The Single Market for Investment Funds
When the original Undertakings for Collective Investment in Transferable Securities (UCITS) Directive was adopted in December 1985, Jacques Delors' idea of a "single market" had only just emerged and the "Single European Act" with the now all too familiar "1992 objectives" had yet to be endorsed. This is why, from today's perspective, the Directive's fairly unambitious aim to approximate conditions of competition and to ensure more effective and more uniform investor protection was easily attained. Also, when the discussion on a modernisation of the Directive started in late 1991, nobody considered achieving a single market for investment funds - the intention simply being to modernise the Directive and to include as yet nonharmonised products. Only when the Commission published its "Strategic Programme" in 1993 did the discussion on a single market for financial services really get off the ground. A further significant step forward came in 1999, when the modification of the UCITS Directive became part of the Financial Services Action Plan. This in turn "forced" the Council to advance its discussions over UCITS, which had been locked in stalemate for several years because of very different opinions on issues such as the use of derivatives, funds of funds, index funds or the passport for the depositary. Nevertheless, the basic elements of the Directive are today as undisputed and modern as they were some 20 years ago:
o Comprehensive information for investors;
o Effective supervision of the fund and its manager;
o Meaningful diversification in tradable and liquid instruments;
o Separation of management and segregation of assets
These principles have made UCITS as we know them, that is an efficient savings instrument combined with a high level of investor protection. The new Directive has left these principles untouched and has even gone so far as to reinforce them. While broadening investment opportunities, for example through a wider use of derivatives, the new Directive strengthened risk-spreading rules and improved investor protection with the introduction of a simplified prospectus. While allowing new activities such as discretionary asset management, regulation of the management company too was strengthened, for example through capital requirements and rules on delegation. Despite all this, ten months after its final application date the Directive does not yet really work. A number of transitional issues are only now being solved by the Committee of European Securities Regulators (CESR) (to wit the recently closed public consultation by CESR), the two Commission Recommendations on the use of derivatives and on some contents of the simplified prospectus have yet to be implemented in many countries. Also, a number of definition problems, in particular with respect to eligible investment instruments for UCITS, are only now starting to be considered by CESR and a public consultation as well as a public hearing are planned for April/May 2005.
The final "Level 2" regulation will surely not be on the table before late 2005. Other issues are bound to come up once the new Directive is really working. Even when this happens, the single retail market for investment funds will not have been achieved. This is made clear in the recent report of the Commission's Experts Group on asset management. CESR's working programme on investment management already draws some conclusions. While other markets, such as insurance and banking, seem to be undergoing further development, the Commission and CESR both agree that future regulation is needed to achieve the final goal of a single market for investment funds. What such legislation might look like will be the key discussion point between legislators, regulators and the industry in the years to come. The main obstacles to the single market for investment funds have been more or less identified
o Cross-border registration of passported funds is still far too complicated, time consuming and expensive;
o Merging funds or pooling funds' assets across borders is nearly impossible because of regulatory and tax barriers;
o The passport for the management company is not what it should be: managing funds across borders is impossible;
o A significant number of funds (such as real estate funds) are not covered by the Directive;
o As the Directive is not a Lamfalussy-style directive, any modification and/or modernisation requires a new directive, which we all know is burdensome and very time consuming.
Competition Challenges
Another problem is that the current Directive is mainly a so-called "product directive" - unlike the more modern Investment Services Directive/Markets in Financial Instruments Directive (ISD/MiFiD) and other financial services directives. UCITS are increasingly competing with new products, such as structured notes, which though less regulated and less transparent are nonetheless, in the case of retail investors, difficult to distinguish from the highly regulated investment funds. Retail investors are increasingly keen on these absolute return products. Should it prove impossible to provide them with similar products under the UCITS Directive because of a restrictive interpretation of allowed investments - for example, What are transferable securities? What about investment in structured notes or in listed closed ended funds? - they will, in fact, be the losers.
They will be driven towards products which might look cheaper, but which in reality provide a lower level of investor protection. The discussion on how to achieve a balanced regulation for UCITS in this respect will be one of the core issues on the regulatory agenda in the months ahead. However, a really convincing and consistent solution to the problem will probably not be achievable under the current Directive simply by "including" new products. The shape of the current Directive needs to be reconsidered. Nobody today will argue that investor protection can also be achieved through other means such as a certain level of distribution regulation, as currently being undertaken through Level 2 regulation within the MiFiD. These are all points which the Commission will have to take into account when drafting its Green Paper on UCITS, the answer on the review clause included in the UCITS Directive, planned for mid-2005.
When the original Undertakings for Collective Investment in Transferable Securities (UCITS) Directive was adopted in December 1985, Jacques Delors' idea of a "single market" had only just emerged and the "Single European Act" with the now all too familiar "1992 objectives" had yet to be endorsed. This is why, from today's perspective, the Directive's fairly unambitious aim to approximate conditions of competition and to ensure more effective and more uniform investor protection was easily attained. Also, when the discussion on a modernisation of the Directive started in late 1991, nobody considered achieving a single market for investment funds - the intention simply being to modernise the Directive and to include as yet nonharmonised products. Only when the Commission published its "Strategic Programme" in 1993 did the discussion on a single market for financial services really get off the ground. A further significant step forward came in 1999, when the modification of the UCITS Directive became part of the Financial Services Action Plan. This in turn "forced" the Council to advance its discussions over UCITS, which had been locked in stalemate for several years because of very different opinions on issues such as the use of derivatives, funds of funds, index funds or the passport for the depositary. Nevertheless, the basic elements of the Directive are today as undisputed and modern as they were some 20 years ago:
o Comprehensive information for investors;
o Effective supervision of the fund and its manager;
o Meaningful diversification in tradable and liquid instruments;
o Separation of management and segregation of assets
These principles have made UCITS as we know them, that is an efficient savings instrument combined with a high level of investor protection. The new Directive has left these principles untouched and has even gone so far as to reinforce them. While broadening investment opportunities, for example through a wider use of derivatives, the new Directive strengthened risk-spreading rules and improved investor protection with the introduction of a simplified prospectus. While allowing new activities such as discretionary asset management, regulation of the management company too was strengthened, for example through capital requirements and rules on delegation. Despite all this, ten months after its final application date the Directive does not yet really work. A number of transitional issues are only now being solved by the Committee of European Securities Regulators (CESR) (to wit the recently closed public consultation by CESR), the two Commission Recommendations on the use of derivatives and on some contents of the simplified prospectus have yet to be implemented in many countries. Also, a number of definition problems, in particular with respect to eligible investment instruments for UCITS, are only now starting to be considered by CESR and a public consultation as well as a public hearing are planned for April/May 2005.
The final "Level 2" regulation will surely not be on the table before late 2005. Other issues are bound to come up once the new Directive is really working. Even when this happens, the single retail market for investment funds will not have been achieved. This is made clear in the recent report of the Commission's Experts Group on asset management. CESR's working programme on investment management already draws some conclusions. While other markets, such as insurance and banking, seem to be undergoing further development, the Commission and CESR both agree that future regulation is needed to achieve the final goal of a single market for investment funds. What such legislation might look like will be the key discussion point between legislators, regulators and the industry in the years to come. The main obstacles to the single market for investment funds have been more or less identified
o Cross-border registration of passported funds is still far too complicated, time consuming and expensive;
o Merging funds or pooling funds' assets across borders is nearly impossible because of regulatory and tax barriers;
o The passport for the management company is not what it should be: managing funds across borders is impossible;
o A significant number of funds (such as real estate funds) are not covered by the Directive;
o As the Directive is not a Lamfalussy-style directive, any modification and/or modernisation requires a new directive, which we all know is burdensome and very time consuming.
Competition Challenges
Another problem is that the current Directive is mainly a so-called "product directive" - unlike the more modern Investment Services Directive/Markets in Financial Instruments Directive (ISD/MiFiD) and other financial services directives. UCITS are increasingly competing with new products, such as structured notes, which though less regulated and less transparent are nonetheless, in the case of retail investors, difficult to distinguish from the highly regulated investment funds. Retail investors are increasingly keen on these absolute return products. Should it prove impossible to provide them with similar products under the UCITS Directive because of a restrictive interpretation of allowed investments - for example, What are transferable securities? What about investment in structured notes or in listed closed ended funds? - they will, in fact, be the losers.
They will be driven towards products which might look cheaper, but which in reality provide a lower level of investor protection. The discussion on how to achieve a balanced regulation for UCITS in this respect will be one of the core issues on the regulatory agenda in the months ahead. However, a really convincing and consistent solution to the problem will probably not be achievable under the current Directive simply by "including" new products. The shape of the current Directive needs to be reconsidered. Nobody today will argue that investor protection can also be achieved through other means such as a certain level of distribution regulation, as currently being undertaken through Level 2 regulation within the MiFiD. These are all points which the Commission will have to take into account when drafting its Green Paper on UCITS, the answer on the review clause included in the UCITS Directive, planned for mid-2005.
