisdictions where these products are sold have not yet fully digested the UCITS III. The UCITS IV Directive is an ambitious amendment of the European legislative framework and we truly believe Luxembourg will continue to demonstrate its value and strengthen its position on the European market.

58 Managing Director of Pictet & Cie (Europe). Luxembourg 59 Conducting Officers, Franklin Templeton Investments. Luxembourg



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REFERENCES

− UCITS IV Directive – Directive 85/611/EEC relating to undertakings for collective investment in transferable securities, as amended;

− Luxembourg for Finance web site; − Luxembourg for Finance – UCITS IV An efficiency package takes shape; − Association of the Luxembourg Fund Industry web site; − Association of the Luxembourg Fund Industry – Symbiosis in the evolution of

UCITS; − Association of the Luxembourg Fund Industry – Statistics release − Wikipedia – UCITS; − Ucits-‐iv-‐directive.com; − European Commission web site – Investment Funds ; − Ernst and Young – UCITS IV Transforming the European investment fund

industry, June 2009; − Bank of New York Mellon – UCITS IV a new beginning? June 2010; − BlackRock – View point, the rise of UCITS III, September 2010; − Deloitte, UCITS IV six months on. Can the Directive deliver on efficiency?, 2012; − Deloitte, UCITS IV Operational impacts, March 2011; − The European Fund and Asset Management Association web site; − EFAMA – International Statistical release Q1 2012 ; − EFAMA – Quarterly Statistical Press release Q1 2012 ; − EFAMA – Asset Management report, May 2012 ; − EFAMA/KPMG Analysis of the Tax Implications of UCITS IV ; − Clifford Chance – UCITS IV – A Brief Overview ; − KPMG/RBC DEXIA Investor services – UCITS IV Which business model for

tomorrow?, 2009

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