Financial Services Europe And International Update - February 2012 / Issue 2

Author:Mr Martin Day and Richard Frase


This update summarises current regulatory developments in the European Union and the UK focusing on the investment funds and asset management sectors, during the past three weeks.



Delays have occurred in the negotiations on the proposed European Market Infrastructure Regulations ("EMIR").

On 9 January 2012, the European Parliament has confirmed that it will now consider EMIR in its plenary session to be held from 13 to 16 February 2012.

DG MARKT's Management Plan for 2012: Financial Services Initiatives

The European Commission has recently published the 2012 management plan of the Internal Market and Services Directorate General (DG MARKT).

Amongst other things, the plan includes the following financial services initiatives:

delivering amendments to the UCITS IV Directive (2009/65/EC) (see also the item below on EFAMA's proposals in this respect); delivering a legislative instrument on pre-contractual disclosures (that is, proposals on the regulation of packaged retail investment products (PRIPs), promoting robust investor protection, and providing a level playing field for the originators and distributors of retail investment products; continuing work on revising the Insurance Mediation Directive (2002/92/EC) to improve the functioning of the EU insurance market, making sure that consumers are better informed of the risks, costs and features of insurance products; continuing to build the supervisory and regulatory framework in the financial services sector; proposing measures for dealing effectively with future banking crises and starting work on a framework for crisis management resolution for non-bank financial institutions; preparing a communication on shadow banking, which will clarify the definition of shadow banking and provide a roadmap for the future regulation of the EU shadow banking system; intensifying efforts in the fight against money laundering by proposing a revision of the Third Money Laundering Directive (2005/60/EC); and setting global standards in financial regulation through co-operation and agreement with international partners. The UCITS V Review

The European Fund and Asset Management Association ("EFAMA") has written to the European Commission in connection with the ongoing work of the Commission concerning the revision of the UCITS Directive ("the UCITS V review") to ask that it takes into consideration a number of recommendations of the European funds and asset management industry, represented by EFAMA. These recommendations aim, in particular, at ensuring the effectiveness of some of the key measures adopted under UCITS IV.

Since the entry into force of the UCITS IV Directive, it has become apparent to EFAMA that some of the improvements brought by the UCITS IV Directive (such as master-feeder structures or the cross-border mergers regime, for example) cannot be used to their full extent because of a number of regulatory obstacles which were probably not sufficiently taken into account at the time of the adoption of UCITS IV in 2009.

In order to remedy this situation, EFAMA has worked on a number of technical recommendations set out below and has also included a number of recommendations aiming at ensuring consistency between the UCITS Directive and other EU regulations.

EFAMA also points out to the Commission that tax still remains a significant barrier to cross-border fund mergers. Indeed, from a UCITS' investors' viewpoint, the current Directive does not guarantee the tax neutrality of cross-border mergers irrespective of the legal type of vehicle (corporate type or contractual type funds). Further changes to the European tax and legal framework are therefore required to fully deliver on the benefits of UCITS IV.

EFAMA's recommendations to the Commission are:

To enable UCITS investments in feeder funds the 10 per cent rule should be amended: in accordance with Article 50(1)(e)(iv) of the UCITS Directive, UCITS (the "investing UCITS") are able to invest in another UCITS or other collective investment undertaking (the "target UCITS/CIU") only if, inter alia, the target UCITS/CIU has terms that prohibit more than 10 per cent of its value consisting of units of other CIS, ("the 10 per cent rule"). (The reason for this provision was to limit circularity of investment.) It was intended that UCITS be able to invest in feeder funds, as evidenced by the master-feeder provisions of UCITS IV. However, the 10 per cent rule currently prevents UCITS, such as funds of funds, from investing in feeder funds as those necessarily invest more than 10 per cent in another scheme (a feeder must invest at least 85 per cent in the master). This rule is considered to be seriously hampering the development of master-feeder arrangements with the consequent lack of realisation of economies of scale (and, hence, benefits to consumers) which UCITS IV was meant to deliver. EFAMA requests that the 10 per cent rule is amended to allow "look through" to the underlying master fund into which the feeder UCITS/CIU invests so that the 10 per cent rule applies to the master fund. (An alternative approach would be to amend Article 50(1)(e) so that it applies to investments into funds other than feeder UCITS and to add to Article 50 feeder UCITS as another category of permissible investment.) Merger notifications: notice to be given in writing to unitholders in the receiving UCITS is extremely costly: UCITS IV was also meant to enable reduction of the number of sub-optimal and inefficient UCITS throughout the EU. However, under the Directive, notice of a prospective merger has to be given in writing to unitholders in the receiving UCITS regardless of the size of the merging UCITS. In practice it is extremely costly to meet these requirements, to the extent that the merger may no longer be cost-effective. There is a real risk that this efficiency could falter at the outset, if it is not recognised that the benefits of a merger could be outweighed by the costs of undertaking the merger in certain circumstances. Indeed, the notification requirements could have the unintended consequence of endangering domestic mergers in the future. If, for example, the merging fund has 100 investors and €1 million in assets and the receiving fund has 50,000 investors and €10 billion in assets, then there will be no material impact on the unitholders in the receiving fund. However, the costs of informing them would be so prohibitive that the merger would not be viable. The same issue arises in relation to liquidations/mergers/divisions of master-feeders. Given that master-feeder structures were not permitted in some EU jurisdictions prior to 1 July 2011, it is difficult to quantify the incremental costs of this requirement in this context; but it is certainly the case that the flexibility of the master-feeder structure is seen as one of the main ways in which UCITS managers can achieve economies of scale across the EU. The real problem is the method by which this information has to be provided. When the Commission produced the draft Directive it introduced the requirement that the information had to be provided on paper or (where certain conditions are met) another durable medium. However, this method of communication which entails very high costs for the affected UCITS and their investors, appears not to be justified in all circumstances EFAMA does not see why the information requirements here should be provided in a different manner to any other information to the unitholders (for example, notices of a general meeting, notification of a change in the name of the fund, etc). Accordingly, EFAMA recommends that as regards mergers of UCITS, the initial approach when UCITS IV was being prepared, under which the provision of information to the unit-holders of the receiving UCITS was required only if the proposed merger would have substantial impact on their investments, should be re-examined in the light of the experience to date in order to enhance the efficiency of mergers without compromising investor protection. In addition, EFAMA suggests that circumstances requiring notification to unitholders in writing or by means of other durable medium is reviewed by the Commission having due regard to the need for both effective investor protection and cost efficiency in UCITS management. The need to clarify the framework for merging contractual funds: EFAMA asks the Commission to review the UCITS IV rules on cross-border fund mergers because in practice, a cross-border fund merger can only be realised between two corporate type funds or two trust vehicles. However, whereas a cross-border fund merger between two contractual funds is more challenging, a cross-border merger between a corporate and a contractual type fund is simply not possible at present. EFAMA believes that a statement at EU level that in case of merger of a contractual fund, the law applicable to the merger will always be that of the merging fund would be helpful, and that it would also be very helpful if the Commission reviews the fundamental principles of civil and corporate law governing mergers, in order to come up with a procedure to make cross-border fund mergers practicable for all types of UCITS funds. Regulator-to-regulator...

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