Opinion: The cross-border retail funds at the heart of Luxembourg’s financial sector are at risk of fracturing under divergent regulations, warns Jean-Baptiste de Franssu.
For a quarter of a century, the Ucits directives have been extremely important to Europe. They have given its fund industry a significant competitive edge, helped build the second largest asset management market in the world, protected investors’ assets and increasingly been the vehicle of choice for savers outside Europe.
However, there are very likely to be strong headwinds ahead for Ucits. Competition from other types of long-term retail savings products, which are mostly less transparent, less regulated and more expensive, has never been so intense.
It is far from clear that Ucits will ultimately be the vehicle of choice for indispensable government-sponsored pan-European long-term products that are being discussed. Non-Ucits funds’ net flows have grown steadily and strongly since 2008. Finally, domestic funds, both within and beyond Europe, are benefiting, specifically when the local industries are keen to promote their domicile over Ireland or Luxembourg (the leading pan-European Ucits domiciles).
Ucits funds today have assets of €5.5 trillion, of which 30% comes from Asia, Latin America and the Middle East (the fastest growing source of flows). The investments flow into equities (42%), fixed income (23%), money market vehicles (20%), balanced products (8%) and alternatives (7%) making Ucits an important source of reliable cash flows and assets to capital markets and issuers--exactly what the European economy needs.
Part of their success to date is due to 20 years of regulatory stability, tax transparency principles, clear investments rules allowing for controlled innovation and a European distribution passport. However, in recent years, new directives have come thick and fast--already a consultation on a Ucits VI directive is under way.
This frantic recent regulatory activity has introduced unnecessary regulatory uncertainty and induced a loss of confidence in some non-EU export markets. Some argue the Eligible Assets Directive has given Ucits too much flexibility and allows investment strategies that would have been better in non-Ucits type vehicles.
The outcome is that the percentage of institutions (rather than retail investors) using Ucits is growing at a fast pace and it is estimated that assets under management in “alternative” Ucits have tripled between 2007 to 2011, reaching €90 billion.
Indeed, we see hedge funds engaging with Ucits in order to benefit from the pan-European passport and worldwide recognition, encouraged, in a way, by how the Alternative Investment Fund Managers Directive came about and all its related uncertainties. In the meanwhile guidelines published on Ucits exchange traded funds regarding their use of derivatives raise the question of one regulatory framework but various adaptations.
At the time of Ucits IV, neither the industry nor regulators were supportive enough of the need to harmonise depositary rules. This brought about confusion post-Madoff regarding depositaries’ role and responsibilities, and has led to yet another draft directive.
More recently, other long-winded debates around sophisticated and non-sophisticated Ucits are confusing some of the vehicle’s most loyal supporters outside Europe, such as Chile, Hong Kong and Taiwan. In that context, the historical absence of constructive cooperation and shared vision between most European regulators and legislators has been anything but helpful, and has led to varying degrees of protectionism, nationalist posturing and, ultimately, fragmentation,
As if such challenges were not sufficient, the latest proposal contained in Mifid II, the second Markets in Financial Instruments Directive, is likely to favour the increased divergence of retail markets across the EU. Indeed, rules relating to investor protection including conflicts of interest could give national regulators increased discretion over how to interpret, for example, the notion of complex and non-complex products, as well as in defining the circumstances under which Ucits vehicles can be sold in each country.
In other words the evolving regulatory landscape will encourage each European regulator to set specific rules for the marketing and distribution of those vehicles.
In practice this means that each Ucits fund will very likely have to add extra costs to create specific share classes, marketing documentation and regulatory disclosure tailored to each market in which it will be sold. This is certainly of no benefit to European investors (in fact it is a step back), yet never has the concept of “client first” been more important.
In order to respond to long-term investor needs, and to enhance the success of the European asset management industry, it is indispensable for regulators and industry players to confirm as soon as possible a strategic vision for the role that Ucits should play for long-term savings in Europe as a leading packaged retail investment product, and to stop the current piecemeal regulatory approach.
Jean-Baptiste de Franssu is chairman of Incipit, an M&A advisory and strategic consulting company, and is the former president of the European fund industry trade group Efama. This article originally appeared in December 3 edition of the Financial Times and is reproduced here with the author’s permission.
