Opinion of the European Monetary Institute on a consultation from the Council of the European Communities under Article 109f (6) of the Treaty establishing the European Community (the “Treaty”) and Article 5.3 of the Statute of the EMI; on a Commission proposal for a European Parliament and Council Directive amending Directive 85/611/EEC on the co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (CON/94/8)
Date: 1995-07-27
Institutions: European Monetary Institute
Subjects: UCITS fund, financial stability, monetary policy, money market

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OPINION OF THE EUROPEAN MONETARY INSTITUTE

on  a  consultation  from  the  Council  of  the  European  Communities  under  Article  109f  (6)  of  the  Treaty

establishing the European Community (the “Treaty”) and Article 5.3 of the Statute of the EMI;

on  a  Commission  proposal  for  a  European  Parliament  and  Council  Directive  amending  Directive

85/611/EEC  on  the  co-ordination  of  laws,  regulations  and  administrative  provisions  relating  to

undertakings for collective investment in transferable securities (UCITS).

CON/94/8

1.

The  present  consultation  was  initiated  on  22nd  November  1994  by  the  Council  of  the  European

Communities which, for this purpose, transmitted to the EMI the relevant documents concerning

the Commission proposal (COM (93)37 final (“initial proposal”), modified by COM (94) 329 final

(“amended proposal”)).

2.

The main objectives of the proposal are, firstly, to broaden the scope of Directive 85/611/EEC in

order to include four new categories of investment funds (money market funds, cash funds, funds

investing in units of other UCITS and master/feeder funds), secondly, to update certain provisions

of  the  Directive  to  bring  them  more  in  line  with  developments  which  have  taken  place  in  other

Community  legislation  in  the  financial  field  and,  finally,  to  permit  UCITS  to  choose  a  depositary

established in other Member States.

3.

The EMI’s competence to deliver an opinion in this consultation is based on Article 109f (2) and

(6), first paragraph, of the Treaty as some of the provisions of the proposal affect the stability of

financial institutions and markets as well as the conduct of monetary policy.

4.

The EMI does not deem itself to be competent to assess whether the widening of the scope of the

Directive is consistent with the spirit of the original Directive and therefore does not comment on

the question as to whether, in particular, the cash funds provided for in Amendment No. 1 would

still fall under the notion of undertakings for collective investment in transferable securities.

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Concerning  the  stability  of  financial  institutions  and  markets  there  are  two  aspects  to  which  the

EMI would like to draw the Council’s attention: first, the impact of money market funds and cash

funds  on  financial  markets  and  notably  on  financing  of  credit  institutions  and  secondly,  the

stability of the new funds themselves.

4.1 As  regards  the  first  aspect,  it  is  likely  that  the  establishment  of  harmonised  money  market  and

cash  funds  will  further  contribute  to  the  shift  of  clients’  deposits  from  traditional  non-interest  or

low  interest  individual  retail  deposits  with  credit  institutions  towards  alternative  deposit

arrangements, such as these funds. If money market and, in particular, cash funds become widely

accepted,  they  may  lead  to  significant  changes  in  the  liability  structure  of  European  credit

institutions.  Retail  deposits  which  are  cheap  and,  taken  as  a  whole,  relatively  stable  would  be

replaced  by  wholesale  deposits  made  on  behalf  of  investment  funds.  Taken  as  a  whole,  these

deposits  will  be  less  stable  and  more  expensive  than  equivalent  retail  deposits.  This  could  exert

further  pressure  on  credit  institutions’  interest  rate  margins  and  contribute  to  higher  competition

for funding. It should be noted, however, that experience in the United States with money market

funds has not shown that this posed a major threat to the stability of the US banking system until

now.

However,  in  the  European  context  the  EMI  would  suggest  the  Council  to  consider  imposing  an

obligation to inform the investor that his investment in a cash fund or money market fund will not

be subject to deposit protection. Such an obligation (by an extension of Annex, Schedule A, to the

Directive  85/611/EEC)  appears  desirable  as  the  units  in  these  funds  are  likely  to  be  sold  as

substitutes for bank deposits which, from the implementation of the Deposit Guarantee Directive

(94/19/EC)  scheduled  for  1st  July  1995,  will  require  to  be  protected  by  a  deposit  protection

scheme.  Although  the  principle  of  risk  spreading  will  reduce  the  risk  of  total  loss  to  an  investor,

the  provision  of  appropriate  information  to  investors  about  the  risks  represented  by  particular

classes  of  investments  is  essential  for  the  stability  and  maintenance  of  trust  in  the  financial

markets.

4.2

This issue is related to the second aspect, namely the stability of the funds themselves. The EMI

welcomes  the  proposals  that  the  new  funds  will,  as  a  general  rule,  be  subject  to  the  same

supervisory  standards  as  are  already  laid  down  for  UCITS  and  which  have  so  far  proven  to  be

effective.  The  EMI  also  welcomes  Amendment  No  9  which  would  restrict  a  cash  funds’

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maximum placement with the same credit institution. The limit suggested is 25% of the assets of

the fund. In this context, it should though be borne in mind that, under the proposal as it stands,

an  investor  could  lose  up  to  25%  of  his  investment  through  the  failure  of  one  single  credit

institution.  The  level  of  this  potential  risk  of  loss  adds  further  weight  to  the  inclusion  of  the

information on deposit protection advocated above and it might be also be considered whether this

limit  is  itself  too  high.  A  further  possible  protection  might  be  given  through  an  appropriate

qualitative  standard  being  applied  to  deposits  (e.g.  allowing  only  deposits  placed  with  credit

institutions subject to prudential supervision standards equivalent to those of the EU and/or credit

institutions covered by a deposit protection scheme).

In  addition,  for  cash  funds  the  Council  might  consider  whether  the  restriction  of  these  funds  to

investment exclusively in deposits with credit institutions is too strict. Other assets, such as liquid

assets of high quality, should be permitted and might contribute to greater stability of these funds

following the principle of risk-spreading.

5.

Amendment No. 2 of the proposal concerns Article 8 of the Directive.  This Article, as currently

contained in Directive 85/611/EEC, stipulates that a depositary must have an establishment in the

same Member State as that of the UCITS. Given that the Second Banking Co-ordination Directive

(89/646/EEC) and the Investment Services Directives (93/22/EEC) provide banks and investment

firms  with  the  freedom  of  supplying  financial  services,  including  safekeeping  and  administration

services  (which  are  relevant  for  UCITS),  the  amended  proposal  intends  to  remove  the  foregoing

restriction  by  allowing  UCITS  to  also  select  a  depositary  which  is  established  in  other  Member

States and supplies services on a cross-border basis.

The EMI recognises that the possibility of choosing a depositary which exercises this function, on

the basis of a cross-border provision of services, would contribute to the further development of a

single market for financial services.  However, the exercise of the important control functions of a

depositary  on  a  cross-border  basis  could  prove  extremely  difficult  given  the  still  existing

differences among the Member States’ legal and administrative systems. The EMI acknowledges

that  the  provisions  foreseen  in  amendments  3  and  5  of  the  amended  proposal  are  intended  to

ensure  that  a  cross-border  depositary  can  fulfil  its  control  functions.  However,  there  remain

substantial  doubts  as  to  the  possibility  of  achieving  an  effective  framework  under  the  prevailing

legal situation.

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6.

The EMI therefore suggests that the desirability of the free choice of a cross-border depositary be

stated  as  a  policy  objective  which  should  be  achieved  pending  further  harmonisation  of  the

relevant legal provisions.

7.

Amendment  No.  8  of  the  proposal  on  Article  21  of  the  Directive  aims  at  the  introduction  of  a

quantitative  ceiling  for  the  use  of  derivative  instruments  by  UCITS  with  a  view  to  providing  a

harmonised framework. This aim is clearly stated in the 11th recital of the amended proposal. The

EMI welcomes the intention to add such limit and holds that such a quantitative ceiling would be a

valuable contribution to the stability of the financial system.

8.

Furthermore, the EMI would draw Council’s attention to proposals to class Master/Feeder funds

as UCITS. In view of the lack of tax harmonisation among EU Member States, these funds could

create substantial flows of assets which may have some impact on financial stability. The Council

might therefore wish to give further consideration to the issue of the impact of these funds.

9.

Finally, the EMI notes that the text  on  which  this  opinion  is  based  has  been  subject  to  extensive

discussion  at  Council  level  and  may,  in  certain  respects,  be  superseded.  However,  the  EMI  is

confident  that  the  points  set  out  above  will  still  be  relevant  to  Council’s  further  consideration  of

the substance of this proposal. The EMI welcome the opportunity to comment, as appropriate, on

any future text modifying the present proposal.

10

Dissenting  opinions  of  the  Banque  Nationale  de  Belgique,  the  Danmarks  Nationalbank,  the  De

Nederlansche Bank, the Deutsche Bundesbank and the Central Bank of Ireland are attached as an

Annex to this opinion.

27th July 1995

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ANNEX

DISSENTING OPINIONS ATTACHED TO EMI OPINION ON THE COMMISSION

PROPOSAL FOR A EUROPEAN PARLIAMENT AND COUNCIL DIRECTIVE AMENDING

THE UCITS DIRECTIVE

Dissenting opinion of the Banque Nationale de Belgique, the Danmarks Nationalbank and the De

Nederlandsche Bank

Three National Central Banks (BE, DK and NL) do not agree with Paragraphs 5 and 6 of the opinion in

the  consultation  procedure  CON/94/8.  These  central  banks  believe  that  leaving  the  free  choice  of  a

cross-border  depositary  subject  to  further  harmonisation  and  stating  only  a  policy  objective  would  be

inconsistent with the principles of the Treaty and would run counter to the content of the Banking and

Investment  Firms  Directives.  These  central  banks  believe  that  the  possibility  of  choosing  a  depositary

which  exercises  this  function  on  the  basis  of  a  cross-border  provision  of  services  should  explicitly  be

granted now in the proposal to amend the Directive 85/611/EEC.

However,  this  amendment  has  to  ensure  that  there  will  be  a  sufficient  co-operation  between  the

authorities of the Member States in order to guarantee an appropriate supervision of the control function

of the depositary.

Accordingly,  the  Belgian  Central  Bank  suggests  that,  as  a  consequence,  the  provisions  foreseen  in

amendments 3 and 5 of the amended proposal should be strengthened, in particular, in order to stress the

condition  of  uniformity  in  the  approach  by  different  Member  States  when  granting  derogations  to  the

establishment  requirement.  Further,  the  directive  should  state  explicitly  that  the  depositary  must  fully

comply  with 

the 

legal  and  regulatory  provisions  prevailing 

in 

the  Member  State  of 

the

management/investment company.

Dissenting opinion of the Deutsche Bundesbank

The  Deutsche  Bundesbank  points  out  that  the  proposal  may  impact  on  the  conduct  of  the  monetary

policy.  A  particular  concern  is  that  the  proposal,  as  currently  drafted,  blurs  the  borderline  between

money  market  funds  and  cash  funds  on  the  one  hand,  and  the  traditional  securities  funds  on  the  other

hand. This blurred borderline may, in the future, cause problems for the collection of statistical data and

difficulties  for  defining  monetary  aggregates.  At  the  same  time  a  possible  overlap  between  investment

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fund  activities  in  the  short  and  long-term  range  could  render  an  analysis  for  monetary  policy  purposes

difficult. Even if, in the future, the European Central Bank has the possibility to collect data directly from

the funds or their management companies, the absence of a clear legal definition of the respective funds

will make the inclusion of units in investment funds into a broadened definition of monetary aggregates

very difficult. Therefore, the Deutsche Bundesbank suggests that money market funds, cash funds and

securities  funds  be  defined  as  separate  types  of  investment  funds  with  separately  defined  areas  of

activity.

Dissenting opinion of the Central Bank of Ireland

The Central Bank of Ireland has expressed its opposition, in principle, to the proposal to allow a UCITS

to  select  a  depositary  which  is  established  in  another  Member  State.  As  a  result,  the  Central  Bank  of

Ireland dissents from the statement, contained in paragraph 6 of the EMI opinion, that the desirability of

the  free  choice  of  a  cross  border  depositary  should  be  stated  as  a  policy  objective  to  be  achieved

following further harmonisation of relevant legal provisions. In its view, the duties of a depositary, which

are onerous, cannot be carried out properly by a depositary which is not established in the same Member

State  as  the  UCITS  itself.  It  considers  that  the  depositary  is  an  integral  part  of  the  UCITS  and  the

competent authorities cannot properly supervise a UCITS unless they can directly supervise the activities

of  the  depositary.  It  also  considers  that  any  proposal  to  permit  UCITS  to  appoint  non-established

depositaries is inconsistent with recent legislative developments in the financial services area which have

adopted a principle of one complete unit for supervision and one authority being responsible for the core

substance of that unit.