The European investment funds industry has grown to be a major player in capital markets and has significant potential for growth in the years ahead. The most common type of investment funds in Europe are known as undertakings for collective investment in transferable securities, or UCITS. These account for 75% of assets under management in the fund industry in Europe and a growing percentage of assets under management in the fund industry worldwide1. Against this background, this article discusses:
• The benefits, costs and intricacies of offering UCITS for sale globally.
• Cross-border registration of UCITS within the EU.
• Cross-border registration of UCITS outside the EU.
• The impact of upcoming changes to the UCITS regime (UCITS IV) on cross-border registration.
The UCITS regime
The UCITS directives, the first of which was introduced in 1985 (UCITS I) and later amended by two directives (collectively referred to as UCITS III), aimed to establish a product known for investor protection, through strict investment limits, capital and disclosure requirements, and independent oversight procedures. The directives also allow a UCITS to operate under a passport system, whereby it can be offered for sale throughout the EU once it has been authorised in any EU member state.
UCITS I was part of an early effort to create a uniform retail market for investment funds in EU member states. The objective behind UCITS I was to establish a common market for investment funds meeting certain criteria:
• Its sole objective must be collective investment in transferable securities.
• Its capital must be raised through the public offering of interests in the fund.
• Its securities must be subscribable and redeemable out of fund assets (that is, it must be an open-ended fund).
• It must comply with certain prudential investment limits and investor safeguards.
A fund that qualifies as a UCITS and is authorised by an EU member state (the home jurisdiction) can then be marketed to the public in any other EU member state following proper notification in the relevant EU member state (each a host jurisdiction). This procedure is commonly referred to as “passporting”. Although the UCITS passporting procedure is in theory fairly straightforward, it is sometimes more difficult in practice. Under the UCITS directive, each host jurisdiction can enact (and many have enacted) its own regulatory and advertising regimes for the marketing of a UCITS, which include language requirements as well as the requirement to submit marketing documents to the host jurisdiction regulator for prior review. As a result, each UCITS, although authorised to be marketed on a commercial basis in its home jurisdiction, will also have to comply with the different regulatory regimes of each host jurisdiction in which it wishes to sell its shares.
In part because of limitations on the ability to market on a cross-border basis and limits in available investment techniques, UCITS had limited initial success. UCITS I succeeded in laying the groundwork for a single European market for investment funds and their registration and sale throughout the EU member states. However, UCITS did not achieve the level of participation in the investment community that the European Commission had envisioned. One reason was that the process for registering a UCITS on a cross-border basis was left to the discretion of each host jurisdiction, which led to considerable variance not only in the documentation required by various regulators in host jurisdictions but also the time regulators in host jurisdictions took to review and consider the product for approval in the respective host jurisdiction. This variance resulted in frustration for investment firms, especially those with UCITS umbrella funds that launched new sub-funds. In many cases, it was possible to be one or even two prospectuses behind the home jurisdiction prospectus in those host jurisdictions that took the longest to approve passported UCITS for sale.
There have been calls to simplify the notification procedures for passporting UCITS to other member states within the EU2. The Committee of European Securities Regulators (CESR) has worked to develop common guidelines to streamline and simplify the cross-border registration process to market UCITS across EU member states’ borders more efficiently. In June 2006, CESR released its guidelines to simplify the notification procedures of a UCITS that wished to market its shares in a host jurisdiction3. These guidelines harmonised the UCITS passporting procedure which all host jurisdictions are obliged to follow. These guidelines remain the current guidelines for UCITS wishing to market shares cross-border into a host jurisdiction.
Cross-border registration of funds within the EU
Under the CESR guidelines, a UCITS must submit its prospectus, simplified prospectus, latest annual report (and, if it has a subsequent semi-annual report, the semi-annual report), and constitutional documents, as well as evidence of authorisation by the home jurisdiction. These documents are usually required to be translated into the national language of the host jurisdiction. Once filed with the regulator in the host jurisdiction, the review period is two months.
A regulator in a host jurisdiction should not comment on the substance of a UCITS which has been authorised by another EU member state. The host jurisdiction’s regulator can, however, implement its own regulatory and advertising requirements for UCITS, which can require the UCITS to produce additional documentation to be submitted with the application for cross-border registration. As noted above, each UCITS, although authorised to be marketed on a commercial basis in its home jurisdiction, therefore must also comply with the different regulatory regimes of each host jurisdiction in which it wishes to sell its shares.
The following are some examples of different approaches taken by EU host jurisdictions with respect to passporting requirements:
Italy To passport a foreign UCITS into Italy for sale to retail investors, it is necessary to prepare an “extended application form”, which is an application form with supplemental information for Italian retail investors investing in a UCITS. Certain institutional Italian investors must also receive an informative note (nota informativa) containing additional information for Italian investors.
France To passport a foreign UCITS into France, a UCITS must prepare and distribute to French investors a supplement to the prospectus called the “French addendum” or “French marketing memorandum” containing additional information for French investors. In part, the French addendum is meant to provide additional information to French investors so they receive the same information about a UCITS as a French investor investing in a French fund would receive. The French regulator has a prescribed form of French addendum which it requires all foreign UCITS to use.
Local prospectus supplements/addenda
Most EU jurisdictions require a local supplement or addendum to the prospectus to be prepared, containing information of relevance to investors in the host jurisdiction, including information about how to contact a representative of the UCITS in that jurisdiction and the tax ramifications of investing in the UCITS. The preparation, translating and updating of these documents creates additional costs for UCITS. The integration of these supplements/addenda into the prospectus of the UCITS can also create difficulties; on occasions, host jurisdiction regulators and home jurisdiction regulators have disagreed on the appropriate place to include this information, either within the prospectus or appended to the prospectus, leaving the approval of the passporting UCITS unresolved until the host jurisdiction regulator and the home jurisdiction regulator can reach agreement.
Most host jurisdictions also require a UCITS to have a local presence. This may range from a local paying agent (which serves as a repository for the UCITS’ documentation and directs investors’ queries to the UCITS’ home jurisdiction service providers), to local distributors, or the use of a local firm which by law must act as nominee for all investors from that jurisdiction. The requirements for local contracts can differ from jurisdiction to jurisdiction. For example:
Germany A foreign UCITS cannot submit an application to passport into Germany until it has a finalised, executed paying agency agreement with a German paying agent. Other jurisdictions also require the submission of the local documentation, but are willing to review draft documents and do not require signed, translated agreements to initiate the application process.
Italy In Italy, a correspondent bank agreement with an Italian bank is required if the foreign UCITS wishes to be registered for sale to retail investors. The correspondent bank agreements typically contain many detailed provisions based on complex local requirements for the nominee arrangements, and these agreements can be time consuming to negotiate.
The translation of relevant documents to passport a foreign UCITS is usually also required before submitting an application to the regulator of a host jurisdiction. The general requirement in many EU jurisdictions is that the prospectus, simplified prospectus, constitutional documentation, latest annual and semi-annual reports and other documents required for the marketing of the foreign UCITS must be translated into the national language of the host jurisdiction before filing the documents to passport the UCITS. This can be time consuming, often taking more than six to eight weeks, as well as expensive.
As discussed above, CESR imposed a two-month review period for a host jurisdiction’s regulator to approve the registration of a foreign UCITS once it receives a completed application/notification. A problem with this two-month review period has arisen because, in some jurisdictions, the host jurisdiction’s regulator asks questions during the review period and “tolls” the two-month review period, starting from the date it requests additional information from the UCITS until it has received and approved the additional information requested. This can change the two-month review period into a much longer period of four to five months. When this timeframe is added to the time for the translation of the documents, it makes the total time period required to passport into a host jurisdiction much longer, and it has been argued that this timeframe makes UCITS uncompetitive with certain other vehicles.
Reliance on local distributors for filings
Finally, although in most jurisdictions the UCITS is the entity to prepare and file all documents with the host jurisdiction’s regulator, in a few jurisdictions (such as Portugal) the initial filing is actually submitted by the local distributor appointed by the UCITS, with the result that the UCITS does not control the process of submitting its own initial filing to the local regulator.
Ongoing compliance requirements
Other topics that can differ from jurisdiction to jurisdiction are ongoing compliance requirements, including:
• The filing of periodic sales reports in various jurisdictions.
• Differing requirements for annual general meetings or extraordinary general meetings (including publications of notices in journals or filings with the regulators).
• Differing requirements for advertising materials. In some jurisdictions, any advertising materials given to investors or potential investors must be pre-approved by the host jurisdiction’s regulator.
• Varying tax filing requirements.
• Various translation and mailing requirements for filings with the host jurisdiction’s regulator and communications with investors in the UCITS in the host jurisdiction.
The impact of UCITS IV on the cross-border registration process within the EU
On 16 July 2008, the European Commission released proposed changes to the UCITS directive (known as UCITS IV), and the European Parliament approved UCITS IV on 13 January 2009. The changes should come into effect in mid-2011 and bring much anticipated reform to the European retail investment funds sector. It is hoped that these changes will increase the efficiency of the cross-border registration process in a number of key areas.
The European Commission asserts that the UCITS directive has been key to the successful development of the European market for investment funds. However, critics observe that the cross-border registration process is long and bureaucratic. The cross-border flow of funds is reduced and the cost of managing remains high: ultimately these costs are passed on to investors.
Under UCITS IV, the cross-border registration procedure would be simplified. Under thereforms, a foreign UCITS intending to register in a host jurisdiction would file a notification letter with its home jurisdiction regulator. The notification letter would contain information on how the UCITS proposes to market its shares in the intended host jurisdiction. Along with the notification, the UCITS would be required to submit to its home jurisdiction regulator:
• The prospectus.
• The constitutional documents.
• Where appropriate, the latest annual and semi-annual report.
• The key investor information document (which would replace the simplified prospectus), also translated if required.
From the time the notification letter is received by the home jurisdiction, the home jurisdiction would have 10 days to transmit the complete documentation along with a UCITS attestation or certificate to the host jurisdiction. Once all documentation has been sent by the home jurisdiction to the host jurisdiction, the home jurisdiction would immediately notify the UCITS. The UCITS would then be permitted to start marketing its shares in the host jurisdiction as of the date of this notification. Therefore, the two-month review period before the UCITS could commence marketing in the host jurisdiction under the current regime would be eliminated under UCITS IV. However, the reforms would allow a host jurisdiction to impose local marketing rules on UCITS, but only after the UCITS has placed its shares on the market of a host jurisdiction. In addition, the host jurisdiction would not be permitted to request any additional documents, certification or information other than those provided by the home jurisdiction.
This procedure will simplify the cross-border registration process considerably by shortening the time period which a foreign UCITS must wait before commencing marketing in certain host jurisdictions. It is difficult to tell, however, how this would work in practice. As noted above, many host jurisdictions require additional documentation before allowing a registration to proceed, such as country supplements/addenda to the prospectus. It is difficult to see how the host jurisdictions would permit the sale of the foreign UCITS without them. In practice, it may prove difficult to implement this proposal.
It has also been proposed, under UCITS IV, to eliminate the translation requirements for all documents in English (and perhaps certain other languages), except for the key investor information document. This would save a considerable amount of time and expense for a UCITS (as noted above, it can take up to six to eight weeks to translate the necessary documentation for a registration in a new jurisdiction).
Cross-border registration of funds outside the EU
UCITS have become an increasingly popular investment in countries outside the EU. UCITS registering on a cross-border basis outside the EU have increased dramatically and a large percentage of investment in UCITS comes from outside the EU. The European Fund and Asset Management Association has commented, following a survey of large asset management firms, that 90% of net sales of UCITS promoted by those firms originated in Asia in 2007. UCITS as a brand has been recognised across the world, and many UCITS are registered in non-EU countries such as Switzerland, Hong Kong, Singapore, Taiwan, Bahrain, the UAE, Chile and Peru.
It is important to remember when considering registration in a non-EU jurisdiction that the UCITS passporting regime is not available. A UCITS that wishes to register in a non-EU jurisdiction must therefore apply for registration under the local regime and comply with all local registration and compliance requirements. In particular, local regulators outside the EU have the authority to impose additional restrictions on the way a UCITS is managed. In certain jurisdictions, there are a number of substantive limitations on a fund’s ability to manage various kinds of assets. For example, Taiwan used to require (until a recent easing of these regulations) that a fund registered in Taiwan could invest no more than 0.4% of its assets in mainland Chinese securities, and no more than 10% of its assets in China-related securities traded in Hong Kong or Macau. It was necessary to consider that by registering in Taiwan, a fund’s portfolio managers might be restricted in the future from investing in Chinese securities. This requirement impacts all investors in the fund, not just Taiwanese investors, and if the portfolio managers subsequently determined that investment in Chinese securities was attractive for the fund as a whole, it would be necessary to de-register the fund in Taiwan, in order to act in the best interests of all investors in the fund.
In addition, non-EU regulators may have statutes and regulations which are different from or actively conflict with the regulations of the UCITS home jurisdiction. At times, registration in these non-EU jurisdictions may result in the need to approach the home jurisdiction regulator to request permission to change the UCITS prospectus to comply with the other jurisdictions’ requirements. For example, the Hong Kong Securities and Futures Commission often questions the extent to which UCITS may invest in certain derivative instruments.
Finally, when dealing with regulators in multiple jurisdictions (and it is not unusual for a UCITS to be registered for distribution in over 25 jurisdictions, both within and outside the EU) it can take a long time to implement changes across many different jurisdictions. A number of regulators can take weeks or months to consider and approve potential changes in prospectus disclosure; it may be necessary to engage in three-way or four-way negotiations between regulators to ensure all accept the final disclosure. In addition, many jurisdictions have special notice publication requirements (in a journal or by notice to investors) which may differ from the requirements of the home jurisdiction. In spite of these difficulties, however, the UCITS brand name is growing strongly in acceptance across many jurisdictions globally.
UCITS in the future
The goal of a creating an environment in which UCITS can be marketed effectively across a single market is making progress. The European Commission and CESR are working together to deliver consistent implementation of the UCITS directive and changes to the UCITS directive with UCITS IVs. The approval of UCITS IV by the European Parliament continues to move the EU in the right direction toward this goal, although much work remains. THFJ
1. EFAMA Quarterly Statistics Release No. 35 (Third Quarter of 2008), European Fund and Asset Management Association.
2. See, for example, the Green Paper on the Enhancement of the EU Framework for Investment Funds (COM (2005) 314) (12 July 2005), at page 4.
3. See CESR’s Guidelines to Simplify the Notification Procedure of UCITS (June 2006).
ABOUT THE AUTHORS
Karen L. Anderberg is a partner in Dechert’s financial services group. She is admitted to practice before the District of Columbia Court of Appeals and the Maryland Court of Appeals. She is also a member of the District of Columbia and Maryland Bar Associations.
Jessica Brescia is an associate in Dechert’s financial services group. She advises U.K., U.S. and European financial services firms on U.S. and U.K. regulatory issues. She was admitted to the Bar of the State of New York in January 2006 and admitted as a solicitor in England and Wales in December 2007.