Please find attached the Investment Management Association s (IMA) response to the Asset Management Green Paper. 1

Transcription

1 15 th November 2005 Niall Bohan DG MARKT G3 Unit Head European Commission B-1049 Brussels Belgium Dear Niall Asset Management Green Paper Please find attached the Investment Management Association s (IMA) response to the Asset Management Green Paper. 1 Congratulations to you and your team on the Green Paper itself. It is a comprehensive and thoughtful document which, we believe, correctly identifies the key changes required to deepen the single market for asset management. As you are aware, many IMA members are already engaged in cross-border business throughout Europe and we are very strong supporters of the Commission s efforts to improve the single market for asset management. On the basis of the work we have done in this area over recent years, and consultation resulting from the publication of the Green Paper, we believe that the recommendations made in the Green Paper will make a significant contribution to deepening the single market for asset management. In particular we would emphasise the urgency of: Simplifying the notification procedure; Enabling fund mergers; Enabling fund pooling; Providing a passport for the management company; and Harmonising European private placement regimes It will also be vitally important for the Commission to oversee effective implementation of the Markets in Financial Instruments Directives (MiFID). 1 The IMA represents the UK-based investment management industry. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes. They are responsible for the management of about 2 trillion of funds based in the UK, Europe and elsewhere, including authorised investment funds, institutional funds (e.g. pensions and life funds), private client accounts and a wide range of pooled investment vehicles. In particular, our Members represent 99% of funds under management in UK-authorised collective investment schemes. 65 Kingsway London WC2B 6TD Tel:+44(0) Fax:+44(0) Investment Management Association is a company limited by guarantee registered in England and Wales. Registered number Registered office as above.

2 We believe that there is very broad consensus across the asset management industry on what needs to be done and that there is now sufficient clear evidence to support the development of EU-level initiatives in these priority areas. It is now time to move from agenda setting to implementation. In the interests of acting sooner rather than later, we support the Commission in preferring non-legislative policy instruments. We recognise, however, that some of the proposals may not be susceptible to such initiatives, either because of constraints on what CESR members can do under domestic law or because the necessary mechanisms do not yet exist at EU level (e.g. on mergers). We therefore support any focused and targeted legislative initiatives that may be required. The Commission is the best judge to determine, on a case-by-case basis, whether legislative or non-legislative instruments will be required. Our submission is divided into two parts. Appendix A provides short, direct answers to the questions asked by the Green Paper. Appendix B provides a more detailed analysis of the technical issues arising. We stand willing and able to support the Commission and other policy makers in their future work and please do not hesitate to contact me (snicoll@investmentuk.org) with any queries you may have or points you would like to follow up. Yours sincerely Sheila A Nicoll Deputy Chief Executive enclosure 2

3 Appendix A European Commission Green Paper on Asset Management IMA s summary answers 1. Will the initiatives (relating to transitional arrangements, notification procedures, implementation of Commission s recommendations on use of derivatives and the simplified prospectus and work on definition of eligible assets) bring sufficient legal certainty to the implementation of the UCITS Directive? We strongly support the Commission s proposal to simplify notification procedures. We estimate that the direct costs to the industry of initial notification are in the order of 20 million, and the recurring costs are approximately a further 25 million per year. Furthermore, our members tell us that the direct costs of notification pale in comparison with the indirect costs, i.e. significant amounts of management time have to be spent on notification to manage the reputational risk of failing to notify properly, and, perhaps more importantly, notification causes a large opportunity costs in terms of delayed time-to-market. We therefore welcome CESR s recent consultation on this subject and intend to respond in detail. However, we are concerned that CESR has not been sufficiently bold in its approach, and urge the Commission to intervene if required to realise a simplified notification procedure. See page 10 for our detailed comments. We have actively participated in CESR s work on eligible assets. Most of our concerns relating to the first set of draft guidelines have been allayed in the second. Ultimately, we are optimistic that the final guidelines will be robust and fair, and will serve as the basis for re-establishing trust between regulators and, therefore, will provide more legal certainty in the operation of the UCITS Directive. See page 14 for our detailed comments. We strongly support the Commission s proposal to ensure consistent implementation of its recommendation on the simplified prospectus, particularly in relation to the publication and calculation of total expense ratios. See page 14 for our detailed comments. 2. Are there additional concerns relating to day-to-day implementation of the Directive which need to be tackled as a priority? Members have experienced significant disruption and uncertainty as a result of third country regulators not being informed of changes resulting from the introduction of the UCITS III regime. It is important to recognise that the EU is becoming a global centre for funds, with significant sales of European-based funds taking place particularly in Asia and in South America. It will be vital for regulators there to be 3

4 kept informed of developments and re-assured by the Commission and their European counterparts that the levels of investor protection for European products remain high. They need to be allowed time to consider the changes and make any necessary adjustments to their foreign fund registration requirements. See page 44 for our detailed comments. 3. Would an effective management company passport deliver significant additional economic advantages as opposed to delegation arrangements? Please indicate sources and likely scale of expected benefit. We believe that a management company passport would deliver significant benefits to the single market. UCITS III has significantly increased the costs of operating a management company, our members having been quoted third-party service provider fees of between 750,000 and 1,500,000 per annum in order to comply with the new substance requirements of UCITS management companies. There are also significant increases in capital requirements, which have encouraged a move towards self-managed UCITS. See page 16 for our detailed comments. 4. Would splitting of responsibility for the supervision of the management company and the fund across jurisdictions give rise to additional operational risks or supervisory concerns? Please describe sources of problems and steps that would have to be taken to manage such risks effectively. Far from split supervision increasing operational risks, we believe that a management company passport would result in better operational risk management and improved internal controls. This is because it would allow for the centralisation of, for example, risk management processes, with senior management taking an overall view of, and responsibility for managing, the risks involved in managing funds on a pan-european basis rather dealing with such issues on a jurisdictional basis. Concerns about compliance with local laws can be dealt with in contracts between the fund and the management company. We believe that UCITS III already allows for a management company passport for corporate funds. See page 16 for our detailed comments. 5. Will greater transparency, comparability and attention to investor needs in fund distribution materially enhance the functioning of the European investment fund market and the level of investor protection? Should this be a priority? We agree with the Commission that MiFID could provide a useful toolbox to clarify distributors and fund operators relationships with, and obligations towards clients, and thereby improve transparency and comparability in fund distribution. Specifically, we believe that if there is to be greater transparency of the cost of distribution, this information needs to be provided to the client by the distributor and we believe this is the approach taken by MiFID. We also note that similar disclosure should be required by distributors of substitute products not at present covered by MiFID. See page 20 for our detailed comments. 4

5 We support the Commission s proposed work to clarify the boundary between marketing and sales/advisory services, as well as its work on the cross-over between MiFID Level 2 requirements and UCITS requirements. 6. Will clarification of conduct of business rules applying to firms which retail funds to investors contribute significantly to this objective? Should other steps (enhanced disclosure) be considered? We support further clarification of conduct of business rules and would support the application of relevant Level 2 requirements in MiFID to UCITS and/or their management companies. See page 20 for our detailed comments. 7. Are there particular fund-specific issues that are not covered by ongoing work on detailed implementation of MiFID conduct of business rules? We have not identified any such issues at this stage, but would like to return to this point if necessary as the work on MiFID progresses. 8. Are there commercial or economic logic (net benefits) for cross-border fund mergers? Could these benefits be largely achieved by rationalisation within national borders? We believe that a strong case has been made for facilitating cross-border fund mergers and that this should be a priority for Commission work. Rationalisation at a purely national level already takes place where possible, but is not an adequate substitute for a proper, cross-border fund merger framework which would enable funds based in different Member States to be merged (e.g. a merger of an Irish and a Luxembourg fund) and funds based in the same Member State but with unit holders in another Member State, to be merged, without giving rise to a taxable event in the hands of those unit holders (e.g. a merger of two Luxembourg funds with German unit holders). See page 25 for our detailed comments. 9. Could the desired benefits be achieved through pooling? We believe there is a strong economic case for facilitating cross-border pooling of UCITS, and cross-border pooling of pension scheme assets, and that this should be a priority for Commission work. We do not believe that pooling is a substitute for fund mergers (or, an alternative route to industry consolidation, in the words of the Green Paper). Rather, pooling is a complemen to mergers. In some situations, asset managers will prefer to pool their funds (e.g. because this will enable them to achieve economies of scale while still offering local products to investors) and in other situations they will prefer to merge them (e.g. because this 5

6 will enable them to achieve full consolidation within a single fund hub). See page 29 for our detailed comments. 10. Which are the advantages and disadvantages (supervisory or commercial risks) stemming from the possibility to choose a depositary in another Member State? To what extent does delegation or other arrangements obviate the need for legislative action on these issues? We believe that the economic benefits of a depositary passport are considerably less than those arising from a management company passport. We also believe that there are investor protection reasons for requiring a fund and its depositary to be situated in the same Member State. Therefore we do not believe that a depositary company passport should be made a priority. However, in the event that the Commission were to pursue a depositary passport, this would require significant harmonisation of the responsibilities of a depositary and, in that context, we would strongly recommend strengthening the role and independence of the depositary. See page 34 for our detailed comments. 11. Do you think that on-going industry-driven standardisation will deliver fruit within reasonable time-frames? Is there any need for public sector involvement? We are fully engaged in EFAMA s work to bring about standardisation and efficiency in fund processing, in both domestic and cross-border markets. We believe that public sector intervention is not necessary or desirable at this stage, although public sector support is important to the extent that the industry identifies legal, regulatory or fiscal barriers to its work. See page 35 for our detailed comments. 12. Is competition at the level of fund management and/or distribution sufficient to ensure that investors will benefit from greater efficiency? We subscribe to the economic theory behind the Green Paper that more crossborder activity will enhance competition which should then result in efficiency gains being passed on to consumers. 13. Does heavy reliance on formal investment limits represent a sustainable approach to delivering high levels of investor protection? We believe that the formal investment limits in the UCITS Directive have an important part to play in maintaining investor protection, particularly for investment products that can be publicly marketed to retail investors. However, we also acknowledge that formal investment limits can inhibit financial innovation. Therefore, we believe a harmonised private placement regime would provide an valuable complement to the UCITS Directive, since it would create a space in which 6

7 more innovative products could be developed outside formal investment limits and placed with appropriate investors. In time, as those innovative products establish acceptance in the market place, the formal investment limits in the UCITS Directive can be adjusted so that those products can be authorised as UCITS and publicly marketed. In any event, we believe that more experience is needed of the new freedoms that have been introduced with UCITS III before beginning an extensive overhaul of existing formal investment limits or a move to principles-based investment limits. 14. Do you think that safeguards at the level of the management company and depositary are sufficiently robust to address emerging risks in UCITS management and administration? What other measures for maintaining a high level of investor protection would you consider appropriate? On the whole, we agree with the green paper that the UCITS framework provides good safeguards for managing risks and maintaining consumer protection: figures show that the asset management sector is so far less affected by fraudulent activities than other sectors but that this does not amount to considering that AM is exempt of fraud, conflicts of interest of dysfunctions. However, as noted above, we believe that the framework could be further strengthened by applying the relevant Level 2 conduct of business requirements in MiFID to UCITS and/or their management companies, and would support strengthening the role of the depositary, particularly in relation to its independence. See page 35 for our detailed comments. We also support the Commission s ongoing assessment of risks in the fund industry value-chain and will play our part in any follow-up to that work that may arise. 15. Are there instances resulting in a distortion of investor s choice (in relation to substitute products) that call for particular attention from European and/or national policy-makers? We believe that the market may be distorted by heavier regulatory and fiscal burdens imposed on UCITS as opposed to other substitute products. Whilst we believe it would be a retrograde step to scale back disclosures relating to UCITS, we nevertheless feel that it is very important to ensure that disclosures by products which compete with UCITS are similar to those applicable to UCITS. Additional disclosures should not be required of UCITS if they are not also to be required of substitute products. See page 38 for our detailed comments. 16. To what extent do problems of regulatory fragmentation give rise to market access problems which might call for a common EU approach to a) private equity funds; b) hedge funds and funds of hedge funds? 7

8 We agree that the market for non-harmonised funds is currently fragmented by virtue of the difficulty of distributing non-harmonised funds cross-border. We therefore support the Commission s proposal to establish a working group to consider how European markets for these types of fund might be developed. We believe that there are two possible ways forward. Either the European Commission could harmonise domestic product regulation into a UCITS-like regime for hedge and private equity funds for example, by harmonising their investment and borrowing powers, their operational requirements and disclosure obligations, and as a quid pro quo permit them to be publicly marketed throughout the EU - or the Commission could harmonise local private placement rules to make it easier to sell such funds throughout the EU. We do not believe that product regulation is the correct way of dealing with this problem, but do believe that harmonising private placement rules would be a valuable step forward. See page 40 for our detailed comments. 17. Are there particular risks (from an investor protection or a market stability perspective) associated with the activities of either private equity or hedge funds which might warrant particular attention? We believe that proper implementation and enforcement of the Markets in Financial Instruments Directive, the Market Abuse Directive and the Transparency Directive will provide an appropriate regulatory response to the risks posed by all market users, including hedge funds and private equity funds. We agree with the Financial Authority s (FSA) recent analysis of possible risk factors posed by hedge funds, but do not believe that these risk factors are unique to hedge funds rather they should be viewed as applicable in varying degrees to every user of the market. 18. To what extent could a common private placement regime help to overcome barriers to cross-border offer of alternative investments to qualified investors? Can this clarification of marketing and sales process be implemented independently of flanking measures at the level of the fund manager etc? We strongly support further work on a common private placement regime and do not believe that at this stage it must, of necessity be accompanied by additional measures at the level of the fund manager, particularly given that managers of portfolios will be subject to the requirements of MiFID. See page 40 for our detailed comments. 19. Does the current product-based prescriptive UCITS law represent a viable long-term basis for a well-supervised and integrated European investment fund market? Under what conditions, or at what stage, should a move towards principledriven, risk-based regulation be contemplated? We believe that the concept of product regulation, as enshrined in the UCITS Directive remains valid. 8

9 From a commercial perspective, it has provided opportunities for firms to develop their cross-border activities. However, we recommend that it could be materially improved, and the single market deepened and broadened, by prioritising: Simplification of the notification procedure; Enabling fund mergers Enabling pooling; Providision of a passport for the management company; Harmonisation of European private placement regimes; and Proper implementation MiFID. In the long term, no doubt the UCITS Directive and all other Directives for that matter will have to be further amended to take account of evolving client needs and competitive conditions, and perhaps this will result in a more principles-driven, risk-based regulatory framework. However, at this point in time we strongly believe that the Commission should use its limited resources to focus on the task of realising the priority recommendations described above, rather than speculating about longer term changes or significantly overhauling or restructuring the UCITS Directive. See page 43 for our detailed comments. 9

10 Appendix B European Commission Green Paper on Asset Management IMA s detailed analysis Contents Notification 10 Eligible assets 14 Simplified prospectus and derivatives recommendation 14 Management company passport 16 Distribution 20 Mergers 25 Pooling 29 Depositary passport 34 Fund order processing 35 Investor protection 35 Competition from substitute products 38 Alternative investments 40 Modernising UCITS law 43 Other issues exporting UCITS outside the EU 44 Other issues tax discrimination 45 Other issues sector classification 45 Notification The Green Paper recommends that the notification procedure should be simplified: the contents, complexity and length of the notification phase vary greatly from one Member State to the next. There is a need to streamline procedures and to consider practical mechanisms for resolving questions within the scope of current responsibilities. This may also involve improving inter-administrative collaboration in order to avoid home country authorisation from being contested. CESR has already started work to build up convergence among regulators in this area. IMA strongly supports this recommendation, and believes it should be a priority for future work. 10

11 Article 46 of the Directive sets out the notification procedure for UCITS which seek to market their units on a cross-border basis 2. While in theory the notification procedure does not appear to be particularly onerous, in practice it has been implemented by Member States in such a way as to increase significantly the costs and risks of doing business on a cross-border basis. IMA and the European Fund and Asset Management Association (EFAMA) copublished a report on notification in April We found that the direct costs to the industry of initially notifying funds are in the order of 20 million, and the recurring costs are approximately a further 25 million a year. Furthermore, our members tell us that the direct costs of notification pale in comparison with the indirect costs, i.e. significant amounts of management time have to be spent on notification to manage the reputational risk of failing to notify properly, and, perhaps more importantly, notification causes a large opportunity cost in terms of delayed time-to-market. Indeed, the direct and indirect costs are sufficiently high to have incentivised a small industry of lawyers and professional advisers to develop around the notification procedure, offering products which help their clients to manage the risks of notification. The marketing material used to sell those products shows just how far the practice of notification diverges from the theory. For example, the marketing literature of UcitsEuroFile (a notification product offered by PricewaterhouseCoopers) states 4 : Obtaining authorisation to enter local markets is a time consuming process requiring substantial resources. Internal and third-party distribution networks require promoters to ensure that the complex registration process is conducted as efficiently and quickly as possible. Once market entry is secured, local regulators require foreign funds to satisfy ongoing reporting obligations. Multiple products distributed in multiple jurisdictions often result in an array of different and complex reporting obligations to be satisfied. In our opinion, the notification procedure in certain Member States is a source of market failure, i.e. its direct and indirect costs are so high that they act as a barrier to entry and therefore reduce competition. Our opinion was confirmed in preparing this submission when a number of firms, including some with substantial resources, cited the costs of notification as the main reason they chose not to compete in the single market. One firm also pointed out that the reputational and operational risk involved in maintaining notification acted as a significant deterrence to doing business cross-border. For many larger firms who are already doing business in the 2 If a UCITS proposes to market its units in a Member State other than that in which it is situated, it must first inform the competent authorities of that other Member State accordingly. It must simultaneously send the latter authorities: an attestation by the competent authorities to the effect that it fulfils the conditions imposed by this directive; its fund rules or its instruments of incorporation, its full and simplified prospectuses, where appropriate, its latest annual report and any subsequent half-yearly report, and details of the arrangements made for the marketing of its units in that other Member State. An investment company or a management company may begin to market its units in that other Member State two months after such communication, unless the authorities of the Member States concerned establish, in a reasoned decision taken before the expiry of that period of two months, that the arrangements made for the marketing of units do not comply with the provisions referred to in Article 44(1) and Article

12 single market, simplification of the notification procedure has become the litmus test of reform if the European Union cannot properly enforce such a basic right, then the prospects for the single market appear to be poor. We understand that some Member States have contested the need to simplify notification on the basis that the large number of existing UCITS notifications indicates that the notification procedure must already be working effectively. We believe this argument is irrelevant. We do not dispute that many UCITS have been successfully notified. Rather, our complaint is that the notification procedure is too costly and too time consuming. Others have sought to explain notification as a consequence of the lack of trust between regulators, i.e. that regulators in certain importing Member States suspect that regulators in certain exporting Member States have authorised UCITS to invest in ineligible assets. Importing Member States use notification as a means to reassure themselves that exporting Member States have acted properly. It has therefore been suggested that CESR s parallel work clarifying the eligible assets of a UCITS will lead to greater trust and improvements in notification. We support CERS s work on eligible assets and hope that it does help restore trust. However, we do not think a lack of trust is an adequate explanation for costs and delays in notification - after all, it can be as problematic to notify a plain vanilla long-only bond fund (which is clearly investing in eligible assets) as to notify a derivatives fund. Although UCITS III has exacerbated the problems of notification, it is a long-standing issue. IMA therefore strongly supports the Commission s recommendation to simplify the notification procedure. Our earlier joint report with EFAMA made six key recommendations which can be accommodated within the existing text of the Directive. First, Member States should be able to request only the information specified by the Directive (i.e. fund rules or instruments of incorporation, latest annual report, full and simplified prospectus, annual and half-yearly report). Since the home state regulator should already have attested that information, host states should maintain only a droit de regard - there should be no need for double checking. Where a local distributor is used to market UCITS, there should be no need to provide a detailed marketing plan beyond a statement to that effect. As regards other marketing arrangements, Member States should agree on a standardised format for such submissions, containing minimal essential information. Where the information is already available to the regulatory authorities (e.g. where a new sub-fund is being added to an existing umbrella), the host state authority should acknowledge that it is already in receipt of the relevant information and not require further filing except of the document from the host state attesting conformity with the requirements of the Directive. Second, notification should be required only for those sub-funds of an umbrella fund and those share classes of a fund/sub-fund which are intended to be marketed in the host state. Third, a UCITS should be able to maintain its notification by merely filing any changes to its prospectus with the host state, without the need for further approval or delay. 12

13 Fourth, only the simplified prospectus should have to be translated into the official, or one of the official, local languages for notification purposes. Experience suggests that the overwhelming majority of unit-holders have little, if any, interest in other documentation. Moreover, we believe that it is a commercial, rather than a regulatory, matter whether a UCITS provider deems these documents of interest to potential and existing unit-holders and whether it elects to make further documentation available to such unit-holders in the local language. Fifth, a UCITS should be able to start marketing its units in a host state one month after filing the necessary information, just as services can be passported by a management company after a one-month period. The original two-month deadline is excessive in light of the speed of modern communication and processing methods by and scanner. Sixth, the basis for charging registration fees should be harmonised and reduced. Current practice varies in relation to the regulatory fees charged for notification. Some Member States impose a fee per sub-fund of an umbrella fund while others charge set fees which are sometimes the same and sometimes different - for a single fund and an umbrella fund. In addition, some Member States require the notification, including the payment of the associated fee, of all sub-funds whether or not only some of the sub-funds are to be marketed in the host state, while others require the notification only of those sub-funds to be marketed in that particular host state. Since our recommendations would simplify the notification procedure, it would make sense to agree to a harmonised approach based on a set fee for single funds and umbrella funds, which should naturally be a lot less than current fees given that there will not be double checking of documentation by regulators. Regulators should also ensure that fees are not discriminatory, i.e. that there is no distinction on the basis of nationality of the fund. The Green Paper essentially proposes to rely on CESR to simplify the notification procedure. Whilst we are supportive of CESR s work, we understand that some of its members feel constrained by national law in such a way that they may not be able to materially simplify the notification procedure. We therefore believe it is essential that the Commission monitors CESR s work very closely, and, if it is unable to deliver simplification along the lines recommended above, then the Commission must stand ready to take legislative action, amending the existing Directive if necessary, in order to legally oblige simplification or to do away with the notification requirement in its entirety. We also believe that firms should be actively encouraged to relay their ongoing experiences of notification to the Commission. This will maintain Member States focus on this important issue, and will help the Commission build up its case for future legislative intervention, if required. The Commission must also ensure that simplification of the notification procedure does not result in some of the requirements currently associated with notification being justified, in turn, as falling within Articles 44 and 45 (i.e. the provisions which require UCITS to comply with local marketing and advertising rules). This issue should be addressed in the context of the Commission s proposal to clarify the meaning and operation of advertising and marketing in the context of Articles 44 and

14 Eligible assets The Green Paper recommends clarifying the eligible assets of a UCITS: Clarify the definition of assets which can be acquired by UCITS. One of the cornerstones of UCITS legislation is that the fund should invest primarily in liquid financial instruments. The UCITS III left room for different views on whether certain categories of financial instrument could be acquired by UCITS. Legally binding clarifications of asset eligibility will be finalised by the Commission in early 2006, further to article 53a of the Directive. We support CESR s work and hope that this will help restore trust between regulators and assist in the simplification of the notification process. We have considered with our members other possible assets to be included within the eligible assets of a UCITS, and concluded that the main asset which remains missing is real estate. Simplified prospectus and derivatives recommendations The Green Paper recommends the consistent implementation of the Commission s recommendations on the use of derivatives and the simplified prospectus: Promote implementation of Commission s Recommendations on the use of derivatives and the simplified prospectus: these aim to improve risk management standards and fee transparency. Preliminary analysis, based on CESR s review, suggests that, with isolated exceptions, Member State authorities have moved to implement this guidance. Given the importance of these issues, the Commission will push for further progress in crucial areas, such as the disclosure of fees and charges. IMA is not aware of any particular problems with the implementation of the recommendation on the use of derivatives. However, we are aware of significant problems with the implementation of the recommendation on the simplified prospectus. Each member state has implemented the recommendation differently. The level of detail included in the simplified prospectus varies significantly - we understand that the average simplified prospectus is 8 pages long in France, and 11 pages long in Italy. The average simplified prospectus is likely to be between 2 and 4 pages long in the UK, but the position is not entirely clear because the final regulations were only released on 16 September 2005, notwithstanding the fact that CESR guidelines require the simplified prospectus to be offered from 30 September Furthermore, although it is recommended that the simplified prospectus should include a UCITS total expense ratio (TER) we understand that this is calculated differently in Member States and so is not properly comparable. Luxembourg (the main UCITS export hub) has made inclusion of the TER optional, and the UK has confused matters by also requiring inclusion of a reduction-in-yield calculation (RIY). There is an almost complete lack of harmonisation. 14

15 We therefore believe that the simplified prospectus has failed in its objective to enhance effective investor information. What was intended as a brief and easy-toread explanation of the product has turned into a long document that is not consumer-friendly or comparable between Member States. It is perhaps the most disappointing aspect of UCITS III. A number of firms have observed that whilst they had originally planned to use the simplified prospectus as a marketing tool, they now regard it merely as a regulatory nuisance with little commercial value or application. Worse still, the simplified prospectus has not only failed to harmonise, but might actually act as a barrier to, public cross-border marketing. One firm has reported on two occasions host state regulators objecting to the contents of a simplified prospectus that it had filed when notifying its intent to publicly market its UCITS, notwithstanding the fact that Article 28(3) expressly forbids such behaviour. Thus the simplified prospectus has become another reason for host states to delay notification. Whilst we appreciate that there are problems with the comitology provisions of the UCITS Directive, we nevertheless believe that the recommendation on the simplified prospectus should be revisited, and make three principal recommendations. First, the Commission should reconsider the contents of the simplified prospectus. In doing so, the Commission should also consider its size research indicates that consumers value concise disclosure (i.e. they simply do not read lengthy prospectuses or annual accounts). Since UCITS are non-complex, highly regulated products, we believe that a single sheet of A4 (i.e. two sides) should be sufficient to confer the key facts in a format that is easily understandable by the average consumer. A short format would discourage Member States from using the simplified prospectus as a disclosure dustbin. The emphasis should be on information that is relevan to consumers in relation to the UCITS product, and the Commission should determine such information on the basis of consumer testing (perhaps through the auspices of FIN-USE). Some of the information compressed into those documents that are two pages might be better excluded, to make the important information more readily accessible. Second, the Commission should ensure that TER calculations are harmonised and fully comparable. We understand that differences arise because transaction costs (which are excluded from the TER) are calculated and reported differently in certain Member States. These differences can be used to reduce the reported TER by teeming and lading between transaction and other costs. The best execution requirement in MiFID might help resolve this issue, since it should discourage firms from teeming and lading transaction costs. Consideration may need to be given to different accounting treatments in order to ensure consistency as to what is considered to be an expense for the purposes of the TER. We also support greater cost transparency, particularly in relation to the cost of distribution, but believe the responsibility should be placed with the distributor (rather than with the UCITS manufacturer), as described in our comments on distribution below. Third the Commission should consider whether a different legal instrument (e.g. a directive or a regulation) would bring about a higher degree of harmonisation. 15

16 Management company passport The Green Paper recommends providing a management company passport: The possibility for fund managers to establish and operate UCITS domiciled in other Member States is seen by some segments of the industry as the route to greater efficiency and specialisation in portfolio management and fund administration. Such a possibility was invoked by the management company Directive for corporate UCITS. However, due to the perceived ambiguities and the incompleteness of the Directive, these opportunities have not materialised. In particular, concerns have been expressed that splitting the supervision of the fund and its manager between two jurisdictions could compromise the effectiveness of risk controls and investor protection. Before taking further steps in this respect, the Commission wishes to gather further evidence on the extent to which the management company passport can open up significant additional commercial possibilities and to identify related supervisory concerns. On the basis of responses to this Green Paper, the Commission will indicate whether and how effect can be given to the management company passport when it issues its follow-up report in early IMA strongly supports the provision of a proper management company passport. The Directive currently requires UCITS to appoint a local management company. Because many UK investment management firms who are active in the single market operate UCITS in the UK (for their UK clients) and Luxembourg/Ireland (for export to their non-uk clients), this means that they have to duplicate the management company function in the UK, Luxembourg, Ireland and any other Member State where they operate UCITS. A management company passport would enable them to avoid such duplication and save costs by operating a single management company in one Member State and passporting its services elsewhere. We understand that French, German, Italian and other investment management firms similarly operate UCITS in their home state and one or more 'export hub', so would also benefit from a management company passport. The Green Paper asks respondents to quantify the benefits of a management company passport. In order to do this, we believe it is important to distinguish the costs of operating a UCITS I management company from the costs of operating a UCITS III management company. The costs of operating a UCITS I management company can be mitigated by delegating core functions back to head office - i.e. the Luxembourg/Irish management company of a UK investment manager is able to delegate many of its functions back to the UK, particularly those relating to the asset management, in effect approximating a management company passport. One member firm of IMA has estimated the costs of operating an Irish UCITS I management company to be in the order of 180,000 per annum. The UCITS III Management Company Directive will substantially increase those costs. 16

17 Part of the increase in costs is due to the new capital requirements of UCITS III management companies which will, in many cases, result in a capital charge of 125,000 plus 0.02% of funds under management. One member has reported a consequent increase in capital from 150,000 to 2,000,000. The increased capital requirement particularly hits high-volume UCITS, such as money market funds and exchange traded funds, which, ironically, are at the less-risky end of the operational risk spectrum. What is worse, this increased capital requirement is in addition to the capital that must be held by sponsoring investment management firms under the Capital Requirements Directive, i.e. two separate amounts of capital have to be held in relation to the same operational risk. Article 5a(1)(a) fifth indent requires the Commission to review the capital requirements specified by UCITS III. We recommend that they should be made consistent with the Capital Requirements Directive, i.e. should be based on one-quarter of the preceding year s fixed overheads. The more significant reason for the increase in costs is because UCITS III specifies various governance, risk management and infrastructural requirements which, whilst capable of being delegated, are intended to confer 'substance' on the management company in the Member State in which it is established. Specifically, the management company is not able to delegate to the extent that it becomes a 'letter box' entity. For example, the Luxembourg regulator has stipulated the substance requirements of a Luxembourg UCITS management company (circulars 03/018 and 05/185), requiring, amongst other things: that at least one of the two responsible managers of the UCITS must reside in Luxembourg; that the management company must hold regular and substantial board meetings in Luxembourg; and that, while investment management and marketing may be based elsewhere, the central administration of the fund needs to be in Luxembourg. A small industry is beginning to coalesce around these 'substance' requirements. The Luxembourg regulator has authorised a number of service providers to supply 'substance' to UCITS III management companies on an outsourced basis, only whereas UCITS I management companies are able to delegate key functions on a cross-border basis, UCITS III management companies are generally only able to outsource 'substance' within Luxembourg. It is now possible to obtain substance by renting a UCITS III management company from a third-party service provider in Luxembourg. However, renting 'substance' is not cheap - one member firm of IMA was quoted a fee of 750,000 per annum to rent a management company to oversee a relatively simple fund structure, and another firm was quoted a fee of 1,500,000 per annum for a more complex umbrella fund structure. We believe that the costs of providing substance to a UCITS III management company will discourage small investment management firms from competing in the single market, just as the costs of notification also discourage them. An article in Funds Europe ('Handing Over the Headaches', April 2005) about Luxembourg substance requirements, notes: For larger players, the regulations pose little difficulty, but for small- to midsized firms, where cost is a greater concern, the requirement imposes significant challenges. 17

18 At this point, it is important to record that we do not object to the requirement that a UCITS III management company should have adequate capital, governance, risk management and infrastructure. These requirements are the logical corollary of UCITS III funds being able to invest in derivatives and structured securities. Indeed (as we argue elsewhere) if anything the requirements in the Directive do not go far enough - we believe that a UCITS management company should be subject to the higher standards of professional conduct specified in MiFID. What we object to is the requirement that a UCITS III management company can provide those services only locally, and cannot passport them on a cross-border basis. If they can be outsourced within a Member State, then there is no reason they should not be outsourced cross-border. And if they can be outsourced crossborder then surely it is time to end the fiction of local management companies, and provide for a proper passport? The key argument against passporting management company services is that it would result in split supervision - for example, a UCITS being regulated in Luxembourg but its management company being regulated in the UK. There are a number of things to be said about split supervision. First, there is nothing new about split supervision. A key feature of European market structures is that the investment management of a UCITS can be carried out in a different Member State from that in which the UCITS is domiciled. As described above, UCITS I management companies delegated many of their key functions back to the home state of their sponsoring investment management firm, and in considering the authorisation of a fund, the Irish and Luxembourg authorities would often take comfort from the reputation of the underlying promoter of the fund. In effect the FSA, Bafin, AMF, Consob and others always fundamentally regulated the firms which provided delegated services, via a local management company, to Irish and Luxembourg UCITS funds. In any meaningful sense, the regulation of a UCITS and its management company has been split between different regulators for many years. Second, the argument about split supervision presupposes that a UCITS, its depositary and its management company should be subject to unitary supervision. We accept that the depositary should be regulated in the same Member State as the UCITS which it oversees, because the depositary, in some sense, stands in for the regulator of the UCITS. As noted elsewhere in the Green Paper: Thus, in many countries, the depositary can be compared to a gatekeeper, i.e. a first line of defence for the investor. However, we do not believe that the same can be said of a management company. We therefore believe that whilst a UCITS and its depositary should be subject to unitary regulation, this is not true of the management company. Third, a variant of the split supervision argument is that a management company passport would make it impossible for regulators to enforce UCITS regulation, and would confuse legal liability in the event of an operational failure in the management company. For example, if a UK management company passported its service to a Luxembourg UCITS, how could the CSSF enforce Luxembourg regulations in relation to, say, the investment and borrowing powers of that UCITS, and how could it legally pursue the UK management company if there were an operational failure? The answer, of course, is that the contract between the Luxembourg UCITS and its UK 18

19 management company would specify that the UK management company must exercise its management of the UCITS in compliance with Luxembourg regulation. The contract would also specify that, in the event that the UK manager failed to ensure that the UCITS remained compliant, then in would be legally liable under the laws of Luxembourg. There is nothing new in this. The Occupational Pensions Directive provides pension schemes with the ability to appoint an investment manager on a cross-border basis. The contract between, say, a German pension scheme and a UK investment manger would specify the regulatory obligations of the UK investment manager and his legal liability in the event of a breach of contract. It is on the basis of that contract that German regulations would be enforced and legal liability determined, in the event of an operational failure. Therefore, we do not believe that split supervision is a fundamental obstacle to the management company passport. That is not to say that regulators might not wish to pursue greater co-operation in relation to passported management companies, perhaps through the auspices of CESR-Pol 5. In any event, the argument about split supervision fundamentally misjudges the main regulatory risk of UCITS management companies, which is no that a passport would result in split supervision, but rather in supposing that a management company which meets local substance requirements could necessarily be able to monitor risk management processes without reference and reliance back to the home state of its sponsoring investment management firm where the asset management is taking place. One of our members, an internationally active bank, put it to us like this: Who would you rather have overseeing the risk management processes of a UCITS a locally resident director, or a global, specialised risk management team back in head office? Centralised risk management (by a passporting management company) provides much stronger management of risk. We therefore believe that there is a strong regulatory and economic case for permitting management companies to passport their services. What is more, we believe that this was the clear intention of the amending Management Company Directive. Article 6 of the Directive provides: Member States shall ensure that the management company, authorised in accordance with this Directive by the competent authorities of another Member State, may carry on within their territories the activity for which it has been authorised, either by the establishment of a branch or under the freedom to provide services. Management of a UCITS is clearly an authorised activity, and there is no indication in the Directive that this activity cannot be passported. Therefore, the Commission could realise a management passport quickly and without legislative change, merely by enforcing Article 6. 5 CESR-Pol s reported objective is to facilitate effective, efficient and pro-active sharing of information between Member States, in order to enhance the co-operation and the co-ordination of surveillance and enforcement activities between CESR members. 19