EU Paves The Way For Unified Investment Fund Regime

Ulrika Lomas, Tax-News.com, Brussels

15 March 2001

The European Union edged closer this week to the creation of a unified investment management and marketing regime when political agreement was reached by the ECOFIN Council on a Directive which would extend Single Passport rules to companies managing investment funds. Taken together with a Directive agreed last October which significantly widens the range of investment funds that can be sold throughout the Union, the prospects for a Union-wide investment market seem noticeably brighter - although the recent setback to plans for harmonised pensions provision are no help at all.

Since 1986, the UCITS Directive has had considerable success, given the limited nature of the freedoms it provides. UCITS (Undertakings for Collective Investments in Transferable Securities) are really just funds of quoted equities, and the Directive allowed them to be marketed throughout the EU - but only by their 'sponsors'. So, if you were a fund manager licensed in Ireland, you could market UCITS products in Ireland regardless of your local legislation - but you couldn't start up a marketing operation in Germany without getting licensed there. Despite these restrictions, UCITS funds have clocked up more than 3.5 trillion euros in assets.

The new Directives mean that an Irish fund manager (for instance) will be able to market an approved product anywhere in the EU, and that the range of approved products is substantially extended - perhaps even to incorporate hedge funds. Slow-moving regulators wouldn't have gotten even this far if they hadn't been pushed by clever fund management lawyers who have found ways of marketing hedge funds legally in Europe, using nominee or share-related structures to make hedge funds look like quoted investments. In the UK structures are treated as repackaged equity for legal purposes, while the German structure is based on long-term equity options, or warrants. A warrant structure could also soon open up the French market.

However, 'political agreement' is just one step in the tortuous EU legislative process, which has only ever been fully understood by three people, all of them now dead. What is clear, however, is that the next step is for the adoption of a 'common position' (that's when the civil servants of the fifteen member states have run out of administrative objections to the proposed legislation). After that the legislation goes to the Parliament, which has ill-defined but considerable powers to delay or vary it. Only then can it be voted into real existence by the Council of Ministers. And it still has to be implemented by the 15 Member States, many of whom will have obtained 'derogations' (permission to delay implementation). Optimists in Brussels are saying that the new rules could be in operation with two years. Try 4, or more likely 6.

Here is the statement issued by Brussels this week:

The European Commission has welcomed the political agreement reached on 12 March by the Council of Economics and Finance Ministers on the proposed Directive updating legislation on companies managing collective investment undertakings (UCITS). UCITS (such as common funds, unit trusts and SICAVs), where investors’ money is placed by a qualified fund manager in a diverse range of assets according to defined risk criteria, enable private investors with limited resources to invest in financial markets. They constitute a major market sector, with assets of more than euro 3.5 trillion at the end of 2000. The agreed proposal is to be applied jointly with another proposed Directive, on which Council reached political agreement 17 October 2000. The latter aims at removing barriers to cross-border marketing of units of collective investment undertakings by widening the range of assets in which they can invest. Both proposals form part of the Financial Services Action Plan which aims to build a single European financial market by 2005 and was strongly endorsed at the Lisbon European Council. They are based on the twin amended proposals the European Commission adopted in May 2000, which take into account the European Parliament’s February 2000 Opinion. The Council now has to adopt a common position on each of the UCITS proposals and is expected to put them forward to the European Parliament by mid- spring.

Internal Market Commissioner Frits Bolkestein said: "I am pleased that the Council has managed to reach agreement on this important proposal to give a ‘single European passport’ to investment fund managers. This gives a positive signal in the run up to the Stockholm European Summit that the Council takes implementation of the Lisbon agenda seriously and should clear the way for rapid adoption of both this Directive and the proposal to extend the range of assets in which harmonised UCITS funds can invest. I strongly urge the Parliament and Council to complete the adoption process as soon as possible in accordance with the priorities we have set for the Financial Services Action Plan."

Directive 85/611/EEC on Undertakings for Collective Investment in Transferable Securities (UCITS) established a "single licence" regime for collective undertakings (i.e an authorisation for products to be sold throughout the Internal Market on the basis of approval in one Member State). As a result, collective investment undertakings are now established in all Member States and represent the equivalent of more than 40 % of EU GDP.

The licence regime, however, applied only to investments in transferable securities (essentially shares and bonds).

Moreover, new market practices have experienced tremendous growth amongst fund managers in recent years, and call for adapted regulation. For example, the whole industry benefits from economies of scale through delegation contracts, by which a management company outsources part of its activities to a third-party. But the investment fund industry also needs harmonised prudential rules to protect the investor and level the playing field among fund managers all over Europe.

Through its twin UCITS proposals, the Commission has therefore endeavoured to maintain the basic principles of the 1985 UCITS Directive, but to extend its scope to bring it into line with new practices to create a truly Internal Market for collective investment funds.

The proposed legislative framework would ensure a high level of protection for individual investors by setting standards for both the investment products and the managers undertaking the investment. As regards the products, the proposed rules aim to ensure that funds raised from the public are invested in suitably qualified assets and that basic risk-spreading requirements are fully respected. As for the portfolio managers, the rules are set to impose harmonised market access and operating conditions and controls. This dual approach is expected to encourage a climate of investor confidence in which the markets can develop on an EU-wide basis.

The first proposal (agreed by the Council 17/10/00) focuses essentially on the "product" (the investment fund). It extends the range of financial assets in which collective investment undertakings benefiting from the single licence may invest, and recognises investment management techniques widely and successfully employed such as index "tracking" or securities lending.

The second proposal, on which the Council reached political agreement on 12th March 2001, focuses on the financial intermediary which may manage UCITS (the management company). It proposes co-ordinated rules on market access, operating conditions and prudential safeguards to be respected by management companies. This co-ordination would allow a "European passport" regime equivalent to that already enjoyed by other financial service providers (banks, investment firms, insurance companies), whereby financial undertakings authorised to offer services in one Member State may offer their services throughout the Internal Market without additional authorisation. It would also increase investor protection by ensuring that such intermediaries were sound, reliable, and duly supervised professional institutions.

The second proposal also overcomes the existing segmentation between individual and collective portfolio management. In the future, management companies could be authorised to carry out both the management of collective investment undertakings and portfolios on behalf of private and institutional investors, including pension funds.

Directive 85/611 on Undertakings for Collective Investment in Transferable Securities is one of the oldest Directives in the field of financial markets. The original proposals to modernise it were adopted by the European Commission in July 1998. But the European Parliament was unable to finish its first reading before the June 1999 elections and so the newly-elected Parliament had to re-start the process. The amended version of the Commission’s proposals incorporated a significant number of points raised by the European Parliament – for example, on-going capital requirements for management companies, which have been one of the main provisions debated in the Council.

Other important issues under discussion in the Council have concerned details on the regulation of delegation and requirements applying to self-managed investment companies.

The political agreements on both UCITS proposals now need to be adopted as formal common positions, which it is hoped will be achieved shortly, before going back to the European Parliament for a second reading.

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