Press article: The challenge of cross-border distribution and the registration of UCITS fundsDOWNLOAD
In an effort to gather assets under management fund promoters have for many years been registering their European investment funds for sale in other countries. In the early days of UCITS investment funds, from the first transposition in 1988 onward, the target markets were close to Luxembourg, such as France and Germany. Now the net is being cast further each year as fund promoters seek to service clients in various countries with the same investment fund and thereby gain economies of scale. Evolution of the UCITS market now leaves us in no doubt that Luxembourg is the domicile of choice for the cross border distribution business model. However, the management of this business model entails significant cost and complexity.
Recently, the European Commission has acted on pleas from the fund industry to reduce the costs and delays in the industry and has amended the UCITS regime with what it calls an efficiency package. The aim of UCITS IV, which is due to be implemented into member state law by 1 July 2011, is to further underpin the single market and to reduce time delays and costs.
One aspect of the UCITS IV efficiency package is the revised UCITS cross border notification procedure. Under the existing UCITS regime, which allows for a two month approval period, on occasions there are delays of up to eight weeks implying a turnaround time of 16 weeks. Deloitte estimate the costs of maintaining these cross border registrations to be approximately EUR 50 million given that the 60,000 foreign fund registrations by European’s 26,000 UCITS funds stemming from fund promoters active in up to 40 countries according to Lipper FMI data.
The current draft of the UCITS IV proposal includes a revised mechanism for the way in which the UCITS passport should be deployed.
The UCITS IV text states that the notification should be conducted in “no later than ten working days”. UCITS IV certainly accelerates the notification process for fund promoters but there are several issues which need to be examined, prior to celebrating an unmitigated success. The new regime is limited to the initial notification so what happens with subsequent submissions? Further the rules do not yet foresee how the transition from the old UCITS III rules to the new UCITS IV rules will be conducted prior to the 1 July 2011 implementation date.
Going forward the profusion of European investment funds may be reduced via the UCITS IV mergers mechanism while the number of cross border registrations may be reduced via UCITS IV master feeder arrangements.
The simplification of the cross border notification procedure is one of the main elements of the UCITS IV efficiency package. With UCITS IV the home state regulator, in Luxembourg’s case the Commission de Surveillance du Secteur Financier (CSSF), will grant the cross border passport; in contrast the European Union “host” member state regulators will no longer have powers of delay or veto.
The UCITS IV proposal foresees a simple instruction in the form of a standardized notification letter (accompanied with various supporting documents) to be sent by the UCITS to its home state regulator, largely consistent with the MiFID, prospectus directive and UCITS management company notification procedure. It is important to note that the home state regulator is not responsible for the verification of marketing arrangements with respect to the host member state regulations. Therefore, it will be the UCITS itself which must ensure the marketing arrangements are compliant prior to instructing the home state of its wish to distribute in the host member state.
A significant success is the option in the UCITS IV proposal to make all UCITS documents, with the exception of the key investor information document, available in the English language. This may contribute to reducing further the time to market as fewer translations will be mandatory. In practice many fund promoters targeting retail clients will continue to translate the prospectus and annual report in order to better service clients and compete with domestic funds.
In Luxembourg it is possible that more UCITS will use the English as the base language for home state purposes to minimize translation requirements when distributing cross border. It is estimated that choice of base language in Luxembourg is currently split 40% French, 20% German and 40% English.
The UCITS IV proposal, like the previous UCITS directives, foresees that the marketing arrangements in the host country are within the jurisdiction of the host member state. The UCITS IV proposal will further highlight the demarcation between the UCITS field of influence and the host member state marketing arrangements. The home state regulator will ensure the completeness of the UCITS documents as referred to in the list above. The less obvious host country marketing arrangements which consist of country specific annexes, paying agency arrangements, proof of regulatory payments and similar obligations will not be validated by the home state regulator and will remain the responsibility of the UCITS. The notion of marketing arrangements is open ended but includes areas such as:
It is in this area, which is outside the remit of the UCITS directive and therefore is not co-ordinated at an EU federal level, that there is a risk that no significant development is made when compared to current practices.
This measure will hopefully reduce the ambiguity currently experienced when registering UCITS cross border. But, given that the host member state is limited to ex post controls, this may increase the instances of regulatory penalties.
In conclusion, the UCITS IV proposal delivers everything the fund industry requested, but due to the remit of the directive a number of potential obstacles may remain, notably in the complexity of host member state marketing arrangements. This will depend on the host member states’ willingness to relax rules, such as the need for local paying agents, or maintain their local practices. In order to avoid regulatory sanction, UCITS will need to employ sound due diligence for all cross border activities. Furthermore, the co-ordination between European regulators still needs to be determined including permutations such as how the communication will cascade in the event that a UCITS and its management company are domiciled in different member states and how the transposition of the rules will be handled. Time to market will be improved but overall costs are likely to remain substantially unchanged for retail fund promoters.
CESR’s advice on the implementing measures is the next step towards reaping the benefits of the UCITS IV efficiency package.