broaden the single market freedoms available to fund managers; give investors better access to best of breed products;

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1 Investment A publication from Mason Hayes & Curran Solicitors Investment Spring 2005 Elsewhere in this issue Page 2 CESR revises guidelines for supervisors implementing the Transitional Provisions of Amending UCITS Directive Page 4 Finance Bill 2005 Extension of Eligible Investor Base for Common Contractual Funds ( CCF s ) to all institutional investors Page 5 Revised IFSRA Notices and related Guidance Notes Page 6 Transatlantic Co-operation Initiative Page 7 Looking to the Future: UCITS III Retail Exposure to Hedge Funds Page 8 Reduction of Capital Duty Investment Funds Bill on the way Another new high as assets reach US$552 billion A bit of an old banger Brussels pledges revamp of Single Market structure for Investment Funds To be honest it s a bit of an old banger is how European Commissioner for Internal Market and Services, Mr. Charlie McCreevy, put it, referring to the EU s present single market structure for investment, when addressing the Commission of European Securities Regulators ( CESR ) in December He went on to say that a revamped fund sector could play a large part in defusing Europe s pensions time bomb when addressing the Commission of European Securities Regulators ( CESR ) in December The European Commission ( EC ) would, he said, develop plans next year to re-regulate the EU s asset management sector with the aim of promoting an integrated modern and competitive industry. He noted that a stock taking of the EU s ambitious financial services action plan ( FSAP ) revealed that the EU s present single market structure for investment needed considerable improvement and that more action was required to: broaden the single market freedoms available to fund managers; give investors better access to best of breed products; embrace financial innovation; and give investors regulatory protection. While many groups representing the securities industry, insurance and banking industries have called on the EC for a regulatory pause, asset management groups have urged the EC to introduce new steps to develop the single market for investment. In particular, they have recommended the following: A revamped fund sector could play a large part in defusing Europe s pensions time bomb (i) an end to the requirement for UCITS to be registered separately in each market where they are sold; (ii) moves to facilitate mergers of across borders; and (iii) provisions for to pool their holdings across jurisdictions. Mr. McCreevy pledged to involve fund management in his plans and that stakeholders would be invited to comment on the EC s findings and options as a first step in a potentially significant project to promote the industry. He confirmed that reformation of asset management rules was just one of several financial services priorities set for next year and beyond. He also highlighted the need for a more efficient and more secure post-trading environment for cross-border securities transactions and endorsed that 2005 would be a year of preparation, analysis, economic impact assessment and building consensus on measures to improve clearing and settlement. He also signalled a policy view in the second half of 2005 to regulate rating agencies. His overall message to the wholesale financial markets was that his term in office would be a period of consolidation. By contrast, for the retail financial services market, he mapped out a longer term goal of more integration. He promised to reflect and consult on possible targeted legislative action for the retail financial market.

2 CESR revises guidelines for the Transitional Provisions of On 3 February 2005, CESR, in consultation with the European investment management industry, concluded, approved and published a revised set of guidelines for supervisors implementing the transitional provisions of UCITS III. CESR intends to review the compliance by members during the second half of 2005 The revised guidelines are in response to issues raised by the European investment management industry on CESR s initial draft guidelines (which were circulated to the industry for comment on 21 October 2004) and seek to clarify the following issues raised: issues relating to the marketing of and the simplified prospectus (e.g. in case the relevant home Member State regulator has not yet issued detailed guidance notes on the simplified prospectus); issues relating to the scope of permissible activities of grandfathered management companies (e.g. with respect to the launching of passportable UCITS III ); issues relating to UCITS launched after February 2002 which benefit from a grace period (e.g. smooth convergence to the new UCITS regime, co-ordinated approach to a transitional treatment by statements of conformity etc.) and similar issues relating to grandfathered UCITS I umbrella which launched further sub- after February 2002; and practical questions relating to the scope of the European passport and problems resulting from the relationship between the management company s passport and the fund's passport. The revised guidelines do not constitute EU legislation and CESR members will have to undertake to introduce these guidelines in their daily regulatory practices on a voluntary basis. CESR intends to review the compliance by members during the second half of In summary, CESR concluded the following in relation to transitional treatment. UCITS Management Companies (i) Can a grandfathered UCITS I management company, i.e. authorised before 13 February 2004, launch passportable UCITS III? A grandfathered UCITS I management company is allowed to launch passportable UCITS III only until 30 April The conversion of the management company to UCITS III must be approved by the competent home State authority by this deadline. However, a grandfathered UCITS I management company has in any case to comply with the requirements of Article 21 of the UCITS Directive 85/611EEC ( UCITS Directive ) as amended by the Product Directive concerning an appropriate risk-management process. This has to be confirmed by a written attestation by the competent authorities of the home Member State of the management company, in order for it to be allowed to launch passportable 2

3 Investment A publication from Mason Hayes & Curran Solicitors supervisors implementing Amending UCITS Directive UCITS III in host Member States until April Furthermore, grandfathered UCITS I management companies which have not launched passportable UCITS III so far, and which do not intend to launch them during the transitory period until 13 February 2007, will not be affected by the 30 April 2006 deadline. Thus, management companies can continue to operate their grandfathered UCITS I until 13 February 2007, however taking into account the necessary conversion to UCITS III by that date at the latest. (ii) Can a grandfathered management company continue to launch passportable UCITS I after 13 February 2004? A grandfathered management company is not permitted to launch passportable UCITS I after 13 February The UCITS I fund must have been authorised before 13 February UCITS I Funds Single Fund Structure (i) Can a UCITS I fund authorised between 13 February 2002 and 13 February 2004 and wishing to be marketed in another Member State obtain a UCITS I - product passport and benefit from a grandfathering period until 13 February 2007? All CESR members must provide for a period until 31 December 2005 for UCITS I authorised between 13 February 2002 and 13 February 2004 to be converted to UCITS III. The conversion must be approved by the competent home State authority by this deadline. In the interim period, these may still continue to be marketed under the UCITS I regime. UCITS I Umbrella Fund Structure Grandfathered UCITS I umbrella, which have not launched additional sub- since 13 February 2002, have a deadline to convert to the UCITS III regime by 13 February Management companies can continue to operate their grandfathered UCITS I until 13 February 2007 The deadline of 31 December, 2005 will have no impact on the closure of a sub-fund, or the launch of new share/unit classes in sub-. Thus, grandfathered UCITS I umbrella, which existed on 13 February 2002, can continue to launch new share/unit classes in sub-, which already existed on 13 February 2002, until the end of the transitory period, 13 February (i) Can a passportable UCITS III sub-fund be launched in a grandfathered UCITS I umbrella fund? CESR has concluded that the combination of sub- of both regimes under one umbrella is not permissible. Simplified Prospectus UCITS I must have a simplified prospectus available as soon as possible but no later that 30 September Host Member States will not be obliged to accept UCITS I without a simplified prospectus after this deadline. The revised guidelines can be downloaded from CESR s website 3

4 Finance Bill 2005 Extension of Eligible Investor Base for Common Contractual Funds ( CCFs ) to all institutional investors On 3 February 2005, the Minister for Finance published the Finance Bill 2005 ( the Bill ). Its main objective is to amend and extend the current tax code regime in. In particular, section 48 of the proposed Bill widens the eligible investor base for CCFs beyond pension to all institutional investors. The underlying investor in such a CCF will be taxable on any returns and their tax position will depend on their particular circumstances Currently, the position is that under the Finance Act 2003, only CCFs created under the UCITS Directive, which are used exclusively for the pooling of pension fund assets, allow for tax transparency. The Bill confirms the tax status of this proposed general CCF vehicle as being tax transparent irrespective of the nature of the assets involved. This change is made subject to the necessary conditions being put in place to safeguard the Irish Exchequer from potential tax avoidance opportunities as no tax will be levied on the CCF. Instead, the underlying investor in such a CCF will be taxable on any returns and their tax position will depend on their particular circumstances. This change is being made to facilitate the Irish financial services sector to compete internationally for this business and is welcomed by the industry, as can now provide a tax transparent structure specifically designed for asset pooling. To summarise, the CCF has a similar structure to Fonds Commun de Placement established in Luxembourg. It is an unincorporated body established by a management company under which the investors participate as co-owners of the assets of the CCF. A CCF does not have a distinct legal personality and is formed by way of deed of constitution between the manager and the custodian. A CCF structure enables the assets held on behalf of such schemes to be centralised through a single vehicle, which is owned jointly by the trustees or custodians of the individual pension schemes in proportion to the assets or cash subscribed to the CCF structure. A CCF is a tax-transparent contractual arrangement. The CCF structure is seen as having a number of advantages over other types of fund structures: lower costs and obvious efficiencies associated with the pooling of pension fund assets under one fund structure; wider risk spreading; its exemption from tax on income and gains; and no withholding taxes on distributions. However, intending promoters and their advisers must be aware of the conditions attaching to the grant of tax transparency to this type of fund. Among other obligations, the CCF must: distribute all income; publish an annual breakdown of income by type and source; not have a redemption charge; not have meetings of participators; and not permit the transfer of holdings. The main benefit to pension operating on a cross-border basis depends on how the tax transparency of the vehicle is viewed by tax authorities in the pension own jurisdiction. 4

5 Investment A publication from Mason Hayes & Curran Solicitors Revised IFSRA Notices and related Guidance Notes IFSRA publishes two series of Notices, UCITS Notices and Non-UCITS ( NU ) Notices (the Notices ). These Notices explain and clarify various aspects of collective investment scheme ( CIS ) legislation in and set down conditions not contained in such legislation, with which UCITS and NU CISs must comply. In addition, IFSRA issues guidance notes, from time to time, to provide guidance on issues related to the CIS industry in (the Guidance Notes ). In November 2004, following consultation with the industry, IFSRA revised its requirements in relation to the use of financial derivative instruments by UCITS and took the opportunity to make other technical amendments to both sets of Notices and to the Guidance Notes. The following amendments were made to the Notices and Guidance Notes. (i) UCITS 5 & NU 8, (paragraph 8) General Conditions for CIS Clarification that the provisions in respect of increases in annual management fees apply equally to investment management fees where the fee is paid directly from the assets of the CIS; (ii) UCITS 6 Prospectus Revision to disclosure requirements vis-àvis financial derivative instruments; (iii) UCITS 9 (paragraph 7) and NU 13 (paragraph 2) General Investment Restrictions Amendment to the list of acceptable credit institutions to include those authorised in the Channel Islands, Australia and New Zealand; (iv) UCITS 9 (paragraphs 12, 13) General Investment Restrictions Technical amendments arising from the amendment to acceptable credit institutions; (v) UCITS 9 (paragraph 29) General Investment Restrictions Technical amendment to include reference to paragraph 4 of this Notice in the list of requirements which can be subject to the initial six month derogation provision; (vi) UCITS 10 Financial Derivative Instruments Amendments arising from the recent consultation on financial derivative instruments; (vii) UCITS 12 Use of Repurchase/Reverse Repurchase and Stocklending Agreements Technical amendment arising from the amendment to acceptable credit institutions. Also an amendment to paragraph 3(iv), at the request of the industry, in relation to diversification of non-cash collateral; (viii) NU 1 (paragraphs 3 and 4) Fund of Funds Amendments arising from IFSRA's consultation paper of April 2004 on retail of unregulated including the removal of the limit in direct investments by fund of ; (ix) NU 16 Techniques and Instruments for the purpose of Efficient Portfolio Management Technical amendment arising from the amendment to the criteria for acceptable credit institutions and also revisions necessary to incorporate provisions of IFSRA's memorandum of June 2003 in relation to the use of derivatives; (x) NU 20 (paragraph 3) Futures and Options Schemes NU 21 (paragraph 4) Leveraged Futures and Option Schemes Amendments to align counterparty exposure requirements with those set out in NU16, which provides for techniques and instruments for the purpose of efficient portfolio management; (xi) Guidance Note 1/96 Permitted Markets for Retail CIS Amendments to include reference to regulated markets under the Investment Services Directive and to clarify requirements regarding the listing of markets in CIS documentation; (xii) Guidance Note 1/01 Feeder Schemes and Fund of Funds Schemes: Acceptable investment and related issues Technical amendment to include reference to NU 25 which provides for of unregulated schemes; (xiii) Guidance Note 2/03 Acceptable investments in other collective investment undertakings Amendment to clarify disclosure requirements where a UCITS will have limited investment in other CIS; and (xiv) Guidance Note 3/03 Financial Derivative Instruments Amendments arising from the recent consultation with industry on financial derivative instruments. 5

6 Transatlantic Co-operation Initiative In December 2004, the United States Commodity Futures Trading Commission ( CFTC ) and CESR announced a transatlantic co-operation initiative (the Initiative ). The Initiative states that the two bodies intend to develop a practical action plan on cross-border issues. The Initiative intends to recognise that a successful cross-border arrangement is based on practical means of co-operation This comes in response to many years of successful operation of a variety of bilateral cross-border arrangements that rely upon the exercise of supervisory responsibilities by various CESR members, the growing importance of CESR as a vehicle for developing technical implementation of European Directives and the expansion of the European definition of financial instruments to include commodity-based products. The Initiative intends to: recognise the increasing complexity and intensity of cross-border relationships; the evolution in integration of our respective markets; the increasing commonality of interest in regulatory changes in the United States and the European Union; and the critical role played by CESR in finding common solutions to the integration of financial services in the EU. Furthermore, the Initiative intends to recognise that a successful cross-border arrangement is based on practical means of co-operation. Under the Initiative, the CFTC and CESR have agreed to hold regularly scheduled meetings to share views on regulatory issues of common operational concern, particularly with respect to facilitating: cross-border transactions by exchanges and firms in the two respective markets through the promotion of appropriate convergence and developing practical operational arrangements to ease access to the two markets and to avoid unnecessary obstacles or duplicative supervisory requirements; the exercise of each of their supervisory responsibilities with regard to cross-border conduct by intermediaries, exchanges and clearing organizations and the identification of common evolving issues from each of their respective enforcement experiences; and the early identification, discussion and resolution of regulatory issues arising from the CFTC's and CESR's regulatory initiatives. The CFTC and CESR stressed that the Initiative is intended to complement and improve upon the existing bilateral relationships and programs between the CFTC and CESR members and not as a substitute for such arrangements. As such, the Initiative is intended to supplement any matters being discussed in the EU-US Financial Markets Dialogue. The Initiative is set to commence with a supervisors round-table in February, with plans to release a more detailed action plan in the first quarter of

7 Investment A publication from Mason Hayes & Curran Solicitors Looking to the Future: Retail Exposure to Hedge Funds The UCITS Directive 2001/108/EC (the Product Directive ), being one of the two directives which are together commonly known as UCITS III, introduced changes to the scope of the investment products available to a UCITS. Accordingly, a UCITS III scheme can now invest, as its primary objective, in other collective investment schemes, bank deposits and cash instruments, money market instruments, financial derivative instruments and index tracker. In relation to derivatives, a UCITS III scheme is permitted to invest, where the underlying assets consist of instruments covered by Article 19 (1), in financial indices, interest rates, foreign exchange rates or currencies. Therefore, a UCITS III scheme may not make an investment through a financial instrument which it would be prohibited from making directly. However, the Product Directive did not expressly state that the assets comprising the underlying financial indices must themselves be instruments covered by Article 19 (1) of the UCITS Directive. Identifying this as an opportunity, the industry in Dublin made submissions to the Irish Financial Services Regulatory Authority ( IFSRA ) claiming that there is no prohibition against a UCITS III fund from gaining exposure to instruments which it could not otherwise invest directly in, for example, commodities and hedge. In addition, the Product Directive implies that unlike other underlying instruments of derivatives (such as those referred to above), it was not necessary to look at the position of exposure of the underlying instruments of a financial derivative index to ensure compliance with the UCITS investment restrictions, provided that the financial derivative index is recognised by IFSRA on the basis that it is: (i) sufficiently diversified; (ii) represents an adequate benchmark for the market to which it refers; and (iii) published in an appropriate manner. Furthermore, as it was possible to avoid the look through principle for financial derivative indices, it was arguable that Article 19 (1) (g) of the Product Directive should not be interpreted as requiring the assets comprised in a financial derivative index to be scrutinised in order to determine the eligibility of a financial index to which a UCITS III scheme may invest. The concept is driven by a desire on the part of IFSRA and the industry to promote Dublin as a well-regulated domicile for alternative collective investment schemes IFSRA took the position as expressed in its UCITS Notices (Notice 10) issued in November 2004, that a UCITS III scheme can invest in financial derivative instruments ( FDI's ) provided that: the relevant reference items or indices, consist of one or more of the following: transferable securities, money market instruments, collective investment schemes, deposits, financial indices, interest rates, foreign exchange rates or currencies; the FDI does not expose the UCITS III to risks which it could not otherwise assume (e.g. gain exposure to an instrument/issuer/currency to which the UCITS III cannot have a direct exposure); and the FDI does not cause the UCITS III to diverge from its investment objective. According to IFSRA s interpretation above, it was not possible for an Irish UCITS III scheme, to invest in the following type of instruments: transferable securities where the return on those securities was derived from an embedded derivative based on an index of hedge /commodities/ futures commodities, etc.; and/or swaps where the return was based on the performance of an index of hedge /commodities/futures commodities. Consequently, submissions to IFSRA were made by industry participants, the result of which is that IFSRA has indicated a willingness to consider proposals involving financial derivative indices which give exposure to hedge, subject to any future deliberations by the CESR on the issue. Retail Hedge Funds In addition, IFSRA and the Dublin Funds Industry Association ( DFIA ) are currently in discussions to create a regulatory framework for retail hedge. The concept is driven by a desire on the part of IFSRA and the industry to promote Dublin as a well-regulated domicile for alternative collective investment schemes. The industry is especially intent on increasing the number of Irish domiciled alternative investment products. Considering that a regulatory framework was specifically designed in 2003 by IFSRA and the industry for retail of hedge, it makes sense that the next step should be to formulate regulations for direct investment in retail hedge. 7

8 IN BRIEF CONTACTS Reduction of Capital Duty With effect from 2 December, 2004, the 1% capital duty charged when an Irish company raises capital through the issue of shares was reduced to 0.5% by the Minister for Finance in the Budget With regard to the introduction last year of a holding company/headquarter company regime, it was argued by the industry that without a capital friendly environment, companies would not take up the benefits offered by the new regime and move their holding companies to. Although it is a significant welcome measure, the industry would like to see the measure abolished altogether in the budget next year and it is envisaged, by the industry, that this will ultimately be achieved. Investment Funds Bill on the way In order to facilitate existing products and to assist the industry maintain a competitive range of products, the Investment Funds, Companies and Miscellaneous Company Law Provisions Bill (the Bill ) was recently approved for urgent drafting by Minister for Finance, Mr Brian Cowan. The Bill has been forwarded to the Office of the Parliamentary Counsel for formal drafting. The Bill will provide segregated liability and cross investment for investment companies. The Minister said segregated liability will have obvious advantages from the point of view of investor protection and cross investment will facilitate investment by one sub-fund of an umbrella fund into another sub-fund of the same umbrella. The Bill will also provide for the establishment of non-ucits common contractual and will also provide for changes to company law to facilitate the transposition of EU company law directives dealing with market abuse and prospectuses, as well as other changes to company and consumer legislation respectively. It is expected that the Bill will be published in the first quarter of Another new high as assets reach US$552 billion Recent figures obtained from IFSRA show that as at 30 November 2004, Irish registered collective investment schemes had a total net asset value of approximately US$552 billion which represents growth of 18% since 31 December As at 31 December 2004, the number of Irish registered (including sub-) authorised by IFSRA grew by 6% from 3507 to A date for your Diary The DFIA and the National Investment Company Service Association will host the Annual Global Funds Conference on May The venue will be the O Reilly Hall, UCD Belfield, Dublin 4, and speakers will include Mr. Brian Cowan, Minister for Finance, and Mr. Charlie McCreevy, European Commissioner for Internal Market and Services. DUBLIN Fionán Breathnach Partner fbreathnach@mhc.ie Direct Line: David O Donnell Partner dodonnell@mhc.ie Direct Line: NEW YORK Dan Walsh of Counsel dwalsh@mhcny.com Direct Line: The contents of this publication are to assist access to information and do not constitute legal or other advice. Readers should obtain their own legal and other advice as may be required. Copyright 2005 Mason Hayes & Curran. Dublin: 6 Fitzwilliam Square, Dublin 2, Tel: mail@mhc.ie New York: 261 Madison Avenue, Suite 400, New York, NY 10016, USA Tel: mail@mhcny.com CORPORATE HUMAN RESOURCES TECHNOLOGY LITIGATION INVESTMENT FUNDS