It was meant to reduce the number of funds in Europe but according to our panel, Ucits IV will fail to do so.
Christophe Girondel (Nordea Investment Funds)
Jon Griffin (JP Morgan)
Charles Muller (Alfi)
Pierre Weimerskirch (Ernst & Young)
Johnny Yip (Deloitte)
Part 1: The impact of introducing Ucits IV on consolidation.
Funds Europe: Luxembourg has become the first jurisdiction to ratify Ucits IV, with some provisions coming into force from 1 January. What impact will this have on Luxembourg-based funds and fund management firms over the next two years in terms of their development?
Jon Griffin, JP Morgan: Ucits IV comes in on the 1 July 2011, so many firms are focused on the implementation steps. The legislation largely falls into what you must do and what you could do.
What fund managers must do is develop the Kiid [key investor information document], and I would say that’s probably the biggest focus right now. The challenge is to condense elements of what is in a fund’s prospectus today with other information that is prescribed onto two sides of A4.
There is also the need to support it and figure out the right infrastructure that is required to make sure that the document remains current.
In Luxembourg, we are seeing a whole niche industry starting to propose solutions for managing the Kiid.
When you take the permutations of multiple share classes and language requirements we are looking to have to produce in excess of 12,000 Kiids so importantly we need to get the right technology and processes in place. It’s helpful from a Luxembourg standpoint that there is a transition period, until July 2012, so as long as we don’t launch a new fund umbrella then we’re not looking to create and distribute Kiids until the first quarter of 2012. However, the work still needs to be undertaken now, and our independent fund boards are particularly interested in terms of what goes into this document.
We understand that in Germany, there is a need to produce a Kiid-like document from 1 July 2011, so that’s a prototype if you want to keep registration and distribution going there. We are keeping our ears and eyes open for any other countries that may come up from national requirements that wouldn’t be compatible with where Luxembourg is on the transition. This is really only an issue for those domiciles that have cross-border fund models like Luxembourg and Ireland.
The other mandatory aspect of Ucits IV is the simplification of the notification process. There is a lot of interest in how the supervisory authorities will connect themselves up for the notification of new funds. It will be a split model however, as changes to existing funds will continue to go via today’s channel. Figuring out how to manage this and amending processes will be important.
As far as the optional elements of Ucits IV go, there is the possibility to passport the Man Co’s [management company] services to manage Ucits in another EU country. We only have two management companies, one in the UK and one in Luxembourg, so for us we’re not looking at consolidating into one Man Co. We feel comfortable having the two. One of the well-publicised issues around Ucits IV – the lack of any European tax harness or framework to make these things happen - applies around the Man Co operating cross- border and it applies particularly to the investor-level impact of any cross-border fund mergers. I don’t think we’re going to end up with any fewer funds in Europe as a result.
The master-feeder option is quite interesting and we have our product development team thinking about whether we could be faster to market in the creation of new products primarily for our UK market in terms of being feeders into Luxembourg where the breadth of existing fund product is largest.
Charles Muller, Alfi: So there could be more funds in Europe, not less?
Griffin: I think there is that possibility, yes.
Christophe Girondel, Nordea: I share these views. We are working on the Kiid and the German Kiid-like document. This is the main topic.
We have more Man Cos, though. We have one in Norway, one in Sweden, one in Finland and one in Denmark, as well as Luxembourg. As a result we have launched a project to look at that and, obviously, the tax element around it.
The benefits of consolidation of Man Cos are not tremendous; the exercise is more of a strategic way of looking at the world rather than a very strong cost exercise. The overall aim when Ucits IV was launched was the reduction of funds - that’s what was ‘sold’ to everybody - but I doubt that this is going to happen at all.
In terms of cross-border mergers, the recent news from Germany may be an indication of where this is going. It’s not going to be tax neutral, and if it’s not tax neutral then there is no possibility to merge funds. It’s true that a master feeder could be an option because in some countries it could be faster. We could probably use it in Denmark, for example, and others where it makes sense.
Griffin: But even on the master-feeder option it’s important to figure out why passporting of the product isn’t working. Why do you feel you need to create a local version and could you see that proliferate?
Girondel: Take the example of Poland. For the Poles it is important to have a Polishdomiciled fund, which means a fund manager is probably going to penetrate the market much faster if they offer a Polish fund rather than a Luxembourg fund passported into Poland.
Griffin: A new market opportunity?
Girondel: Yes, there is some marketing element that comes into play here, but obviously from an efficiency perspective that creates additional costs, and there is no question that passporting would be the best option.
Griffin: How will the auditors approach their work and pricing with master-feeder structures?
Johnny Yip, Deloitte: As you know, with the master feeder there are structures where you could have different auditors within a jurisdiction and different jurisdictions for cross border master feeder - one in Ireland, one in Luxembourg, for example. There are frameworks that are available for auditors to carry out cross-border audits with cooperation between two different audit firms. For the Institute of Auditors in Luxembourg this is something that is on the agenda in order to clarify the scope of the audits.
Pierre Weimerskirch, Ernst & Young: Going back to the main question, like Jon we are also seeing, from an advisory point of view, two compulsory points in Ucits IV. Most of our work as of today is about the Kiid, and the other one is about the notification process.
And then I want to qualify strategic points in Ucits IV, which we discussed.
I certainly have a couple of doubts that cross-border mergers will work. Tax is clearly the big issue here. I think that probably from a strategic point of view, the master feeder offers new commercial opportunities, such as how to attack a certain market.
We are also doing quite a lot of work on the restructuring of Man Cos. Some clients that have more Man Cos around Europe are looking at centralising them from an asset management point of view, a risk management point of view and also an administration point of view to really get efficiencies out of it.
An interesting question is, of course, will there be less funds or more? I agree that we will see probably an increase in the number of funds.
Griffin: I would say that Ucits IV was billed as an efficiency package and I think the Commission will take a look at it again in about three years and ask themselves: ‘Have we created efficiency? And has it achieved more in terms of the single market aims in Europe?’
I guess those around the table probably doubt that it will have.
Muller: The crucial point is tax and tax requires unanimity - that is why the Commission didn’t want to go down that route because they didn’t want to jeopardise the whole package because of tax. Alfi, as an organisation, always said that as long as the tax situation was not clear, part of the efficiency package would be difficult to implement.
If you make a cost-benefit analysis of all the management company, it might well be the case that due to all this uncertainty it is better to just keep them the way they are and that the benefits of just having one Man Co in Europe are not as big as anticipated.
From a Luxembourg standpoint, Ucits IV has now been in place since the 1 January 2010 and the law has solved the tax issue, so you can have a management company in Luxembourg and manage funds outside Luxembourg without running the risk of the funds then also being taxed in Luxembourg.
But that’s just unilateral, and if other countries don’t go down the same route, the impact of Ucits IV on these issues might remain limited, especially also regarding cross border mergers.
I agree that the Commission should look at this again. It could well be the Commission will make the assessment that perhaps those benefits - the efficiencies that should have been brought to us through the Ucits IV package are not as big as was anticipated.
Funds Europe: If a fund manager does consolidate Man Cos, does it matter to the individual jurisdictions’ authorities where they consolidate?
Weimerskirch: I am talking quite extensively to fund managers and asset managers from the emerging world such as China, Asia, Latin America, and the Middle East, and these firms are looking now at different domiciles. I visited investment firms in the Middle East as the crisis in Ireland broke out and they asked me a lot of questions about the whole stability of the EU and about Ireland. I think this is becoming a domicile question for these asset managers coming from the emerging world.
Muller: We are certainly not trying to convince firms in Ireland to come to Luxembourg. The competition for the moment centres on asset managers that are neither in Ireland nor in Luxembourg, and there is increasing competition from other domiciles for these. There are Maltese ambitions, French and UK ambitions. They all see Ucits IV as a good starting point to try and attract business.
Funds Europe: If Ucits IV fails to cause fund consolidation, isn’t that a fundamental failure?
Griffin: But the issue is tax. Efama [European Fund and Asset Management Association] and KPMG published a very good document which calls for a European tax directive around this, because for example without an agreed framework on cross-border fund mergers that would protect investors from being hit with a capital gains tax or not allow them to pass through, it’s just too big a barrier. You’re not going to harm those investors just to have fewer funds.
Girondel: I don’t think you can say it’s a failure of Ucits IV. Ucits IV was necessary but is not sufficient. It was absolutely key to make the cross-border merger of funds possible but there is a second element that is not addressed, which is tax.
Griffin: It behoves the tax administrations in each of those countries to get on board with that theme and say: ‘Yes it would make sense generally to reduce the number of investment funds and not impact our investors.’
Muller: Then we should not forget that we have more and more investors outside of the European Union, so even a European tax directive would not solve all the problems. If non-EU investors get taxed because their funds are merged, asset managers will refrain from the merger.
Funds Europe: Can Luxembourg maintain the integrity of the Ucits brand and remain competitive with other jurisdictions as Ucits funds become ever more adventurous and risky within the so-called “newcits” framework?
Muller: Yes. The only thing that is new about ‘newcits’ is the name. It’s a catchy invention and everybody likes it; but there is no such thing as a ‘newcits’ framework. You are either a Ucits or you are not and it is very important to know that there is just one framework. The European regulator has decided that these funds are funds that are suitable for retail investors and any fund that complies with Ucits is certainly not going to threaten the Ucits brand.
The question is more about whether sophisticated products are suitable for non-sophisticated investors, and that’s a question of distribution, not a quality-of-product question. Efama’s lternative Ucits working group looks at this question, and the Commission is looking at this situation under the MiFID review.
Also, we receive information from regulators outside of Europe, for example from Hong Kong who question if some of these funds are suitable products for retail investors that have no basic understanding of the products they buy. But they also are going down the route of saying the product is a quality product, but that the way it is distributed has to be regulated.
Yip: I agree. With Ucits III, the definition of eligible assets was widened to include the use of derivatives within the Ucits framework. Before the crisis we had seen a lot of funds seeking alpha returns created under the Ucits framework. We used to refer to them as ‘sophisticated’ Ucits. I think ‘alternative’ Ucits is a better definition for these investment strategies where portfolio managers make the use of derivatives.
We should not forget that within the Ucits world there is a framework for the use of derivatives. There is also a need for clear and robust risk management procedures, and I think without regardless of the ‘newcits’ discussion Luxembourg has already been very active in these type of products, and I think it will continue because of the benefits from the convergence between traditional managers and hedge fund managers and the needs of sophisticated investors. Investment houses have been putting in place the right combination of distribution abilities, internal controls, and risk management combined with modern portfolio theory from hedge fund managers’ strategies, and this combination is for me the ingredients to continue to have successful funds using derivatives within the Ucits world.
Weimerskirch: The term ‘newcits’ is confusing and I think we should stick with Ucits and all the regulation that implies. We then have alternative funds and, as Charles was saying, this is about suitability, about who is going to buy, and to whom we are going to sell, these types of funds.
Referring back to what we were discussing before, to the Kiid; why do we have this Kiid? What should it provide? Greater transparency to clients?
The other issue is about better risk management, in the sense that people can better see and understand what it is they are buying and probably do better risk management on their own.
So I think ‘newcits’ is confusing. I was in China before Christmas and there was one asset manager asking me the question about ‘newcits’, about what ‘newcits’ funds are. That is a little bit confusing.
Girondel: I don’t think the Kiid will solve these kinds of issues. Producing a two-page document to explain risk will not mean much to the man on the street if it is really sophisticated.
Again, it’s a question of distribution and to whom we sell product. Distribution is a multifaceted animal today. People wrap products, so it’s not only about the fund, it’s about structured products, and more generally the distributors’ responsibility towards the end client. The matter is crucial in Europe but it has definite global implications when those funds are used in structures across the world.
It is an extremely complex undertaking and requires a lot of work by the Commission and respective regulators, because the distribution of funds and broader savings products are likewise complex. The work in Europe on the Prips [Packaged Retail Investment Products] Directive is therefore very important.
Griffin: I think it’s important that everyone understands that ‘newcits’ is all about Ucits. It doesn’t mean that the growth of that alternative Ucits business is necessarily any more risky than the existing Ucits business which is subject to having in place the appropriate risk management process. I agree that it’s more about distribution, and I think that’s why we must pay attention to the MiFID Review to understand the discussion on complex/non-complex product evolution. Frankly, Ucits should continue to be categorised as non-complex.
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