Green paper on the enhancement of the EU framework for investment funds (SEC(2005) 947)
Date: 2005-07-12
Institutions: European Commission
Subjects: financial market, investment company, investment protection, investment transaction, securities

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 12.7.2005 
COM(2005) 314 final 

GREEN PAPER 

ON THE ENHANCEMENT OF THE EU FRAMEWORK 
FOR INVESTMENT FUNDS 

(SEC(2005) 947) 

. 

(presented by the Commission) 

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GREEN PAPER 

ON THE ENHANCEMENT OF THE EU FRAMEWORK 
FOR INVESTMENT FUNDS 

Introduction 

The investment fund industry has grown over the space of a decade to become a key actor in 
European  capital  markets.  Investment  funds  mobilise  household  savings  and  channel  them 
towards  productive  investments.  The  European  fund  industry  currently  manages  over  €  5 
trillion  of  assets.  This  Green  Paper  evaluates  the  impact  of  European  legislation  which  was 
put in place to support the development of the most common type of investment funds in the 
European  market  place  –  UCITS.  These  account  for  over  70%  of  the  assets  under 
management by the fund industry.  

What are UCITS? 

UCITS  (Undertakings  for  Collective  Investment  in  Transferable  Securities)  are  specially 
constituted collective investment portfolios exclusively dedicated to the investment of assets 
raised from investors. Under the UCITS Directive1 UCITS investment policy and its manager 
are authorised in accordance with specific requirements. UCITS’ legislation aims to establish 
a defined level of investor protection. This is achieved through strict investment limits, capital 
and disclosure requirements, as well as asset safe-keeping and fund oversight provided by an 
independent  depositary.  UCITS  benefit  from  a  ‘passport’  allowing  them,  subject  to 
notification,  to  be  offered  to  be  offered  to  retail  investors  in  any  EU  jurisdiction  once 
authorised in one Member State. 

There is a perception among most stakeholders that UCITS legislation could function better. 
It  does  not  allow  the  full  potential  of  the  fund  industry  to  be  optimised  on  a  pan-European 
level.  Nor  does  it  have  the  flexibility  needed  to  cope  with  the  challenges  posed  by  rapidly 
evolving financial markets. However, there is no compelling case for fundamental legislative 
overhaul at this stage. Instead the focus should be on exhausting the possibilities offered by 
the current legislative framework. The Green Paper therefore identifies ways to facilitate the 
successful  development  of  the  fund  industry  in  the  short  to  medium  term  by  building  on 
existing legislation while at the same time guaranteeing the necessary high level of investor 
protection. The appended table summarises the steps that are currently envisaged. The focus 
on these initiatives in the coming two years should not, however, exclude reflection on more 
far-reaching actions that may be needed to ensure that the European fund industry can work 
efficiently, and that investors enjoy high levels of protection.  

Socio-economic  challenges  make  the  time  ripe  for  this  review.  The  EU  regulatory 
environment should enable the fund industry to develop soundly structured, well-administered 
collective  investments  which  deliver  the  highest  possible  returns  consistent  with  the 
individual investors’ financial capacity and risk appetite while giving them all the necessary 

1 

Directive 85/611/EEC of 20 December 1985 (OJ L 375, 31.12.1985, p. 3) amended, inter alia, by Directives 2001/107/EC ("Management company Directive") 
of 21 January 2002 (OJ L 41 of 13.2.2002, p. 20) and 2001/108/EC ("Product Directive”) of 21 January 2002 (OJ L 41 of 13.2.2002, p. 35) both referred to in 
the text as UCITS III. 

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information  to  evaluate  risks  and  costs.  Integrated  and  efficient  European  markets  for 
investment  funds  are  of  strategic  importance:  they  can  contribute  significantly  to  adequate 
provisioning for retirement; they allocate savings to productive investments; and they can be a 
force for sound corporate governance. 

The analysis presented in this document draws on the asset management expert group report 
published in May 2004 and subsequent discussions with Member States, CESR members and 
market participants. This consultations and the detailed analysis of the functioning of UCITS 
legislation which Commission services have undertaken2 have highlighted a number of issues 
which the Commission believes warrant extensive public debate. This Green Paper represents 
the Commission’s first contribution to this debate. 

1. 

GENERAL ASSESSMENT 

The UCITS Directive has proved an important first step towards integrated and competitive 
European  markets  for  investment  funds.  28,830  UCITS  funds  manage  €4  trillion.  UCITS 
enjoy wide market recognition inside but also outside the EU.  

The  use  of  the  UCITS  product  passport  has  more  than  doubled  in  the  last  5  years.  16%  of 
UCITS  are  true  cross-border  funds  and  are  winning  increasing  investor  share.  However, 
cross-border UCITS are only beginning to establish themselves as significant players in host 
country markets.  

Viewed  from  the  perspective  of  overall  market  efficiency,  the  sector’s  potential  is  not  yet 
fully  exploited.  The  landscape  remains  dominated  by  funds  of  sub-optimal  size.  European 
funds are on average 5 times smaller than their average US counterpart. As a result, the fund 
industry  is  not  able  to  benefit  fully  from  scale  economies  –  reducing  net  returns  to  end-
investors.  

From  an  investor  protection  perspective,  there  have  not  been  notable  financial  scandals 
involving  UCITS.  UCITS  has  provided  a  solid  underpinning  for  a  well-regulated  fund 
industry.  Recent  trends  in  the  industry  are,  however,  changing  the  risk-features  of  the 
business. Outsourcing of operational functions or moves towards open-architecture may entail 
increased  operational  risk  or  conflicts  of  interest.  New  fund-types,  based  on  more 
sophisticated  investment  strategies,  may  embody  features  that  are  not  well-understood  by 
retail  investors.  The  possible  implications  of  alternative  investment  strategies  for  investor 
protection and financial stability remain poorly understood. Furthermore, substitute products, 
such  as  unit-linked  products  or  certificates,  compete  with  UCITS  for  long-term  savings. 
However, they are not necessarily subject to the same level of disclosure and transparency.  

The  Green  Paper  examines  how  well  the  UCITS  framework  meets  its  objectives  in  this 
evolving context. 

2 

Published as a Commission services working document 

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2. 

MAKING EXISTING LEGISLATION DELIVER  

2.1. 

Priority actions 

In  January  2002,  the  original  UCITS  Directive  was  amended  in  several  key  respects.  The 
“Product  Directive”  extended  the  range  of  assets  in  which  a  UCITS  can  invest.  The 
“Management  Company  Directive”  reinforced  capital  and  organisational  requirements  for 
management  companies.  It  allowed  them  to  passport  certain  services  and  introduced  a  new 
disclosure document, the simplified prospectus. Since their entry into force in February 2004, 
divergences have emerged between Member States in how some of the amended provisions 
should be interpreted and implemented. Funds still encounter difficulties in making use of the 
product passport.  

In recent months, the overriding priority has been to consolidate the UCITS passport and to 
provide  more  guidance  on  investor  protection  safeguards.  In  this  respect,  a  crucial 
contribution  is  being  made  by  the  CESR  Investment  Management  Expert  Group.  The 
cooperation  and  commitment  of  national  supervisors,  working  through  CESR3,  is  central  to 
finding pragmatic solutions to implementation problems.  

This work will continue. The focus will be to: 

1. 

2. 

3. 

4. 

Eliminate  the  uncertainty  surrounding  the recognition  of  funds  launched  during  the 
transition from UCITS I to UCITS III. CESR guidelines have helped to resolve the 
uncertainty  regarding  the  treatment  of  ‘grandfathered  funds’.  It  is  extremely 
important that these guidelines are implemented faithfully in a way that ensures the 
smooth functioning of the passport. 

Simplify  the  notification  procedure  for  passporting  funds:  the  contents,  complexity 
and length of the notification phase vary greatly from one Member State to the next. 
There  is  a  need  to  streamline  procedures  and  to  consider  practical  mechanisms  for 
resolving  questions  within  the  scope  of  current  responsibilities.  This  may  also 
involve improving inter-administrative collaboration in order to avoid home country 
authorisation  from  being  contested.  CESR  has  already  started  work  to  build  up 
convergence among regulators in this area. 

Promote  implementation  of  Commission’s  Recommendations  on  the  use  of 
derivatives  and  the  simplified  prospectus:  these  aim  to  improve  risk  management 
standards  and  fee  transparency.  Preliminary  analysis,  based  on  CESR’s  review, 
suggests  that,  with  isolated  exceptions,  Member  State  authorities  have  moved  to 
implement this guidance. Given the importance of these issues, the Commission will 
push for further progress in crucial areas, such as the disclosure of fees and charges. 

Clarify  the  definition  of  “assets”  which  can  be  acquired  by  UCITS.  One  of  the 
cornerstones of UCITS legislation is that  the fund should invest primarily  in liquid 
financial instruments. The UCITS III left room for different views on whether certain 
categories  of  financial  instrument  could  be  acquired  by  UCITS.  Legally  binding 
clarifications of asset eligibility will be finalised by the Commission in early 2006, 
further to article 53a of the Directive.  

3 

Further to Commission Decision 2001/527/EC of 6 June 2001 (OJ L 191, 13.7.2001, p. 43). 

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Q1 :  Will the above initiatives bring sufficient legal certainty to the implementation of the 
Directive?  
Q2 :  Are  there  additional  concerns  relating  to  day-to-day  implementation  of  the  Directive 
which need to be tackled as a priority? 

2.2.  Making better use of the current framework 

Can the existing EU legislative framework be further developed to deal with some of the main 
structural  challenges  confronting 
its 
competitiveness and responding to changing investor demand? Two areas where further work 
could be undertaken on the basis of existing legislative framework have been identified.  

industry  –  notably 

the  EU  fund 

improving 

2.2.1.  The management company passport  

The possibility for fund managers to establish and operate UCITS domiciled in other Member 
States  is  seen  by  some  segments  of  the  industry  as  the  route  to  greater  efficiency  and 
specialisation  in  portfolio  management  and  fund  administration.  Such  a  possibility  was 
invoked  by  the  management  company  Directive  for  corporate  UCITS.  However,  due  to  the 
perceived  ambiguities  and  the  incompleteness  of the  Directive,  these  opportunities  have  not 
materialised. In particular, concerns have been expressed that splitting the supervision of the 
fund  and  its  manager  between  two  jurisdictions  could  compromise  the  effectiveness  of  risk 
controls and investor protection. Before taking further steps in this respect, the Commission 
wishes to gather further evidence on the extent to which the management company passport 
can open up significant additional commercial possibilities and to identify related supervisory 
concerns.  On  the  basis  of  responses  to  this  Green  Paper,  the  Commission  will  indicate 
whether and how effect can be given to the management company passport when it issues its 
follow-up report in early 2006. 

Q3 :  Would  an  effective  management  company  passport  deliver  significant  additional 
economic  advantages  as  opposed  to  delegation  arrangements?  Please  indicate  sources  and 
likely scale of expected benefit 
Q4 :  Would the splitting of responsibility for the supervision of the management company 
and  the  fund  across  jurisdictions  give  rise  to  additional  operational  risks  or  supervisory 
concerns?  Please  describe  sources  of  problem  and  steps  that  would  have  to  be  taken  to 
manage such risks effectively 

2.2.2.  Distribution, sales and promotion of funds  

A second area which could benefit from clarification is the way in which UCITS are offered, 
sold  or  promoted  to  individual  investors.  Investors  faced  with  more  complex  products  need 
better and user-friendly disclosure of performance and charges. There is increased demand for 
advice on most suitable and best-performing products. Change is also manifesting itself on the 
supply-side.  Banks  are  gradually  opening  their  networks  to  third-party  funds.  This  allows 
them to focus on their core competencies and attract clients seeking “the best product in the 
market”. Finally, the distribution end of the value-chain is a major cost-centre in the European 
fund  industry  (particularly  cross-border).  Competition  and  transparency  in  fund  distribution 
could  usefully  be  brought  to  bear  in  the  interests  of  the  end-investor.  For  example  the 
conditions under which a product can legitimately carry the label “guaranteed fund” should be 
also clarified in order to avoid risks of mis-selling. 

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The recently adopted MiFID4 could provide a useful “toolbox”, notably to clarify all duties of 
care, risk warnings or other obligations that an investment firm owes to a client considering 
an investment  in  UCITS.  MiFID  could also serve  as a basis to  improve transparency  of the 
distribution process, via its rules on management and disclosure of conflict of interest and on 
“best execution”. 

In  a  first  stage,  the  Commission  services  will  reflect  on  the  boundary  between  marketing 
(UCITS)  and  sales/advisory  services  provided  to  fund  investors.  In  a  second  stage,  a  ‘gap 
analysis’  will  examine  whether  level  2  legislation  implementing  the  conduct  of  business 
principles  and  other  relevant  provisions  of  MiFID  represent  a  sufficient  and  effective  basis 
governing intermediation activities in respect of investment funds. This, however, will have to 
wait until these level 2 rules are finalised. 

Q5 :  Will  greater  transparency,  comparability  and  attention  to  investor  needs  in  fund 
distribution materially enhance the functioning of European investment fund markets and the 
level of investor protection? Should this be a priority? 
Q6 :  Will clarification of ‘conduct of business’ rules applying to firms which retail funds to 
investors contribute significantly to this objective? Should other steps (enhanced disclosure) 
be considered? 
Q7 :  Are  there  particular  fund-specific  issues  that  are  not  covered  by  ongoing  work  on 
detailed implementation of MiFID conduct of business rules?  

3. 

BEYOND THE EXISTING LEGISLATIVE FRAMEWORK – LONG-TERM CHALLENGES 

The  European  fund  business  is  undergoing  profound  structural  changes  which  will  have 
lasting  consequences  –  continuous  innovation  in  investment  strategies  and  products;  new 
forms of business model; emergence of specialised service providers; distribution systems in 
flux; more discerning investors. Europe needs to ensure that the UCITS framework is capable 
of  representing  a  viable  basis  for  the  successful  development  of  the  fund  industry  over  the 
longer-term  while  assuring  a  high  level  of  investor  protection.  The  regulatory  environment 
should  enable  the  industry  to  provide  attractive  and  soundly-managed  products  that  can 
compete successfully for investor custom. The following section discusses ways in which the 
European legislative framework can contribute more to this objective: by creating a European 
framework  to  exploit  cost-efficiencies  and  synergies  on  a  cross-border  basis;  by  sustaining 
investor confidence; by avoiding unnecessary distortion of the competition between substitute 
investment  products;  by  encouraging  the  healthy  development  of  onshore  alternative 
investments.  However,  further  progress  towards  these  objectives  cannot  be  delivered  within 
the existing framework. It will require, in some cases, potentially far-reaching adjustments or 
extensions  to  existing  UCITS  legislation.  The  UCITS  review  therefore  is  an  opportunity  to 
begin  reflections  on  whether  and  how  some  of  these  broader  issues  will  need  to  be 
accommodated by the EU legislative framework in a longer-term.  

3.1. 

Towards a cost-efficient industry 

The existence of too many small funds impedes the EU industry from fully benefiting from 
economies of scale. 

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Directive 2004/39/EC of 21 April 2004 (OJ L 145, 30.04.2004, p. 1) on Markets in financial instruments. 

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1. 

2. 

3. 

4. 

Greater consolidation through cross-border fund mergers has been identified by the 
expert  group  and  others  as  one  route  to  reducing  costs  and  improving  fund 
performance,  although  fund  managers  have  been  slow  to  rationalise  their  product 
offer  even  at  national  level.  The  UCITS  Directive  does  not  prevent  cross-border 
mergers of funds, but neither does it address many of the practical obstacles that may 
need  to  be  tackled  in  order  to  facilitate  such  mergers.  Isolated  cross-border  fund 
mergers do take place, but due to the difficulties caused by divergent corporate law 
and tax regimes, they are uncommon. 

Fund  pooling  may  offer  an  alternative  route  to  industry  consolidation:  this  would 
allow  legally  separate  fund  ranges  to  be  collectively  managed  and/or  administered, 
either by feeding their assets into a master fund (cf. “master-feeder” structures), or by 
using information technology to allow them to be managed as if they were a single 
range.  However,  cross-border  pooling  is  also  faced  with  legal,  supervisory  and  tax 
barriers, in addition to considerable technological challenges. 

Fund custody and depositary services could benefit also from further rationalisation. 
The  UCITS  Directive  requires  the  management  company  and  the  depositary  to  be 
located in the same Member State. In the past, proximity and integrated supervision 
were  considered  essential  to  ensure  effective  performance  of  fund  administration, 
depositary  and  custody  functions.  More  recently,  a  number  of  stakeholders  have 
advocated  greater  freedom  in  the  choice  of  the  depositary.  As  previously  noted  by 
the Commission5, moving in this direction will require further harmonisation of the 
status,  mission  and  responsibilities  of  these  actors.  The  comparative  costs  and 
benefits of changes to the legislative framework will need further analysis – not least 
compared  to  what  can  be  achieved  through  delegation  and/or  sub-custody 
arrangements.  The  Commission  proposes  to  examine  the  implications  for  effective 
supervision  and  investor  protection  arising  from  splitting  responsibility  for 
supervision  of  the  fund  and  depositary  and  asset-custody  functions  across  Member 
States. 

The  European  infrastructure  for  processing  subscription/redemption  (fund  units) 
orders is fragmented. This results in high operating costs and operational risks in the 
transaction  value  chain.  The  Commission  strongly  supports  the  industry’s  ongoing 
efforts to improve the organisation of fund administration, particularly with regard to 
cross border arrangements. The Commission’s initial instinct is that industry should 
continue  to  take  the  lead  in  this  respect:  EU  policy-makers  should  only  become 
involved  in  the  event  of  manifest  ‘co-ordination’  problems  or  insurmountable 
regulatory or policy barriers.  

Is there a commercial or economic logic (net benefits) for cross-border fund mergers? 

Q8 : 
Could those benefits be largely achieved by rationalisation within national borders? 

Q9 :  Could the desired benefits be achieved through pooling?  

Q10:  Is competition at the level of fund management and/or distribution sufficient to ensure 
that investors will benefit from greater efficiency? 

5 

Communication COM(2004) 207 from the Commission to the Council and the European Parliament of 30 March 2004. 

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Q11:  Which  are  the  advantages  and  disadvantages  (supervisory  or  commercial  risks) 
steaming from the possibility to choose a depositary in another Member State? To what extent 
does delegation or other arrangements obviate the need for legislative action on these issues? 

Q12:  Do  you  think  that  on-going  industry-driven  standardisation  will  deliver  fruit  within 
reasonable time-frames? Is there any need for public sector involvement? 

Once account has been taken of the responses to this Green Paper, the Commission will create 
an expert group to further research the main sources of inefficiencies in the EU fund industry 
outlined  above.  This  work  will  also  consider  the  feasibility  and  effectiveness  of  possible 
facilitation measures. 

3.2.  Maintaining high levels of investor protection  

The  UCITS  Directive  establishes  several  lines  of  defence  to  protect  investors.  In  terms  of 
investor protection, the record to date has been satisfactory. However, new risks are emerging 
and market expectations are changing. There may be need to consider reflections on a more 
comprehensive risk-based approach to investor protection.  

The  revised  investor  protection  safeguards  provided  by  UCITS  III  should  be  given  time  to 
prove  themselves.  CESR  will  also  work  to  build  up  convergence  among  the  European 
regulators  regarding  the  prevention  of  conflicts  of  interest  and  the  investor  protection 
safeguards  for  UCITS  managers  as  revised  by articles  5f  and  5h  of  Directive  2001/107/EC. 
However,  the  Commission  feels  that,  with  its  reliance  on  formal  investment  limits,  UCITS 
may  struggle  in  the  longer  term  to  keep  pace  with  financial  innovation  and  more  complex 
distribution systems. This could mean undertaking a more systematic assessment of the main 
risks that arise at each stage in the fund industry value-chain. Given the stated ambition of the 
industry to become the investment vehicle of choice for the retail investor, the Commission 
will  work  continuously  to  reinforce  investor  protection  safeguards.  Ongoing  work  of  the 
IOSCO  Standing  Committee  on  investment  management  may  provide  a  starting-point  for 
further reflection on these issues in a European context. 

Q13:  Does  heavy reliance  on  formal investment limits represent a sustainable approach to 
delivering high levels of investor protection? 

Q14:  Do  you  think  that  safeguards  –  at  the  level  of  the  management  company  and 
depositary  -  are  sufficiently  robust  to  address  emerging  risks  in  UCITS  management  and 
administration?  What  other  measures  for  maintaining  a  high  level  of  investor  protection 
would you consider appropriate? 

3.3. 

Competition from substitute products 

As the debate on the European legislative framework for UCITS evolves, it will be important 
to consider the wider asset management landscape. UCITS compete with many other products 
for the private savings of European investors. Products, such as unit-linked life insurance or 
certain  structured  products,  replicate  some  UCITS  features.  They  are,  however,  subject  to 
different regulatory or  tax treatment and are sold through  different  sales processes. In some 
Member  States  such  competing  products  enjoy  wide  acceptance.  The  Commission  is 
concerned that this different regulatory treatment may distort investment decisions. It believes 
that  it  would  be  a  retrograde  step  for  investors  if  UCITS  disclosures  were  scaled  back  as  a 
result of regulatory competition.  

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Q15:  Are there instances resulting in a distortion of investor’s choice that call for particular 
attention from European and/or national policy-makers? 

3.4. 

Europe’s alternative investment market 

The  alternative  investment  industry  –  comprising  hedge  funds  and  private  equity  funds  –  is 
here to stay. It offers new diversification benefits for asset managers, the promise of higher 
returns for investors and can boost overall market liquidity. However, alternative investment 
strategies  are  more  complex,  and  may  involve  higher  risks  for  investors  than  mainstream 
UCITS.  

Alternative investments 

•  Private  equity  funds  entail  a  long-term  commitment  to  investments  involving  an  active 
participation in their management. However, private equity funds are faced with additional 
tax complications  and most funds  structures are not  mutually recognised  in  the  different 
Member States.  

•  Hedge  funds  use  a  broad  array  of  techniques  and  instruments  (such  as  short-selling  or 
leverage) often not available to more traditional forms of collective investment schemes. 
Hedge Funds may represent a source of counterparty risk for financial institutions which 
lend to them. Although they are not currently regarded as a significant source of systemic 
risk because of their relatively small size and modest, collateralised use of leverage, their 
fast growth and perceived lack of transparency give raise to growing concerns regarding 
their impact on the markets. Regulators are currently focused on strengthening their ability 
to assess aggregate exposure of the financial system to hedge funds.  

Divergent national regimes carry the risk of regulatory fragmentation which could hamper the 
development of these businesses. As this industry develops, and particularly if European retail 
investors become more exposed to alternative investments, there will be a growing need for a 
coherent and enlightened European approach to this sector.  

Taking  account  of  responses  to  this  consultation,  the  Commission  will  establish  a  working 
group to study whether a common regulatory approach can facilitate the further development 
of  European  markets  for  hedge  funds  and  private  equity  funds.  This  could  also  look  at  the 
types  of  action  that  could  be  most  helpful  in  overcoming  barriers  to  their  cross-border 
development.  This  work  could  consider,  inter  alia,  the  extent  to  which  a  common 
understanding  of  ‘private  placement’  could  facilitate  their  cross-border  offer  to  qualified 
investors. 

Q16:  To  what  extent  do  problems  of  regulatory  fragmentation  give  rise  to  market  access 
problems which might call for a common EU approach to a) private equity funds; b) hedge 
funds and funds of hedge funds?  

Q17: Are there particular risks (from an investor protection or a market stability perspective) 
associated  with  the  activities  of  either  private  equity  or  hedge  funds  which  might  warrant 
particular attention? 

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Q18: To what extent could a common private placement regime help to overcome barriers to 
cross-border  offer  of  alternative  investments  to  qualified  investors?  Can  this  clarification  of 
marketing and sales process be implemented independently of flanking measures at the level 
of fund manager etc.? 

3.5.  Modernising UCITS law? 

Experience  has  highlighted  the  difficulties  encountered  in  adapting  UCITS  provisions  to 
changing market realities, and ensuring their consistent implementation. The UCITS Directive 
testifies  to  the  dangers  of  trying  to  regulate  highly  technical  issues  through  first  level  EU 
legislation.  Some  commentators,  including  CESR,  have  urged  a  recasting  of  the  Directive 
along  the  lines  of  recent  EU  securities  legislation  –  namely  functional  and  principle-based 
first-level  legislation  supplemented  by  scope  for  detailed  implemented  law  and  reinforced 
supervisory cooperation (Lamfalussy approach). However, recasting UCITS legislation in this 
way  would  not  be  a  cosmetic  exercise:  it  would  involve  choices  as  to  the  drafting  of 
overarching  principles  to  be  retained  in  first-level  legislation  and  the  scope  and  content  of 
decisions  to  be  determined  through  comitology  based  law.  It  would  therefore  entail 
substantive  and  institutional  ramifications.  This  would  call  for  careful  preparation  and  full-
blown co-decision procedure. Should views crystallise in the future around the need for such 
changes to the UCITS legislation, the Commission believes that the occasion should be seized 
to restructure the Directive along the lines of the Lamfalussy approach. 

Q19:  Does the current product-based  prescriptive UCITS  law  represent a viable long-term 
basis  for  a  well-supervised  and  integrated  European  investment  fund  market?  Under  what 
conditions, or at what stage, should a move toward principle-driven, risk-based regulation be 
contemplated? 

4. 

CONCLUSIONS 

UCITS  has  served  as  the  focal  point  for  the  emergence  of  a  successful  European  fund 
industry. The UCITS legislation – with its product passport and strong retail investor ethos – 
has  facilitated  this  outcome.  Despite  these  developments,  there  is  a  perception  that  UCITS 
entails missed opportunities and can be improved. However, there is no compelling case for 
fundamental legislative overhaul at this stage. Instead the focus should be on exhausting the 
possibilities offered by the current legislative framework.  

In view of the strategic importance of the sector, there is a need for wide-ranging reflection on 
the future direction of the EU framework for investment funds. Should some of the structural 
concerns identified above materialise, far-reaching action will be required to ensure that the 
vast European fund sector will be equipped with the right tools, and that European investors 
enjoy a high level of protection, as they enter the next decade. 

Responses to this consultation, as well as regular discussions with relevant stakeholders and 
further  preparatory  work  within  the  Commission  will  be  taken  into  account  for  the 
determination of eventual follow-up measures. Orientations for action to enhance the UCITS 
framework will be then announced in early 2006. To the extent that legislative actions may 
come  under  consideration,  they  will  be  subjected  to  extensive  ex-ante  consultation,  impact 
assessment and cost-effectiveness evaluation. 

EN 

10 

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Responses to this consultation should be sent by 15 November 2005, to the following email 
the 
address:  markt-consult-investmentfunds@cec.eu.int  Responses  will  be  placed  on 
Commission’s  website  –  unless  there  is  an  explicit  request  to  the  contrary.  As  part  of  the 
follow-up to this Green Paper, the Commission will publish a feed-back report summarising 
the respondent contributions in early 2006. 

Enhancing the UCITS framework – Proposed steps 

Topic 

Action 

Proposed dates 

UCITS review process 

Consultation process : 

Feedback  report  on  the  public  consultation; 
COM statement on follow-up actions : 

July/Nov. 2005 

Feb/March 2006 

1. Priority actions 

Clarification of UCITS 
eligible assets 

Recommendations on 
Derivatives and simplified 
Prospectus 

CESR Guidelines on 
transitional provisions 

Adoption of implementing legislation 

March/April 2006 

Publication of definitive assessment of Member 
State implementation (CESR and COM) 

Autumn 2005 

Interim report on national implementation  

Autumn 2005 

Notification procedures 

CESR Guidelines for the notification procedure  Autumn 2006 

2. Building on the current framework 

Management Company 
passport 

Analysis  of  conditions  needed  to  facilitate 
effective  functioning  of  management  company 
passport (for corporates) 

Early 2006 

Fund 
promotion 

distribution, 

sales, 

Assessment of the articulation between UCITS 
and MiFID : 

Early 2006 

Gap analysis of MiFID level 2 measures : 

Mid 2006 

3. Long-term challenges 

Cross-border mergers/pooling  Work of specialist forum group  

Investor protection 

Analysis of risks and risk controls in European 
investment  fund  industry  (CESR  and  COM): 
Monitoring  of  IOSCO  work; 
launch  and 
publication of Commission studies 

Alternative investments  

Work of specialist forum group  

Winter 2005-
Summer 2006  

Winter 2005-
Summer 2006  

EN 

11 

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Annex 

OVERVIEW OF THE UCITS MARKET  

UCITS  legislation  has  provided  the  foundations  for  the  development  of  a 
successful  European  fund  industry.  20  years  after  the  adoption  of  the  original 
UCITS Directive, 28,830 UCITS funds manage €4 trillion representing over 70% 
of the assets under management by the EU investment fund industry as a whole. 
Assets  managed  by  UCITS  are  growing  rapidly  (some  4  times  over  the  last  10 
years). This industry has a strong presence in all of the ‘old’ Member States and is 
gaining ground in many of the new Member States. In some Member States, over 
20%  of  the  adult  population  have  invested  in  funds.  UCITS  also  enjoy  wide 
market recognition outside the EU (namely in Asia and South America).  

UCITS 
wide 
acceptance  

enjoy 
market 

Evolution of UCITS's net assets (€ billion)

4.500
4.000
3.500
3.000
2.500
2.000
1.500
1.000
500
0

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

…with 
increasing 
cross-border 
penetration 

Equity

Bond

Balanced

Money Market

UCITS

The  UCITS  Directive  has  proved  an  important  first  step  towards  integrated  and 
competitive  European  markets  for  investment  funds:  it  has  been  the  catalyst  for 
the  growth  of  an  industry  which  is  increasingly  investing  and  competing  on  a 
cross-border basis. At present, less than a fifth of all European UCITS (in terms of 
number of funds) are true cross-border funds in that they are sold in more than one 
country other than that of the sponsoring parent company. However, as shown in 
the table below, the number of cross-border funds has increased more rapidly than 
the total number of funds over the last years. Their assets under management are 
also growing at a fast pace: net sales of cross-border funds represented more than 
60% of the total industry net inflows in 2004.  

End-98 

Mar 2001 

End 2002 

End 2003  Change (98-03) 

X-border funds 

2,287 

3,260 

X-border notifications 

11,338 

22,791 

Total no. of funds 

20,069 

X-border/total funds  

11% 

n.a. 

n.a. 

3,750 

26,966 

28,459 

13% 

4,529 

26,030 

28,149 

16% 

98% 

130% 

40% 

41% 

EN 

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   EN 

 
 
 
 
 
Despite  the  increase  in  the  number  of  notifications  and  the  sales  of  cross-border 
funds, the market share in most host Member States is often small. Despite recent 
years’  move  towards  open-architecture,  the  range  of  products  on  offer  remains 
biased 
towards  national  providers.  National  distribution  networks  remain 
dominated  by  local  players.  Most  European  third  party  funds  (TPF)  distributors 
are “semi-open” with 33% of them offering less than 5 TPF and only 6% putting 
in  their  list  of  products  more  than  49  TPF.  In  addition  to  this,  46%  of  fund 
distributors do not offer even one TPF. Consequently, competition is limited and 
investors do not necessarily have access to the best funds in the EU market. 

Distribution of funds (2002)

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

be

dk

de

el

es

fr

ie

it

lu

nl

at

pt

fi

se

uk

In-house f unds

Third-part y funds f rom domest ic suppliers

Third-part y f unds from foreign suppliers

Viewed from the perspective of overall market efficiency, the facilitation of cross-
border  fund  offer  has  not  yet  delivered  an  optimally  functioning  European  fund 
market.  The  number  of  funds  is  considerably  higher  than  10  years  ago.  This 
reflects  the  rapidity  with  which  managers  have  reacted  to  new  trends  and  the 
needs  of  increasingly  demanding  investors.  For  instance,  products  such  as 
guaranteed funds have recently enlarged the range of investment opportunities for 
UCITS investors. The end-result is that the landscape remains dominated by funds 
of  sub-optimal  size  which  are  on  average  5  times  smaller  than  their  average  US 
counterpart. Fund managers and administrators are not able to benefit fully from 
scale economies – reducing net returns to end-investors. Estimates indicated that if 
EU funds could attain US funds’ average size, annual cost savings of € 5bn could 
be achieved.  

Lack  of  market 
integration 
translates 
into 
higher  costs  for 
investors. 

From  an  investor  protection  perspective,  there  have  not  been  notable  financial 
scandals  involving  UCITS  in  Europe.  UCITS  has  provided  a  solid  underpinning 
for a well-regulated and generally well-managed industry. The investment limits, 
capital  requirements,  and  organisational  controls  on  asset  segregation  and  safe-
keeping,  disclosure  obligations  or  the  oversight  responsibility  of  depositaries 
introduced by the Directive have been important contributing factors.  

No 
notablefinancial 
scandals so 
far… 

EN 

13 

   EN 

 
 
 
 
 
… but business 
is evolving and 
current trends 
may accentuate 
certain risks to 
investors. 

Recent  trends  in  European  fund  industry  are  changing  the  risk-features  of  the 
business.  Changes  in  the  organisation  of  the  business,  such  as  outsourcing  of 
operational  functions  or  moves  towards  open-architecture  may  entail  increased 
operational risk or conflicts of interest. New fund-types, based on more complex 
or  sophisticated  investment  strategies,  may  embody  features  that  are  not  well-
understood by retail investors. The possible implications of alternative investment 
strategies for investor protection and financial stability remain poorly understood. 
Furthermore,  substitute  products,  such  as  unit-linked  products  or  certificates, 
compete  with  UCITS  for  long-term  savings.  However,  they  are  not  necessarily 
subject  to  the  same  level  of  disclosure  and  transparency.  This  may  call  into 
question the levels of disclosure and investor protection promoted by UCITS. 

The  accompanying  Commission  staff  working  document  provides  an  extensive 
treatment of these issues. To further improve our understanding, the Commission 
is  sponsoring  further  research  to  evaluate  the  degree  of  integration  of  European 
fund  markets;  to  assess  whether  there  are  as  yet  unrealised  efficiency  gains  that 
could  be  achieved  through  cross-border  competition  or  a  more  rational  pan-
European organisation of the market; and to study evolutions in the risk-features 
of European asset management business. 

EN 

14 

   EN