COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT pursuant to the second subparagraph of Article 251(2) of the EC Treaty concerning the common position of the Council on the adoption of a Directive of the European Parliament and of the Council amending Council Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), with regard to investments of UCITS

1998/0243 (COD)

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT pursuant to the second subparagraph of Article 251(2) of the EC Treaty concerning the common position of the Council on the adoption of a Directive of the European Parliament and of the Council amending Council Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), with regard to investments of UCITS

1. BACKGROUND

-On 17 July 1998 the Commission presented a proposal for a directive amending Council Directive 85/611/EEC [1] on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), with regard to investments of UCITS [2] - COM(1998) 449 final - 1998/0243 (COD).

[1] OJ L 375, 31.12.1985, p.3. Directive as last amended by Directive 2000/64/EC (OJ L 290, 17.11.2000, p. 27).

[2] COM (1998) 449 final (OJ C 280, 9.9.1998, p. 6).

-The Economic and Social Committee delivered its opinion at its 361st plenary session on 24 and 25 February 1999. [3] At the request of the Council, the European Central Bank delivered its opinion on 16 March 1999 [4].

[3] OJ C 116, 28.4.1999, p. 44.

[4] OJ C 285, 7.10.1999, p. 9.

-On 17 February 2000 the European Parliament adopted a legislative resolution [5] giving its opinion on the Commission's proposal.

[5] OJ C 339, 29.11.2000, p. 228, Rapporteur: O. Schmidt.

-On 30 May 2000 the Commission adopted an amended proposal [6] taking account of its consultation of Parliament and the Economic and Social Committee.

[6] COM (2000) 329 final (OJ C 311 E, 31.10.2000, p. 302).

-On 5 June 2001 the Council adopted the common position [7] which is the subject of this communication.

[7] OJ............

2. PURPOSE OF THE PROPOSAL

The main objective of the proposal is to promote further the cross-border sale of units in collective investment undertakings covered by Community harmonisation and to modernise their investment techniques with a view to boosting yields and competitiveness by:

-extending the freedom to sell throughout the Union to collective investment undertakings investing in certain financial assets other than transferable securities in the strict sense, such as units of other collective investment undertakings, money market instruments, bank deposits and financial derivatives; new transparency rules will ensure that investors are properly informed;

-revising some other provisions of the UCITS Directive in order to update it by taking account of new portfolio management techniques which have been developed since 1985;

-removing a number of problems of interpretation posed by some provisions of the UCITS Directive and which hinder its uniform application.

3. COMMENTS ON THE COMMON POSITION

3.1. General comments

3.1.1. The common position adopted by the Council after very difficult negotiations preserves the essence of the Commission's initial proposal. It aims to modernise all the rules applicable to investments by UCITS: the widening of the range of authorised investments, subject to appropriate prudential restrictions, is matched by a tightening of requirements relating to risk monitoring and control and to information that is published or made available at the request of the subscriber.

3.1.2. The common position takes account of the amendments proposed by Parliament, most of which were incorporated in full or in part in the amended proposal. While it reflects the same overall concern to strike a balance between modernisation of the rules and investor protection, the common position has none the less introduced changes affecting certain aspects of the amended proposal, mainly relating to investment limits and rules. On the other hand, it has consolidated the provisions on the prudential framework for authorised transactions and on investor information.

3.1.3. The main changes made to the Commission's amended proposal in the Council's common position are commented on in detail below. In addition, an overview of the follow-up to Parliament's amendments, first in the amended proposal and then in the text of the common position, is contained in the annex. This summary table also shows the changes introduced by the Commission and the Council that fall outside the scope of Parliament's amendments.

3.2. The substance of Parliament's amendments reproduced in the common position

3.2.1. Recitals [8]

[8] For an analytical overview of the changes made, see table annexed.

3.2.1.1 General comments

Parliament's amendments to the preamble were accepted by the Commission and have been taken into account, subject to a number of changes, in the common position. The Commission considers that these changes are in accordance with the spirit of the amended proposal incorporating the views expressed by Parliament.

3.2.1.2 Recitals changed or added as compared with the text of the initial proposal

The seven amendments adopted by Parliament (Nos 1 to 7) covered the principles governing certain choices of financial instrument and associated management techniques (money market instruments; units in UCITS and other collective investment undertakings; bank deposits; index-tracking funds; limits on investments in liquid financial assets) and the future codification of the UCITS Directives.

Other changes were introduced by the Commission in its amended proposal, particularly with regard to financial derivatives. In its common position, the Council preferred to reorganise the provisions of the preamble into three recitals covering among other things the principles, technical limits and disclosure provisions applicable to derivative transactions and the specific case of over-the-counter derivatives.

Lastly, a specific recital on the committee procedure was introduced in the amended proposal.

3.2.1.3 Recitals deleted as compared with the text of the initial proposal

Apart from the current recital 10 (two recitals having been merged), three recitals have been deleted from the text of the preamble:

- former recital 13 (14 in the amended proposal) on securities lending transactions (see comments on Article 21 [9]);

[9] Unless otherwise indicated, the references to numbers of articles in this communication and the annex thereto refer to the numbering of Directive 85/611/EEC, which is to be amended.

- recitals 18 and 19 concerning the depositary. This issue will instead be the subject of a separate report and of proposals for measures considered appropriate, as agreed, with the approval of the Commission when political agreement was obtained in the Council on the second proposal to amend the UCITS Directive. [10]

[10] See Communication on the common position on the second proposal to amend the UCITS Directive, p. 6.

3.2.2 Substantive provisions

3.2.2.1 Amendments deemed acceptable by the Commission

Eight of the seventeen amendments adopted by Parliament were deemed immediately acceptable by the Commission during the vote at the first reading.

These were mainly amendments (Nos 9, 11, 13, 14, 18, 19 and 20) which improved the wording of a number of provisions on the types of eligible investment and associated information requirements: securities; bank deposits; money market instruments other than those dealt in on a regulated market which fall under Article 1; the role of the Commission and the Contact Committee in the diffusion of information; and specific rules regarding index-tracking funds, funds of funds and cash funds (invested in deposits). Lastly, Parliament (amendment No 21) preferred to restrict the role of the Contact Committee, in its new capacity as a regulatory committee, to the refining and updating of definitions in support of Community harmonisation.

On the whole, the changes made to the amended proposal on the basis of these amendments were subsequently incorporated into the common position, with one exception. This was amendment 14 restoring Article 20 of Directive 85/611/EEC, which establishes a procedure for the exchange and publication of information based on the Commission and the UCITS Contact Committee. The procedure was extended by Directive 88/220/EEC amending the 1985 Directive, in order to take account of the inclusion of bonds subject to a higher investment limit in the range of eligible securities. Although Article 20 is deleted from the text of the common position, the Council established in Article 22(4) a similar procedure covering precisely the categories of bond subject to special investment limits.

3.2.2.2 Amendments deemed unacceptable as they stood by the Commission

During the vote at the first reading, the Commission deemed nine amendments to be unacceptable as they stood. However, seven of them were subsequently incorporated in part into the text of the amended proposal.

A first group of amendments (following the order of the Directive, amendments 37, 36 and 45, 39 and 43) was initially rejected by the Commission out of a concern to protect individual investors from a risk exposure inappropriate to their investment profile. This position must be understood in a context where the legislative framework specific to UCITS was clearly unsuited to the inclusion of over-the-counter derivatives in the general investment policy of UCITS covered by the Directive, given that they require techniques for calculating and monitoring exchange values and risks that are more sophisticated than in the case of most other eligible financial instruments.

Subsequently, by introducing methodology requirements that formed the basis of a common approach to dealing with derivatives in the Member States, the Commission was able to include in its amended proposal most of the substance of the above amendments. The legislative framework was further transformed in such a way that the common position strikes a new balance, which the Commission finds acceptable, between the updating of possibilities for UCITS to invest in derivatives and a corresponding adaptation of the level of requirements relating to internal controls and prudential supervision and to investor information (see detailed commentary below).

Of the other four amendments considered by the Commission to be unacceptable as they stood (Nos 8, 44, 16 and 42 in the order of the Directive), two were incorporated in part into the amended proposal. One was amendment 44 regarding the conditions under which units of UCITS and other collective investment undertakings are eligible for inclusion in a UCITS portfolio, and the other was amendment 16 regarding the provision of collateral in the context of securities lending transactions - in the latter case, it was none the less considered appropriate to delete from the text of the common position all the provisions on the subject (see commentary on Article 21 below).

Lastly, two amendments were rejected by the Commission, in one case because the amended text would have been open to an interpretation that might interfere with Community harmonisation (amendment 8) and in the other (amendment 42) because the deletion of a paragraph specific to a certain type of guaranteed bond (Article 22(3)) seemed politically inopportune. In its common position, the Council confirmed these choices.

3.2.2.3 Changes made to the text by the Commission and the Council independently of Parliament's amendments

First, the Commission's amended proposal made a few minor changes to the substantive provisions. These changes were then incorporated more or less in full into the text of the common position, which, in addition, sets new deadlines for the implementation of the Directive (Article 2 of the proposed Directive).

The relevant provisions cover: the classification of money market instruments normally dealt in on certain regulated markets (Article 1(8) and related articles - see table); the introduction of an acquisition limit specific to units in other funds in the structure of funds of funds (third indent of Article 25(2) -limit increased with a view to a compromise in the common position); clarification of the conditions for exemption from the limits on influence for subsidiaries of investment companies (Article 25(3)(e)), a change incorporated in full in the common position.

Overall, the Commission considers that the changes help to improve the text of the proposed Directive.

Second, a number of more substantial changes concerned the following: Article 21 (now confined to prudential matters relating to derivatives), the alignment of Article 24a (investor information), mentioned above, and Article 22 (on limits on the concentration of investments for the various types of counterparty). These articles were the subject of a number of amendments by Parliament (for details, see table annexed), but the improvements made required a thorough revision of the articles concerned.

3.2.2.4 Financial derivatives: prudential principles (Article 21)

The Commission's proposal contained provisions on securities lending transactions that could be undertaken by a UCITS in the context of efficient portfolio management. These specific provisions have been deleted from the text of the common position, with securities lending transactions still being covered by default by the very general provisions of paragraph 2. Given the differences in national practice, the Council judged it premature to introduce such rules, which would need to be succinct in the context of the negotiations. In view of the need for quick agreement on the UCITS Directive, the Commission accepted the stance taken in the common position.

In the common position, therefore, Article 21 is confined principally to transactions in financial derivatives. The Commission's underlying intention in inserting Article 24b in its amended proposal has been transferred in part to Article 21 in the common position: that is, to combine in a single article all the provisions relating to derivatives in the portfolio management and hedging strategy, with the exception of the rules relating to limits on investment in the underlying instruments (Article 22) and disclosure (Article 24a).

The text approved by the Council has merged most of the provisions of Article 24b in the amended proposal with the former Article 21(1) of Directive 85/611/EEC, while also adding new provisions to tighten up the requirement for prudential control and constant risk control.

It should be noted that the specific limit set for overall exposure relating to over-the-counter derivatives (fixed at 30% of the total net value of the portfolio in the amended proposal, following an amendment made by Parliament adding Article 22(3a)) has been deleted. However, the provisions on calculating the credit exposure relating to such derivatives and, in general, on control and prudential reporting of risks deal precisely with those aspects that are specific to over-the-counter derivatives as opposed to derivatives dealt in on a regulated market (existence of credit exposure, greater difficulty in assessing risks, closing a position and establishing its current value, etc.). All these aspects are taken into account in the text approved by the Council: the compromise reached sets the bases for a common approach among the Member States to risk assessment, monitoring frequency and investor information. This common approach will also be strengthened by the procedure laid down in the new paragraph 4 introduced by the common position for sharing information and exchanging views on the methods for calculating risk exposure under the aegis of the Commission.

Furthermore, the Commission's text introduced a very important clarification which was taken up by the Council and designed to capture all derivative-related risks, including those that are not apparent in the accounting records: it is expressly required that derivatives embedded in securities be taken into account when calculating exposure. This clarification is vital in order to cover risks linked to the inevitable sophistication of the most modern management transactions and is in line with Parliament's amendments aimed at ensuring exhaustive coverage of risks.

3.2.2.5 Limits on investment - counterparty risk (Article 22)

Article 22 was not changed by the Commission's initial proposal of 17 July 1998, which elsewhere introduced specific investment limits for index-tracking funds (Article 22a), funds of funds (Article 24) and funds invested in bank deposits (Article 24a).

Parliament's amendments reorganised these provisions, in particular so that Article 22 would include counterparty risk relating both to transferable securities and to deposits and over-the-counter derivatives. For the latter, Parliament introduced a dual limit: by counterparty, at individual or group level (paragraph 1a), and an overall limit (aggregating exposure relating to over-the-counter derivatives). In its amended proposal, the Commission adopted the same approach, although it moved the overall limit on commitments through over-the-counter derivative transactions to a specific article (new Article 24b).

The Council, in turn, reorganised this structure by itself moving (subject to a number of additions and changes) most of the provisions contained in Article 24b to Article 21 (see table annexed).

Regarding the limits set in Article 22(1), the common position takes an approach which differs in part from that adopted in the amended proposal but which the Commission considers to be perfectly acceptable in the light of a number of prudential considerations. For counterparty risk with the same body, the common position retains an individual ceiling of 5% for risk exposure in transactions relating to transferable securities, money market instruments and over-the-counter derivatives to a counterparty that is not a credit institution within the meaning of Article 19(1)(g). On the other hand, it sets specific limits for over-the-counter derivative transactions with such a credit institution (10%) and for deposits (20%), but without prejudice to a provision limiting overall exposure to a single counterparty (below).

This differentiated approach according to the nature of the counterparty reappears in paragraph 2: given the safeguards relating to prudential supervision, it can be regarded as contributing to investor protection, in the spirit of Parliament's amendments.

Paragraphs 3 to 5 are essentially taken from the amended proposal and incorporate the provisions on the circulation of information and the provision of information to the public, which were transferred by the Council from Article 20 (which is deleted) to Article 22(4). Two important provisions in paragraph 5 on exposure to counterparty risk at group level should also be pointed out.

First, the Council text supplements the reference to Directive 83/349/EEC on consolidated accounts [11] introduced by Parliament by an alternative reference to recognised international accounting rules. Once the precise demarcation of the counterparty group has been established, the individual limits apply, and this not only covers risk but also leaves sufficient flexibility to operators to choose their individual counterparty.

[11] Council Directive 83/349/EEC of 13 June 1983 based on Article 54(3)(g) of the Treaty on consolidated accounts (OJ L 193, 18.7.1983, p. 1).

Second, the Council text introduces a specific group limit of 20% for transferable securities and money market instruments. It should be noted that this limit does not affect the overall limit for all instruments, also set at 20% of the assets of the UCITS in paragraph 2. In other words, exposure to counterparty risk, at individual or group level, remains limited to one fifth of the assets of the UCITS, but there is additional flexibility in the choice of investment. This 20% is none the less raised to 35% where investment in certain debt securities specifically referred to in paragraphs 3 and 4 is included in view of the special guarantees that they entail: this 35% limit was introduced by a specific Directive in 1988 [12] and was not amended by the Council.

[12] Council Directive 88/220/EEC of 22 March 1988 (OJ L 100, 19.4.1988 p. 31).

The group limit of 20% can be compared to the maximum limit that Member States can set for exposure to a UCITS or some other collective investment undertaking in the context of funds of funds (also set at 20% in Article 24(1)) and to the limit set for exposure to a single issuer in the case of index-tracking funds (general limit also set at 20%, subject to the possibility of an exemption restricted to one issuer only).

Overall, the Commission thus considers that the provisions of Articles 22, 22a and 24 setting limits on the concentration of counterparty risk, despite having become rather complex, do constitute a coherent whole.

3.2.2.6 Information published and made available to investors: "disclosure" (Article 24a)

The Commission's amended proposal concentrated in Article 24a all provisions relating to the information to be provided to investors on a UCITS's investment profile and the related risks.

The Council preferred to regroup the points by theme: the prospectus and the investment policy regarding derivatives; more generally, information on the investment policy where it diverges from traditional investments in transferable securities and money market instruments; the information provided to investors where the portfolio is subject to high volatility; and lastly, at the request of the investor, additional information on the link between instruments, yields and risks, and the risk control methodology. In so doing, the Council has followed the spirit of Article 24a, albeit in another form, while the last paragraph (additional information) includes a number of the provisions contained in the amended proposal and relating to the provision of information to investors on risks related to derivatives, extending them to all types of investment.

4. CONCLUSIONS

The Commission considers that the common position preserves the key elements of its proposal and of Parliament's amendments that were accepted and incorporated by it into the amended proposal. It takes the view that the changes made to its amended proposal (in the form of additions and deletions) by the common position do not alter the desired overall balance between the updating of investment rules and the protection of investors. It can therefore recommend to Parliament that it accept the common position.

Done at Brussels, [...]

For the Commission

The President

ANNEX

Overview of the changes to the Commission's initial proposal: follow-up to Parliament's amendments and other changes introduced by the Commission and the Council

N.B. A shaded box means that that particular field is not relevant.

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