Similar to what the Markets in Financial Instruments Directive (MiFID) brought to the investment management industry in the European Union, the revised Undertakings for Collective Investment in Transferable Securities (UCITS) regulatory framework is expected to increase competition among management companies, with the potential for lower costs, greater transparency and other advantages for institutional investors.
With the directive, the ability to “passport” funds from country to country is among the most significant opportunities for UCITS investing. “The new directive brings an easier format for passporting, allowing collective investment schemes to operate through their home state regulator but pursue registrations elsewhere within the European Union. It increases competitiveness, which is an advantage for investors and a huge positive for the industry,” says Debbie Moss, funds product specialist at Northern Trust Asset Management, London.
Some elements of UCITS IV were implemented in July. Earlier installations largely focused on retail investors, while this revision expands upon the more sweeping Part II and III revisions and covers a broader group of investors.
This regulatory evolution also takes into account a dynamic marketplace for UCITS products, notwithstanding the inclusion of periphery European markets with long-established investment domiciles, all under a recognizable UCITS umbrella. “A significant area of growth in UCITS brand demand is from non-EU managers and among EU multi-jurisdiction clients,” says Phillip Caldwell, Northern Trust’s global head of cross-border pooling, London.
Benefits for Investors
UCITS allows for a cross border master-feeder fund that reduces trading, operational and tax costs — savings that can be passed on to investors. In addition, the availability of master-feeder funds is expected to increase competition among investment management firms, to the benefit of institutional investors.
A centrally managed scheme allows for cross-border pooling. As such, investors will have access to an investment manager’s top portfolio managers and a consistent investment strategy without having to sacrifice specialized investment mandates.
In addition, the new regulatory framework allows UCITS-authorized management companies operating in one EU member state to manage a UCITS fund located in another. Additional cost savings can be found in simplified and timely entering and distribution, and with streamlined marketing and administration, including custody, audit and other service fees.
“UCITS IV is basically introducing greater efficiency in the European fund space to save costs and give investors a better product, but with no letdown in solid corporate governance, compliance and risk management,” says Daniela Jönsson, risk and compliance consultant at Northern Trust, London.
The new UCITS regulation also brings potential savings through favorable tax treatment. Cross-border pooling under the master-feeder fund allows certain institutional investors to invest on a tax-efficient basis using treaty arrangements in place between their home jurisdiction and the country of investment.
Intensifying competition between EU member states to attract flows to their investor-favorable tax regimes encourages more market-driven solutions throughout the EU. Present tax leaders in this area are Ireland, Luxembourg and, most recently, the Netherlands. The United Kingdom is primed for its own market entry, a tax-transparent contractual fund regime, as soon as 2012.
“A poorly structured investment solution (without the benefits of tax transparency) could produce a tax drag of 30 basis points on, for example, a fund with a world equity mandate and a 60-basis-point drag on a fund with a U.S.-equity mandate. That’s 0.6 percentage points of return per year. It adds up,” says Caldwell.
Investor communication requirements change as well. A newly crafted Key Investor Information Document (KIID) replaces the familiar simplified prospectus for UCITS funds. The KIID provides an explanation of risk and reward as well as product, performance and charges description. KIIDs are necessary for each fund and/or share class. They will also identify opportunities for the use of master-feeder funds.
Under UCITS IV, governance requirements and reporting frequency increases, covering day-to-day operations, policies, controls and overall risk management.
“This goes beyond simply monitoring levels of Value at Risk, and concerns areas such as counterparty, credit, concentration and other risks. The key is not only monitoring these, but understanding how the interaction between them impacts on your overall risk,” says Ian Castledine, head of investment risk products for asset servicing at Northern Trust, London.
UCITS IV also introduces requirements for unprecedented day-to-day cooperation among financial regulators in the European Union.