The Ucits regime is speeding ahead of itself. As it enters its sixth phase, increasing complexity means there is a need to consult more with non-European regulators, Nick Fitzpatrick finds.
One of Luxembourg’s most prized clients, Schroders, is increasing the population of Ucits funds on its soil following the acquisition of Cazenove Capital Management. In February, Schroders re-domiciled five Cayman Islands funds into Luxembourg, upgrading some of them to Ucits status, and in March it is re-domiciling five Irish Ucits into Luxembourg.
Schroders, the London FTSE 100 fund manager which has its largest fund operations centre in Luxembourg, acquired Cazenove, another UK fund manager, in 2013.
Noel Fessey, managing director at Schroder Investment Management (Luxembourg), says the Cazenove funds will benefit from Schroders’ Luxembourg operations.
Schroders delivers its Ucits funds through a “super” management company – or “manco” – model.
He stresses the move to Luxembourg is about the funds benefiting from Schroder’s distribution power, efficiencies and in-house governance, and not about the relative merits of Ireland and Luxembourg’s governance regimes.
“The mergers have little to do with geographical preference,” says Fessey, “because Luxembourg and Ireland are both reputable and trusted domiciles, and many investors remain comfortable investing in Cayman Islands funds.”
Governance and distribution have been perhaps the two most overarching themes of the Ucits project, which is enshrined in the EU’s Undertakings for Collective Investment in Transferable Securities Directive. The directive was introduced in 1985 and has seen several revisions since.
One of the more recent changes under Ucits IV, introduced in July 2012, was to allow management companies – an operational and legal entity behind a fund – to operate in different countries to where funds are domiciled, allowing asset managers with multiple fund jurisdictions to streamline their operations.
But take-up of this “manco passporting” facility is reported anecdotally as low.
Sébastien Danloy, head of investor services Europe and offshore at RBC Investor Services, says: “Though there are some examples of manco passporting and some managers have reduced their mancos, it has not been done dramatically.”
Marty Dobbins, managing director at State Street, says: “It has not taken off to the degree you would have thought. Those that are doing it are in the minority right now.”
Schroders, for example, does not passport its Luxembourg management company across EU borders though does have a licence for its Luxembourg management company to manage French funds in future. “We see a preference amongst French institutional clients to have France-domiciled funds which are managed by management companies that belong to the asset manager’s group,” Fessey says.
A GRAND SCHEME
Passporting of management companies and other provisions of Ucits IV – such as the cross-border fund mergers – offer fund management companies something they supposedly want very much: the opportunity to consolidate certain activities, making operations more efficient and cost effective.
But it seems the grand Ucits scheme is, in some circumstances, almost too visionary for the politicians that support it. The ability to merge cross-border funds, as any cross-border fund manager or asset servicer knows, has outpaced changes needed at a much deeper structural level, namely in the disparate European tax system.
“The tax regime has made fund mergers too complex,” says François Pfister, managing partner at Ogier, a legal and administration company. “Where fund managers have been obliged to comply with Ucits IV – such as producing Kiids [key investor information documents] – Ucits IV has been a success. But where the directive has offered opportunities rather than obligations, such as cross-border mergers, I haven’t seen any take-up here and the reason for this is tax.”
Similarly, Danloy says: “With Ucits IV, fund managers first looked at what it was that regulation required them to do, and that was the Kiid. When that had bedded down, they then looked to see what opportunities Ucits IV offered – but a huge number of other regulatory initiatives came along which they had to deal with first.”
The situation suggests the regulatory burden could itself be an impediment to development.
There are other factors causing friction on the Ucits rails, though. As well as the cultural issues that Fessey indicates with Schroders’ French customers (though some would argue politics and protectionism are also involved in wanting management companies in the same jurisdiction as funds) there are the regulators, who need to be pleased.
Danloy says: “Some firms face the challenge of regulatory approval because regulators still have to become more comfortable with passporting. At the end of the day, you have a manco in one country supervised by one regulator, and a fund in another supervised by another regulator. They will be more cautious when a manco is not domiciled in their own country.”
Thomas Nummer, a director at Carne Global Financial Services, says: “Where a management company distributes Ucits outside of the EU, the manco needs also to comply with regulatory standards set in other countries. In some cases that might trigger organisational adjustment at the Luxembourg manco. For example, the need to have more substance is growing.”
BEYOND THE EU
This fact, and the success of Ucits sales in Asia and elsewhere, means that overseas regulators should also be considered stakeholders in the scheme, and consulted with, some people say.
“Asian markets have been models of free trade in this space, but some of their regulators have serious concerns about the suitability of derivatives in retail products. We need to answer Asian concerns about complexity and suitability rather than simply hope that they will become accustomed to the changes we have made,” says Fessey.
This consideration is pertinent as the latest Ucits regime – Ucits VI, which essentially reviews many aspects of the scheme a quarter of century after its birth – is upon us.
“Asian investors and regulators are puzzled with some technical aspects to do with risk management and what the Ucits rules refer to as global exposure, which means leverage from derivatives,” says Nummer.
He explains that Ucits rules for calculating a leverage figure using value-at-risk, or VaR, require an additional disclosure of a leverage figure in prospectuses and annual reports, which is calculated as a “sum of notionals”.
“It’s crude figure that sums up all derivative notionals and does not consider any netting and hedging effects and does not reflect the level of risk of a Ucits correctly. As a result of such a crude calculation method, you can arrive at a leverage figure that is higher than what regulators in Asia would expect from a Ucits fund.”
Fessey says Asian regulators were “presented with a fait accompli” under Ucits III reforms that allow derivatives strategies to be sold to retail investors.
Recent work by the regulator Esma suggests there is a more considered evolution, he says.
But he adds: “The question of whether a fund’s use of certain instruments is for good or ill is a tough one to answer. It’s beguiling to think that Europe can simply reverse the Ucits III reforms without losing something in the process.”
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