When the European Commission proposes a raft of new regulation, the usual response from the funds industry is a collective groan.
Now the Commission is hitting the industry with two revisions to its Undertaking for Collective Investments in Transferrable Securities, or Ucits, regime. This time, however, Europe is looking to the industry for ideas on how to improve the regime.
It is an overhaul that many fund managers may come to welcome, particularly if it results in a Ucits structure that is made more acceptable to Asian regulators – and thus leads to new products that can win authorisation in non-European jurisdictions more easily.
Since the 2008 financial crisis, securities regulators in Hong Kong, Singapore and Taiwan have become much more sceptical with regard to approving new Ucits products. This reflects the changes, codified as Ucits 4, which came into effect in early 2008, just before the market crash.
The idea of Ucits is to create a fund that is domiciled in one European jurisdiction but allowed to be marketed to other European Union countries. The Ucits brand was meant to include strong investor protection measures, and for a while regulators in Asia were willing to accept many Ucits products with only a cursory approval process.
The advent of Ucits 4 plus the crisis changed that. Ucits 4 allows for derivatives and other tools and techniques that lead to leverage. Regulators both in Europe and Asia have come to frown on this (given Ucits is sold at the retail level) and approvals of offshore funds in Asian jurisdictions has slowed to a glacial pace. So anything to rebuild regulator confidence in offshore funds should be welcomed by the industry.
The EU is now hitting the industry with Ucits 5 and Ucits 6. In short, Ucits 5 is about harmonising the Ucits code with new, stringent rules recently adopted with regard to alternative investments (see our interview with EU official Nadia Calvino). It brings mutual fund law up to date, post-crisis. That will surely mean some higher costs, but should also create transparency and reliability.
Ucits 6 is a consultation, not a proposed rule, raising fundamental questions about the entire Ucits structure. It is an opportunity for fund managers and regulators to influence the EU in order to put Ucits on solid footing for the long term.
Ucits 5, which is to become effective in 2014 (with plenty of lobbying left to go), will harmonise Ucits rules with those of the Alternative Investment Management Fund Directive, which has overhauled the marketing and operations of hedge funds and private equity funds that sell to European clients.
The main provisions that must be extended to the mutual funds world include rules around liability of custodians, which won’t be able to pass it on to sub-custodians; and risk-management practices within fund companies, particularly with regard to remuneration.
A funds lawyer in Hong Kong says this means performance bonuses and payouts to managers leaving a firm will be tied to long-term performance. “This may not affect the long-only industry as much, but Ucits have become very broad” in terms of the strategies they deploy.
Ucits 6, however, promises to have a more profound impact on the industry over time. The EU has raised eight areas of interest. Whether it adopts measures on all eight areas is unknown, and it is not obliged to follow industry desires. But it is giving the industry a chance to comment.
The most important theme among the details is that Ucits may have strayed too far from its origin as a way to passport simple retail-suited funds. In effect, Ucits 6 may undo a lot of what industry people term ‘newcits’, which included all the derivative-friendly aspects of Ucits 4.
While it is not clear today that the European Commission wants to remove derivatives entirely from Ucits, it does seem keen to emphasise the transparent, simple nature of Ucits-branded products.
“Since the crisis, there is a concern among regulators that the Ucits brand is being used for complicated investment strategies,” says Lawrence Au, Asia-Pacific head at BNP Paribas Securities Services. “Ucits have become less simple.”
The EU wants to look at eligible assets. For example, some Ucits strategies use swaps to recreate exposures to assets that aren’t supposed to be allowed in a Ucits fund, such as managed futures strategies or closed-ended funds. The EU will consider look-through rules that would lead some products to cut out leverage or the use of certain types of instruments. The upside is this would create a clearer distinction between Ucits funds and alternative investments.
However, that distinction may not last, because another element the consultation is looking at is whether to allow illiquid strategies to carry the Ucits brand, including private equity and real estate.
Indeed, it seems like hedge funds are being singled out as the bad guys. The topics in the Ucits 6 consultation also look at securities lending, repurchase agreements, collateral and over-the-counter derivatives, all tools necessary for most hedge-fund strategies.
“This is positive so far as it increases investor protection and transparency,” says Thierry Blondeau, partner at PricewaterhouseCoopers in Luxembourg. “But the European Commission should make sure the rules don't go so far as to discourage investors from taking any risk. You have to allow people to take some kind of risk if they are to earn a return.”
For Asian managers, however, the upside of a Ucits regime that is better defined, streamlined and simpler is that it should become a lot easier to get local regulatory approvals. The Ucits world may become a bit more expensive and a lot more boring – but it could also become bigger and more trusted.