On 13 January 2009, the European Parliament approved a reform of the Council Directive 85/611/ECC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (the UCITS Directive). This recast Directive is commonly referred to as UCITS IV and repeals all other UCITS Directives (in its consolidated form of 2002 known as UCITS III).  

The UCITS IV Directive is designed to make the UCITS market more efficient, in particular as regards the cross-border activities of management companies.

From UCITS III to UCITS IV

Since 2004 when member states implemented UCITS III there was an almost immediate strive for further improvement. In July 2005, the Commission published a Green Paper which was followed in December 2006 by a White Paper. The Commission proposed a recast of the UCITS Directives in July 2008. With some amendments, in particular with the clear decision “pro” the management company passport, the European Parliament finally adopted the UCITS IV Directive. The approval of the European Council is considered to be a formality.  

The road ahead

Similar to the MiFID (as the recast Directive of the ISD), UCITS IV provides that the details of certain crucial amendments should be covered by Level 2 implementing measures most of which are due in July 2010. On such measures, CESR issued a “Call for Evidence” in February 2009.  

Member states have until July 2010 to implement into national law UCITS IV and its implementing measures.  

Highlights  

The paramount changes of UCITS IV in comparison to the UCITS III Directive are:

  • Management company passport allowing UCITS authorised in one member state to be managed remotely by a management company established in another member state.
  • Simplification of the procedures for cross-border distribution.
  • Framework for the domestic and cross-border mergers of UCITS allowing consolidation of UCITS.
  • Introduction of master-feeder structures to facilitate (mostly tax-driven) asset-pooling.
  • Replacement of the simplified prospectus with a key investor information document designed to present comprehensible information similar for the UCITS of each member state.

Management company passport

Following a controversial debate and consultation by CESR, UCITS IV introduces a “management company passport” concept. The management company passport allows a management company domiciled and authorised in, for example, the UK to establish and manage a UCITS authorised in another member state, for example, a Luxembourg FCP. This can be done both by way of establishing a branch, and on a cross-border basis. A branch has to comply with the relevant conduct of business rules of the host member state; in cross-border situations, the home member state conduct of business rules apply. The management company (its organisational structure including risk management) is supervised by home state regulation while the UCITS is governed by host state regulation.

This means that, by way of example, a German management company could benefit from a faster establishment process and the “industry friendly” interpretations of the investment restrictions in Ireland or Luxembourg, without (as it is the case now) being required to set up a domestic subsidiary. This is likely to have an impact on the corporate structures of the industry.

Cross-border distribution

UCITS IV will remove existing administrative barriers to the cross-border marketing of UCITS. Under UCITS III, there is an ex ante control of the host state supervisor before the marketing of units of UCITS can start. This leads, in some cases, to a fairly cumbersome process of registration. When the UCITS IV regime is implemented, the management company will notify the home state regulator that it wishes to distribute the UCITS in another member state and such marketing can commence at the time the home state regulator has notified the host state regulator thereof; this notification shall be made within ten working days. However, the host state rules on the distribution of the units have to be complied with (ex post control of the host state regulator).

As far as sales documents are concerned, it is interesting to note that only the key investor information (see below) has to be translated into the language of the host state. The prospectus and marketing material can be drawn up or translated into “a language customary in the sphere of international finance”. This might have the implication that all prospectuses and marketing materials will be in English. However, depending on civil laws and legislation in each member state, there will be the risk of civil liability because retail investors could well argue that they are not able to understand the information because it was not provided in their first language.

Mergers of UCITS

In order to facilitate the consolidation of UCITS in the EU, the UCITS IV Directive creates a framework for both domestic and cross-border mergers of UCITS regardless of their structure (i.e. all types of funds, contractual, corporate and trust funds can be merged with each other). Three different forms of mergers are provided for:

  • Merger by way of absorption.
  • Merger by formation.
  • A scheme of amalgamation or arrangement.

Fund mergers are possible even if the investment strategies of the merging funds differ. The requirements for authorisation of a merger of UCITS and the information that has to be made available to investors will be harmonised. Importantly, only the approval of the home state regulator of the merging UCITS is required, although such decision shall be communicated to the regulatory authority of the receiving UCITS. The rules require the depository bank or an independent auditor to validate the valuation criteria, cash payment and the conversion ratio of the merger.

As a consequence of the current financial crisis, fund volumes have significantly decreased because of both redemptions and a devaluation of assets. Many funds have fallen below the crucial amount that is required to manage the fund effectively. Therefore it is expected that the industry will make frequent use of the new opportunities of UCITS mergers.

Master-feeder structures

UCITS IV introduces “master-feeder” structures allowing a UCITS (feeder) to be (fully) invested in another UCITS (master). This allows UCITS to have increased economies of scale and lower operational costs and makes the framework more attractive for creating funds for institutional investors. The structure allows the feeder UCITS to invest 85 per cent or more of the NAV into a master UCITS. Up to 15 per cent of the NAV can be invested in ancillary liquid assets and derivatives for hedging purposes. The feeder UCITS de facto delegates the portfolio management to the master UCITS and must therefore monitor the master UCITS. The feeder and master UCITS may be in the same or in different member states and may or may not have the same depositories and auditors; however, agreements between the management companies and the depositories and auditors (in case they are different) must be in place to ensure information sharing.  

Key investor information

The existing UCITS III concept of the simplified prospectus will be replaced by key investor information (KII). The downside of the simplified prospectus concept is that member states are allowed to require additional information than that set out by UCITS III. Therefore the simplified prospectuses of two different jurisdictions are not always comparable. UCITS IV will change that. KII is a short and focused document to be provided to investors at the pre-contract stage. UCITS IV sets out an exhaustive list of the type of information that is required although the details will be dealt with in the implementation measures. KII shall include a short description of the investment objectives, a past performance presentation, information on costs and associated charges, and a risk-reward profile. Additional information is required for specific cases, such as umbrella funds, UCITS with more than one share class, UCITS fund of funds, master-feeder structures and UCITS with a capital guarantee. As under UCITS III, claims for civil liability cannot be based solely on KII unless it is misleading, inaccurate or inconsistent with the relevant parts of the prospectus.