Commission staff working paper - Annex to the : green paper on the enhancement of the EU framework for investment funds - Background Paper {COM(2005)314 final}
Date: 2005-07-12
Institutions: Directorate-General for the Internal Market and Services, European Commission
Subjects: UCITS fund, capital market, financial legislation, investment protection, investment transaction

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 12.7.2005 
SEC(2005) 947 

COMMISSION STAFF WORKING PAPER 

Annex to the : 

GREEN PAPER 

ON THE ENHANCEMENT OF THE EU FRAMEWORK 
FOR INVESTMENT FUNDS 

Background Paper 

{COM(2005)314  final} 

EN 

EN 

Table of contents 

Introduction 

1. 

1.1. 

UCITS and asset management  company 

The UCITS “model” 

1.1.1. 

Economic trends 

1.1.2. 

The UCITS passport 

1.1.3. 

Legal/administrative barriers to UCITS 

Notification  procedure 

The product rules 

1.2. 

AM company framework: passport and other permitted activities 

1.2.1. 

The asset managers 

Fund processing  functions 

An important role: voting rights exercise 

1.2.2.  The management company passport 

UCITS asset management  company 

Self-managed  investment companies 

1.2.3. 

Other permitted activities of management companies 

2. 

2.1. 

2.2. 

2.2.1. 

2.2.2. 

2.3. 

2.3.1. 

2.3.2. 

2.3.3. 

Investor protection 

Managing conflicts of interests in asset management 

Organisational controls on funds and their managers 

Depositary as custodian of investor assets 

Depositaries’ control over operation of funds 

Regulation of sales process 

General disclosure requirements 

Disclosure of fees and commissions 

Legal uncertainties in UCITS distribution framework 

UCITS-Directive: harmonisation of the public marketing of UCITS 

Advertisement rules under UCITS directive 

MIFID rules 

2.4. 

Investor confidence 

5 

7 

11 

12 

12 

13 

13 

13 

14 

14 

16 

16 

17 

18 

20 

20 

22 

22 

23 

25 

25 

26 

27 

27 

28 

28 

29 

EN 

2 

EN 

3. 

3.1. 

3.1.1. 

3.1.2. 

Changing features of EU fund  industry 

Additional single market  freedoms? 

Greater freedom  of choice of depositary? 

Cross-border mergers and pooling techniques 

Cross-border fund  mergers 

Cross-border pooling techniques 

3.2. 

New distribution pattern 

3.2.1. 

Changing conflicts of interest? 

Conflicts of interest in integrated architecture 

New conflicts of interest in fund  distribution 

Considerations on distributor commissions 

3.2.2. 

Clarification  of rules for new distribution channels 

E-commerce and distance marketing 

Listing of investment funds 

3.2.3. 

Needs for clarification  of private placement 

3.3. 

Changing risk patterns 

3.3.1. 

Potential conflicts of interest and fund governance 

Debate on fund  governance and fund  management oversight 

What impact on the current governance framework? 

3.3.2. 

Increasing operational risks 

Is outsourcing a solution? 

Capital requirements 

4. 

4.1. 

4.1.1. 

4.1.2. 

Overall asset management landscape 

Other collective investments: non-harmonised products 

Development of non-harmonised products competing with UCITS 

Policy issues regarding non-harmonised products 

Market fragmentation  and risk of regulatory arbitrage 

Retail investor protection 

Financial stability concerns 

Depositary role in respect of alternative investment strategies 

30 

31 

31 

31 

32 

33 

34 

34 

34 

34 

35 

36 

36 

36 

37 

38 

38 

38 

39 

40 

41 

43 

44 

44 

44 

47 

47 

47 

48 

49 

EN 

3 

EN 

4.2. 

Level playing field with other financial products competing with funds 

4.2.1.  With pension funds  (Fund schemes as occupational pension schemes) 

4.2.2.  With life-insurance 

Regarding disclosure requirements 

In particular: regarding unit-linked insurance products 

• 

Regarding tax treatment 

4.2.3.  With investment certificates 

Annex A: Pooling techniques, advantages, risks 

Annex B:  Some national frameworks  related to alternative funds 

50 

50 

51 

51 

51 

52 

52 

54 

57 

EN 

4 

EN 

Background Paper on UCITS Review 

INTRODUCTION 

In  most  of  Europe,  the  intermediation  role  between  savers  (money  offer)  and  borrowers  (money 
demand)  has  historically  been  played  by  the  banks.  In  recent  years,  non-bank  financial  institutions 
have  emerged  to  meet  the  demand  from  investors  who  prefer  entrusting  their  money  to  specialised 
institutions  (asset  managers),  better  able  to  diversify  risks  and  to  improve  the  performance  of  their 
portfolio.  This  has  led  to  an  important  expansion  of  the  asset  management  industry  which  has 
developed  a  wide  range  of  products1  (collective  investment  schemes  alongside  discretionary 
management),  investing  in  a wide  range  of  markets  and  instruments  and  more  adapted  to  investors’ 
preferences.  Asset management plays a key role in the economy by allocating economic resources and 
investing  in companies, thereby  enabling  real  sector activity to expand  and develop. Investment  funds 
have  also  potential  to  assume  greater  importance  as  public  sector  pensions  remain  under  funding 
pressure and occupational pension funds  shift to defined-contribution  basis. 

EU  legislation  (Directive  85/611/EEC,  so  called  “UCITS  I”  Directive)  introduced  in  1985  aimed  at 
two  objectives: 

•  To  facilitate  the  cross-border  offer  of  investment  funds  for  the  retail  investor,  it  designed  an 
Undertaking  for  Collective  Investment  in  Transferable  Securities  (UCITS)  model, 
intended for cross-border  circulation. 

•  As a corollary to this, to protect retail investor by limiting fund  risks through  strict rules on the 
investment  policy  of  funds.  Institutionalised  risk-diversification,  through  fixed  investment 
limits, has proven to be one of the  successes  of the UCITS model.  The discretion  of the  fund 
manager  is  legally  restricted  so that  investors  do  not  have  to  rely  on  the  skills  and  the  due 
diligence of the fund  manager alone. 

Investment  funds  are  emerging  as  the  main  market-based  mechanism  for  asset-gathering  and  long-
term savings management in Europe. In many Member States, they dwarf assets under management by 
life  insurance and occupational pension vehicles. EU-wide, 28,830 UCITS funds have amassed some € 
4,100 billion (78.75% of the European open-ended  fund market) at the end of 2004. 

On the  one hand, these  figures  show that the  UCITS  “label” has been  successful.  On the  other  hand, 
the  creation  of  a  European  passport  for  UCITS  and  a  greater  integration  of  the  capital  markets  in 
recent years, have not lead to the anticipated acceleration in the sales of cross-border funds.  Excluding 
so-called  “round trips2”, not more than  16.1% of the total number of UCITS are truly  sold on a cross-
border basis, i.e. to one or more countries which are not the national home of the  sponsor company  of 
the  UCITS. Nevertheless,  this  figure  is  increasing  (from  13% in  2002).  Moreover,  among  a total  of 
€234  billion  in  new  capital  placed  in  UCITS  throughout  Europe  in  2004,  the  share  of  cross-border 
sales has been “surprisingly3 high, at around 60%”. 

The  accession  of  10 new  Member  States  has  enlarged  EU  financial  markets, providing  old  Members 
with  greater  commercial  opportunities.  The  fund  market  in  most  of  the  new  Member  States  is  still 
rather underdeveloped.  According  to FEFSI figures,  at the  end of 2003, net assets under  management 
(UCITS  and  non-UCITS)  in  Poland,  Hungary  and  the  Czech  Republic  were  respectively  0.153%, 
0.075%  and  0.072%  of  the  total  net  assets  for  the  EU-15. It  remains,  however,  to  be  seen  how  the 

1At the end of 2004, 41,800 funds  managed around € 5,200 billion of assets within EU. (source: EFAMA) 
2The funds registered abroad by a national promoter with the aim of selling them back into his home country. 
3 EFAMA press release “Europe's  fund industry looks back at a successful 2004” dated 1st March 2005. 

EN 

5 

EN 

competition  forces  will  affect  the  new  Member  States’ often  less  mature  asset  management  industry 
and to which extent cross-border sales will increase. 

Assets under management in Europe (€ billion) 
Figures are estimated and may include a certain degree of double counting, mainly with regard to private equity and alternative funds 

58,35 

955,00 

94,03 

^ r>fc 

L 

1.004,04 

82 

, 

.61,03 

,123,64 

97,02 

1.049,37 

946,01 

187,84 

139,03 
133,02 

1.108,16 

3.070,00 

3.333,26 

3.487,11 

3.200,27 

3.598,70 

4.104,31 

6.000,00 

5.000,00 

4.000,00 

40,60 

3.000,00 

685,70 

2.000,00 

1.000,00 

2.262,18 

0,00 

end 1998 

end 1999 

end 2000 

end 2001 

end 2002 

end 2003 

end 2004 

UCITS 

non UCITS ex. alt. mngt. & PE 

alternative management 

private equity 

Source: www.hedgefundintelligence.com  + Van Hedge Fund Advisors International + EFAMA + EVCA 

Basically,  fund  distribution  in  most  countries  is  still  dominated  by  national  financial  groups  which 
offer  in-house products. It is therefore  difficult  and costly for  foreign  fund  promoters to compete with 
well  established  distribution  channels.  Only  in  the  case  of  the  UK,  is  the  share  in  distribution  of 
independent  intermediaries (Independent  Financial Advisers or IFAs) much higher  than that of  banks. 
Other  distribution  channels  are  insurance  companies  and  increasingly  the  internet.  The  situation  is, 
however,  changing  gradually  as  banks  are  opening  their  distribution  networks  to  third  party  funds. 
This  allows  them  to  attract  clients  seeking  “the  best  product  in  the  market”,  enlarge  their  offer 
(particularly  for  specialised  products)  and  improve their  profitability  (since fund  manufacturers  often 
“retrocede”  part  of  the  fees  and  contribute  to  the  marketing  costs).  The  move  towards  open 
architecture is, however, slow and the potential for a more “open” distribution still high. 

The 2001 amending directives (2001/107/EC and 2001/108/EC) require the Commission  to assess the 
functioning  of  the directive. The first  objective  of  the UCITS review is to assess whether, and to what 
extent, UCITS legislation has facilitated  the integration of the single market for harmonised funds. The 
UCITS review  must  also  consider  more far-reaching  issues  concerning  the  scope of  the  harmonising 
framework  (e.g.  hedge  funds)  and  regulatory  design  (role  of  depositaries,  self-managed  investment 
companies). 

Article 2 of the Directive 2001/108/EC of the European Parliament and of the Council of 21 January 
2002  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 (Official  Journal L 041, 13/02/2002 P. 0035 – 0042) 

1. No later than 13 February 2005, the Commission shall forward  to the European Parliament and the 
Council a report on the application of Directive 85/611/EEC as amended and proposals for amendments, 
where appropriate. The report shall in particular: 

EN 

6 

EN 

(a) analyse how to deepen  and broaden  the single market for  UCITS, in particular  with regard  to cross-
border  marketing  of  UCITS  (including  third-party  funds),  the  functioning  of  the  passport  for 
management  companies, the functioning  of  the simplified  prospectus  as an  information  and  marketing 
tool, the  review  of  the  scope  of  ancillary  activities  and  the  possibilities  for  improved  collaboration  of 
supervisory authorities with respect to common interpretation and application of the Directive; 

(b)  review  the  scope  of  the  Directive  in  terms  of  how  it  applies  to  different  types  of  products  (e.g. 
institutional  funds,  real-estate  funds,  master-feeder  funds  and  hedge  funds);  the  study  should  in 
particular focus on the size of the market for such funds, the regulation, where applicable, of these  funds 
in the Member States and an evaluation of the need for further  harmonisation of these funds; 

(c) evaluate the organisation  of  funds,  including  the delegation  rules  and  practices  and the  relationship 
between fund  manager and depositary; 

(d) review the investment rules for UCITS, for example the use of derivatives and other instruments and 
techniques  relating  to  securities,  the  regulation  of  index  funds,  the  regulation  of  money  market 
instruments,  deposits, the  regulation  of  "fund  of  fund"  investments,  as  well  as  the  various  investment 
limits; 

(e)  analyse  the  competitive  situation  between  funds  managed  by  management  companies  and  "self-
managed" investment companies. 

In  preparing  its  report,  the Commission  shall  consult  as widely  as  possible  with  the  various  industries 
concerned and with consumer groups and supervisory bodies. (…) 

The  assessment  of  the  effectiveness  of  the  UCITS  legislation  must  be  undertaken  having  regard  to  the 
twin  goals  of  a  high  level  of  investor  protection  and  integration  of  markets  for  harmonised  funds  on 
the  basis  of  the  UCITS  ‘product  passport’.  From  a  longer  term  perspective,  social  and  economic 
developments  (contribution  to  finance  pensions,  Lisbon  agenda,  competitiveness  of  EU…)  as  well  as 
new  trends and  emerging  risks in  asset  management  can  fit  deeper  consideration  on  functioning  of  the 
asset  management  business. For  EU  legislator,  the  objective  should  be  to  facilitate  the  emergence  of  a 
cost  efficient  and  dynamic  European  fund  industry  that  deserves  the trust of  its retail investor  base. 

1.  U C I TS  AND ASSET MANAGEMENT COMPANY 

1.1.  T he  U C I TS  “ m o d e l” 

1.1.1.  Economic 

trends 

The  market  for  UCITS  funds  has grown  rapidly, with  the total  number  of  funds  in  Europe  rising4  from 
c. 10,000  in  1993 to over  28,000  in  2003. The  fastest  growth  was  recorded  in  the  mid-1990s,  although 
the  number  of  funds  has  since  reached  a  plateau;  contracting  slightly  in  2003  (as  showed  in  the  table 
below).  In  the  same  year,  this  stagnation  contrasted  sharply  with  a  20%  increase  in  the  number  of 
active cross border  funds. 

4 FEFSI Fact Book, 2004 

EN 

7 

EN 

Cross border funds, as a proportion of the UCITS market 

Fund type 

Total  funds 

Cross border  funds 

Cross border funds / Total  funds 

2002 

28,459 

3,750 

13.2% 

2003 

28,189 

4,529 

16.1% 

change 

-0.9 % 

20.8 % 

Source: FERI; Lipper 

Next  figure  illustrates  that  in 2003 the number  of  cross-border  notifications  increased  in all but  three 
Member States compared to 2001. 

Figure: Trends in cross-border notifications of UCITS 

Number of notifications received in 15 Member States 

3.500  -

3.000  -

2.500  -

2.000  -

1.500  -

1.000  -

500  -

. 

031/03/2001 

•  31/12/2003 

• I 

" 

_• 

J' 

fl  J 

Source: PWC & Lipper 

Despite this increase, the share of  cross-border funds  remains relatively modest, representing just 16% 
of  the total number funds. In addition, having access to a market does not always mean being broadly 
sold. Thus, although the number of foreign  funds  in some Member States is an important proportion of 
the total number  of  funds  available domestically, their market  share may not be very significant.  One 
of  the  reasons  for  this  is  the  fact  that  big  domestic  financial  groups,  which  control  distribution 
networks, tend to offer  in-house products. 

EN 

8 

EN 

The  diversity  of  EU  Member  State’s  tax  regimes  is  also  considered  as  one  important  barrier  to  the 
trade  of  funds  across  borders5.  Barriers  are  sometimes  the  result  of  historical  developments  (and 
cultural  preferences)  or the desire to privilege  the use of  a particular  investment  vehicle (e.g. pension 
funds).  Tax  constraints  generate  often  additional  administrative  requirements  and  are  powerful 
financial  disincentives.  Concrete  examples  of  such  requirements  are  the  need  to  appoint  a  tax 
representative  or to make  a complex  tax computation6. A clear  illustration  of  a financial  disincentive 
could be the fact that dividends distributed by foreign  funds  are subject  to a withholding tax. 

Further  identified  barriers to a greater  integration  of  the European  market  for  investment  funds  lies in 
the  obstacles  to  cross-border  fund  mergers  and  pooling  techniques. Finally,  cross-border  transaction 
processes are characterised by inconsistent operational protocols which put up costs. 

Finally,  the  fact  that  client  preferences  vary  from  country  to  country  makes  it  difficult  for  fund 
manufacturers  to create a “one size fits  all” product  that  can be sold  across the EU  market.  Investors 
often  prefer  funds  investing  in  a  particular  instrument  (e.g.  national  stocks  vs. international  stocks, 
debt  instruments  vs.  equity…).  In  some  countries  they  may  demand  particularly  products  that 
“guarantee”  their  capital  or  a  certain  return.  Sometimes  clients  may  find  it  more  acceptable  to  pay 
redemption  fees  than  entry  fees. Quite often  they  will rely  in  their  bank  for  advice  (because  this  has 
always  been  their  partner  for  all  kinds  of  financial  operations).  And  finally,  in  a  few  countries, 
investors  seem  to  feel  comfortable  using  the  new  technologies  to  build  their  portfolios.  It  seems, 
however, that the main cultural obstacle highlighted by the industry would be the existence of  different 
languages7. All in all, very few consider that cultural barriers are insurmountable8. 

As a result  of  those hurdles to the circulation  of  investment  funds,  the offer  to investors  continues  to 
be fragmented  and biased towards national products. Market fragmentation  has led to a proliferation of 
the  number  of  funds.  These  often  have  a  sub-optimal  size9  which  impedes  fund  managers  and 
administrators  to properly  benefit  from  lower  costs  derived  from  economies  of  scale. This  translates 
into higher costs for the investors10. 

Distribution in most EU countries has been traditionally dominated by local banks. This is the result of 
historical  and  cultural  developments  which  led  to  a  situation  where  universal  banks  were  for  many 
years  the  main  intermediaries  between  borrowers  and  savers.  Their  prevalence  on  the  European 
financial  scene  has  been  consolidated  through  mergers  and  acquisitions  and  an  enlargement  of  the 
services provided (including asset management). They are the logical choice for  many Europeans used 
to employ the services of “the bank around the corner” to deal with all kind of financial  matters. Banks 
have traditionally offered  customers only in-house products. 

The situation is different  in the UK where banks have long faced  competition in their role of  financial 
intermediaries. Thus, the “polarisation”  regime11, introduced  in 1987, has supported  the  development 

5 “Financial Services Action Plan: progress and prospects; Asset Management Expert Group (AMWG) Report” 
published  by the Commission  in May 2004 (post-FSAP AM report), “Towards a Single  European  Market in 
asset Management” (Heinemann report), ZEW, May 2003. 
6 “Cross-border marketing of harmonised UCITS in Europe”, FEFSI and PWC, November 2001 
7 “Towards a Single European Market in asset Management” (Heinemann report), ZEW, May 2003 
8 For example Heinemann considers that they can all be accommodated by asset managers (Heinemann report). 
9  This is reported  to be 5 times smaller  than the average size of  US mutual funds  (ICI and FEFSI data as at 
December 2004). 
10 The Heinemann report points to annual costs savings of € 5 billion if integration resulted in European  funds 
reaching the same average size as US funds (“Towards a Single European Market in Asset Management”, ZEW, 
May 2003) 
11 According to the « polarisation » regime, a firm which advises a private customer on packaged products must 
either  be a product  company or its marketing group associate (and must not advise private customers to buy 
packaged products which are not those of the marketing group) or do so as an independent intermediary. 

EN 

9 

EN 

of Independent Financial Advisors (IFAs) as a distribution channel12. The recent entry into force of the 
“de-polarisation” regime may, however, affect  the UK’s distribution structure13. 

Despite  their  traditional  tendency  to  distribute  “proprietary”  funds,  banks  are  starting  to  open  their 
distribution  networks  to  third  party  funds  (open  architecture).  This  allows  them  to  attract  clients 
seeking “the best product in the market”, enlarge their offer  (particularly  for  specialised  products) and 
improve their profitability. However, the move towards open architecture is slow. 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 TPF14. In addition to this, 46% of fund  distributors do 
not offer  even one TPF15. 

Moreover, gradually, other non-bank financial  institutions are starting to offer  financial  products (such 
as funds)  and  services. Nevertheless, they  have to compete  with  the well established  and  widespread 
bank networks. 

Insurance  is  another  traditional  distributor  of  funds16  which  is  particularly  prominent  in  the  UK, 
Sweden  and  Germany.  Distribution  via  insurance  companies  often  benefit  from  favourable  fiscal 
treatment  and, as in the case of  banks, from  widespread  networks. The range/classes  of  products  that 
they  offer,  even  if  similar  to  investment  funds,  may  have  other  purposes  such  as  the  coverage  of 
certain risks. They can also be less liquid since the policy is designed to be held for an agreed term and 
earlier redemptions may lead to heavy penalties. 

IFAs,  which  are  generally  not  tied  to  a  particular  product  provider,  act  on  behalf  of  the  investors 
advising them  on the most suitable product. In the UK, following  the “de-polarisation”, to be able to 
hold  themselves  as  “independent”,  IFAs  should  provide  advice  on  products  from  across  the  whole 
market  and  offer  their  clients  the  possibility  to  pay  fees  for  the  advice  they  receive.  In  other  EU 
countries, with the exception of Germany, the role of IFAs in fund  distribution is negligible. 

Internet  is  another  channel  that  allows  fund  manufacturers  to  sell  their  products  without  having  to 
develop  costly  local  distribution  networks17.  It  is  increasingly  used  by  (ever  more  sophisticated) 
investors  not  only  as  a  source  of  information  but  also  to  directly  purchase  investment  funds. 
Additionally,  it  is  becoming  an  important  working  tool  for  advisors. Many  studies  in  the  past  years 
have  predicted  an  important  surge  of  volumes  traded  via  fund  supermarkets.  For  instance,  the 
Heinemann  report18  identified  fund  supermarkets  (together  with  insurance  companies)  as  a  channel 
expected  to  expand  the  most  in  the  2003-2013  period. Likewise,  the  CERULLI  report  on  European 
Fund Supermarkets19 estimated  that between  10% (in Spain) to 25% (in UK and Germany) of  the net 
new inflow  into mutual funds  by the end of 2005 would be via supermarkets. A high degree of  market 
penetration has however  not materialised  yet. For instance, according to the FSA, the market  share of 
fund  supermarkets  in  funds  distribution  in  the  UK  market  is  around  5%20. To  date,  only  in  some 
Nordic  countries  does  internet  have  an  important  market  share  in  the  distribution  of  funds21.  Recent 

12 « Towards a single European market in asset management » (Heinemann report), May 2003, p. 38 
13 As from 1st December 2004, the “de-polarisation” will allow bank networks to distribute also non-proprietary 
products. 
14 Eurofund Magazine, DWS Investments, 2003 
15 Idem 
16 e.g. unit-linked  funds  (part of  the premium is used to buy life  assurance and the other invested  in a fund), 
“with-profit” funds (policyholders share the return of the fund)… 
17 “Cross-border  distribution  of  funds : hurdles and developments”, Moody’s Investors Service Global Credit 
Research, August 2000 

“Towards a Single European Market in asset Management” (Heinemann report), ZEW, May 2003, p. 42 
“European Fund Supermarkets”, Volume II, Cerulli Associates, 2001 
Unit trusts and Oeics conference, June 2004 Speech by Mr Dan Waters 
According  to  FEFSI, 27% and  10% of  funds  are  placed  via  internet  in  Finland  and  Sweden  respectively 

(FEFSI Fact Book 2004). 

EN 

10 

EN 

estimates  indicate  that  mutual  funds’  assets on all platform-based  systems were above € 60 billion  at 
the end of 200322 which is a relatively small part of Assets under management for the whole industry. 

‘Funds  of  funds’  have  emerged  as  an  easier  way  for  asset  managers  to circumvent  rigid  distribution 
structures  and  to  avoid  the  costs  of  setting  local  distribution  systems. The  diversification  they  offer 
seems to  be appreciated  by  investors. However,  they  are  often  not  aware  of  the  double  layer  of  fees 
that  they  are incurring23. Recent  studies  point  to  a high  annual  growth  rate  for  funds  of  funds  in  the 
near  future24.  Wrapping  the  product  and  applying  a  management  commission  compensates  for  the 
lower  margin  associated  to  open-architecture  and  makes  it  an  attractive  strategy25.  Similarly,  the 
changes introduced by the UCITS III26 directive should facilitate the marketing of fund  of funds  within 
the internal market. 

1.1.2.  The  UCITS  passport 

Development  of  a single market  for  investment  funds  was  the legislator’s  first  concern. The  product 
“passport”  was  the  tool  the  UCITS  Directive  introduced  in  order  to  facilitate  the  free  circulation  of 
fund  units. To this end, the UCITS Directive  aimed  at creating  a diversified  financial  product  with a 
low  risk-profile  suitable  for  retail  investors.  The  directive  contains  both  general  and  specific 
requirements. Regarding the general requirements, one can refer  to the  following: 

• 
• 

authorization of UCITS by the competent authorities of a Member State; 
sufficient  good  repute  and  sufficient  experience  of  the  directors  of  the  depositary  and  the 
management  company; 

•  with respect to the unit trust, approval of  the management  company, the fund  rules and the choice 

of  depositary; 

•  with  respect  to  the  investment  company,  approval  of  its  instruments  of  incorporation  and  the 

choice of  depositary. 

Furthermore,  in  order  to  protect  investors,  notably  against  market  risks,  the  Directive  applies  a 
formal/quantitative  approach by means of specific elements: 

•  Exhaustive  enumeration  of  eligible  assets  (securities,  money  market  instruments,  deposits, 

investment funds and derivatives); 

•  Establishment  of  fixed  quantitative  investment  limits  (issuer  concentration  limits,  counterparty 
risk, limits referring  to a certain type of  asset, limits referring  to the issuance of  an issuer; limit to 
market risk); 

•  Explicit  exclusions or permission  of  certain  investment  techniques (no short sales, no  borrowing, 

permission of index replication, permission of leverage through derivatives). 

The  passport  is  based  on  the  principle  of  mutual  recognition.  A  UCITS  which  shall  be  marketed  in 
another Member State needs to be authorised in its Home Member State. This authorisation is valid for 
all Member States because the conditions for the authorisation, the structure and the investment policy 
of  UCITS  have  been  coordinated.  The  UCITS  is  exclusively  subject  to  the  supervision  of  its  Home 

22 Cerulli report on European Advisor Distribution, June 2004 
23 Additionally, the (underlying) funds’ selection criteria used by the manager of the fund of funds is not always 
clearly explained to the client. 
24 Based in Cerulli Associates estimates, an Edhec study foresees an annual growth rate of about 15% for multi-
management  (which  also  includes  managers  of  managers)  for  the  period  2003  to  2008  (European  Asset 
Management Practices Survey, March 2003). 
25 “Sizing up the benefits”, Professional Wealth Management (FT Business), February 2005 
26 Directive  2001/108/EC  allows UCITS to be invested  in units of  other  collective  investment  undertakings. 
Thus, funds of funds, under certain conditions, can benefit from the UCITS passport. 

EN 

11 

EN 

Member  State.  The  UCITS  has  only  to  comply  with  a  simple  notification27  procedure  in  the  Host 
Member  State  which  neither  constitutes  a  re-authorisation  nor  a  re-approval  of the  marketing  of  the 
product.  The  Host  Member  State  authority  has  two  months  to  verify  whether  the  marketing 
arrangements  comply with the provisions  of the Directive  and with  its own marketing  rules. The Host 
to  comply  with  the  rules  governing  the 
Member  State  will  be  able  to  require  the  fund 
marketing/advertising  of  UCITS  on  its  territory  as  these  rules  have  not  been  harmonised  by  the 
Directive. 

1.1.3.  Legal/administrative  barriers  to  UCITS 

•  Notification  procedure 

Difficulties,  costs  and  delays  associated  with  the  notification  procedure,  are  perceived  by  market 
participants as a major obstacle to market integration. 

The  “simple”  notification  procedure  is  being  beset  by  practical  problems.  It  is  often  confused  with 
“registration”  and  seems  sometimes  in  practice  more  to  amount  to  an  “authorisation  of  distribution” 
than  to  a mere  notice  of  information.  This  is  also  due to  divergent  interpretations  of the  notification 
requirements  themselves:  some  Member  States  require  further  information,  translation  requirements 
are  diverse  and  more  or  less  onerous,  some  Member  States  require  the  appointment  of  a  local 
representative  whereby  the  details  of  this  appointment  can  vary.  In  terms  of  procedure,  the  average 
time  limits  for  the  notification  procedure  are  widely  variable  and  very  often  superior to two  months. 
Supervisory  authorities  also  have  different  practices  regarding  the  start  of  the  2  months-period 
provided  for  by  the  Directive.  Finally,  the  fees  levied  on  the  notification  procedure  and  on  the 
maintenance  of the notification  can considerably vary. Consequently, the notification  procedure  seems 
perceived  as  expensive  and  time-consuming.  Some  industry  voices  consider  that  the  notification 
procedure  sometimes does not facilitate  the distribution of funds  on a cross-border basis28. It should be 
noted  that the  procedure  is  deemed  to  enable the  Host  Member  State  authority  to  exercise  its  control 
functions  over the advertisement of the UCITS in accordance with local marketing rules, which are not 
harmonised.  This  automatically  implies  -  at  least  to  a  certain  extent  -  that  the  notification 
requirements  are heterogeneously  interpreted  and  applied  because the  authority  has to  ensure that the 
information  delivered  within  the  margins  of  the  notification  procedure  corresponds  to  local 
requirements on marketing and advertising. 

Some industry  actors29 have estimated that direct costs of initial notification  can be roughly  estimated 
to  have totalled  more than €  20 million  euros by the  end  of 2003  for the  whole  industry.  Adding  the 
costs of maintaining notification  across the EU, this would mean a cost of € 25 million per year for the 
industry  as  a  whole.  Apart  from  these  direct  costs,  another  one  is  the  operational  risk  to  asset 
management  companies  of failing  to maintain  registration.  Consequently, provided that direct  sales to 
retail  investors  are  uncommon  and  that  providers  predominantly  sell  UCITS  indirectly  trough  third 
party  distribution,  some  industry  players  question  the  need  for  notification  procedure.  At  this  stage, 
regulators  have  not  expressed  a  clear  position  about  the  costs  and  the  benefits  of  the  notification 
procedure. In addition, it should be noted that reduction of costs should be profitable  to final investors, 
provided that savings are passed on to them. 

27  According  to  the  Directive  the  following  documents  have  to  be  submitted  to  the  Host  Member  State: a 
statement  of  compliance established  by the Home Member  State authority  certifying  that  the fund  fulfils  the 
conditions laid down in the Directive, the fund  rules or statutory documents, the full and simplified prospectus, 
an annual report and subsequent half-yearly report, description of marketing arrangements. 
28 IMA has described the notification procedure as a “market failure” in its own right. 
29 IMA, January 2005 

EN 

12 

EN 

•  The product  rules 

The product rules are divergently interpreted by the different  Member States. The same product can be 
deemed as UCITS in one Member State and ruled out in another. 

UCITS  have  been  successful  in  gaining  consumer  confidence  mainly  because  of  their  determined 
scope.  However,  the  complexity  of  many  financial  products  and  the  speed  of  financial  innovation 
results in a permanent  emergence  of new products. This makes it more and more difficult  for  national 
authorities, but also  for  fund  managers  to  determine  whether  a product  complies with the  rules  of the 
Directive. In some areas, such as the wider use of derivatives  and the possibility to leverage  a UCITS, 
these  developments  have  been  taken  into  account.  Thanks  to  the  Commission  recommendation  on 
derivatives 2004/383/2004 the rules on leverage and the use of derivatives can be applied in a way that 
gives fund managers more flexibility and certainty as regards the management of UCITS portfolios. 

Divergent interpretations  of core directive  provisions  (e.g. on eligible  assets)  can lead to  uncertainties 
as regards the question of whether the notified  product actually fulfils  the UCITS criteria or not. 

In this respect, the  ongoing  work to clarify  definition  of eligible assets is certainly  one important  step 
to achieve a harmonised understanding of investment rules characterizing the UCITS product. 

1.2.  AM  company  framework:  passport  and  other  permitted  activities 

1.2.1.  The asset  managers 

The asset management firm is responsible  for the management  of the investor’s assets. It “creates” the 
products  according  to  clients’  preferences,  market  tendencies  and  their  own  in-house  specialisation. 
Some asset managers are more or less independent  departments  or subsidiaries  of a universal bank. In 
other  cases, they  are  fully  independent  firms  which  have  been  created  around  the  expertise  of  some 
managers  in  particular  geographical  markets,  financial  instruments  or  strategies.  They  are,  therefore, 
often  more  specialised and offer  a narrower range of (sometimes more sophisticated) products than the 
AM firm of a banking group. 

As  other  functions  of  the  AM  business,  the  fund  management  is  also  subject  to  changes  aiming  to 
rationalise  costs  and  to  increase  the  supply  to  clients.  Thus,  the  asset  management  function  may  be 
outsourced to another asset manager.  This can be done through the distribution of third party funds  or 
by the use of multi-management.  By  spreading  assets among multiple  managers, investors  can  benefit 
from  a  diversification  of  management  styles  (and  therefore  of  risks).  Multi-management  includes 
funds  of funds  (mainly for retail investors) and manager of managers  (typically  offered  to  institutional 
clients).  Nevertheless,  the  double  layer  of  fees  may  partly  counter-weight  the  positive  effects  of 
diversification. 

As  regards  the  concrete  situation  in  the  EU,  different  countries  mean  different  situations.  In 
continental  Europe, the  predominance  of universal  banks  in the  financial  arena translates  into  a high 
proportion of asset managers belonging to those financial  groups. The picture is somewhat different  in 
UK where  small independent  asset managers  (boutiques)  are more heavily  represented.  It is, however, 
not  clear which  combination  of tied/independent  asset managers  is the  optimal  one  (i.e. which  would 
enhance the  efficient  functioning  of the AM industry). Furthermore,  it is not established  if both types 
of managers face the same constraints. 

Geographically,  asset managers having the highest amount of assets under management  are located in 
the  UK,  France  and  Germany.  Unfortunately,  it  is  difficult  to  find  comparable  sources  of  European 
data. 

EN 

13 

EN 

•  Fund  processing  functions 

The  Asset  Management  Working  Group  (AMWG)  highlighted  in  its  final  report  that  cross-border 
processing  of  fund  units  is  a key  issue  for  the  European  investment  management  industry.  Actually, 
the  industry  claims that the  European  cross-border fund  processing  landscape  is suffering  from  a high 
level  of  fragmentation30  at  both  trading  and  post-trading  levels.  For  instance,  orders  are  typically 
placed through bilateral  arrangements  between the  distributors  and the manufacturer.  They are largely 
processed through domestic market infrastructures  which are different  from  one market to the other. In 
some markets this  is also true  of  settlement,  whilst  in others the  settlement  infrastructure  is  provided 
almost  totally  by  central  securities  depository31  (CSD).  In  addition,  execution  of  fund  orders  and 
initiation  of  settlement32  processes  are  often  manual  and  differ  among  the  many  domestic  markets. 
Fragmentation  is also reflected  by the huge variety  of communication  standards  (still including  phone 
calls  or  faxes,  nevertheless  being  replaced  by  standardised  protocols),  distribution  channels  and 
business practices33. 

This  results  in  higher  operating  costs  and  operational  risks  in  the  transaction  value  chain  and  could 
represent  a limitation  to the  future  development  of the  fund  sector/industry  in EU.  The move  toward 
an  open  architecture  increases  the  number  of  distribution  channels  and  transfer  agents34  (TA).  The 
continuous  growth  of fund  types will  increase their number.  Hence, processing  volumes  are  expected 
to expand not only in terms of number35 of orders but also in terms of fund  data. The funds  industry in 
Europe would need to adopt an integrated  flexible  infrastructure  and to improve processing  efficiency 
in both domestic and cross-border fund  sectors. 

These  improvements  require  first  co-operation  among  market  players.  The  creation  of  the 
EFAMA/FEFSI’s  fund  processing  standardization  group at European  industry  level or the  association 
DIAMS36  are two  examples  of this needed  co-operation.  Once  European  standards37 are embraced  by 
the industry, they will need to be endorsed by organisations and implemented  among industry actors. 

•  An  important  role: voting  rights  exercise 

The  fund  managers’  primary  responsibility  is to  manage  the  investments  in the  sole  interest  of  their 
clients. In order to pursue this objective, fund  managers have to act responsibly as shareholders  among 
others by making considered use of their voting rights in companies they invest. 

30 The operational problems of  the European industry are mainly driven by domestic distribution  and  processing 
requirements. As a result, there is no such thing as a pan- European funds execution and processing  life-cycle. 
31 CSD  is  an  entity  which  holds  securities  and  other  assets  so  that  domestic/cross-border  transactions  may  be 
effected  for beneficial  owners and settled by way of entries within its own books 
32 The process of  transferring  the cash value of  a transaction  to/from  a fund-side  institution  in exchange  for  the 
registration/de-registration  of title to the units concerned 
33 e.g. different  times of  fund  valuation  in a market day, a different  number of  decimals for  unit/share valuation, 
different  settlement and delivery schedules, different  policies regarding how public holidays impact the valuation 
of  funds 
34 A TA is, in many  jurisdictions, a fund-side  institution  that  executes the issue and redemption  of  units on  the 
fund's  behalf  and  usually  maintains  the register  of  title. In  France  the equivalent  entity  is the “centralisateur", 
which does not maintain the register. 
35  According  to  EFAMA,  transaction  volumes  are  expected  to  double  over  the  next  3-4  years,  with  message 
volumes increasing  accordingly. 
36 Distribution  and  Integration  for  Asset  Management  System. The  purpose  of  DIAMS  group  is  to work  out  a 
Reference  Business  Repository  in  order  to  standardise  communication  in  the  asset  management  sector.  This 
dictionary  is  the  answer  -  data  definition  as  well  as  information  component  definition  -  used  to  build 
communication messages, while DIAMS acts as an interface format  between players. 
37  Operational  standards  would  be  needed  in  all  the  following  administration  functions:  account  opening  and 
referencing,  order  placement, order  acknowledgement  and confirmation,  settlement, messages (between  distinct 
actors of the fund  processing). 

EN 

14 

EN 

As  soon  as  March  2001,  the  Myners  Report38  reviewing  institutional  investment  in  the  United 
Kingdom, recognized that “effective  intervention, when appropriate, is in the best financial  interests of 
beneficiaries”  and  recommended  that  “[fund]  managers  should  routinely  consider  the  possibility  of 
intervening in investee companies as one of the means of adding value for their clients”. 

While  the  UCITS  Directive  remains  silent  on  shareholder  activism,  the  so-called  “Winter  Report39” 
and  the  Corporate  Governance  Action  Plan40  go  further  without,  however,  proposing  to  make 
shareholder  voting  mandatory.  Some  Member  States  regulations  strongly  recommend41  the  voting 
rights  exercise, whereas  other EU-countries42  require  information  from  fund  managers  about the  way 
they have used or not used their shareholders’ rights. 

The  principle  of  transparency  on  the  fund  manager  vote  is  broadly  recognised.  Thus,  according  to 
IOSCO43, two principles  should be respected by asset managers: 

• 

• 

shareholder  rights  attaching to  collective  investment  scheme  (CIS) portfolio  securities  belong 
to  the  CIS  -  these  rights  should  be  considered  by  CIS  operators  and  any  exercise  of  those 
rights must be carried out in the best interests of the CIS and 
public  disclosure  of  CIS  practices  relating  to  corporate  governance  both  encourages  proper 
exercise of rights and allows CIS investors to make informed  investment decisions. 

That being said, the voting rights exercise by investment funds  raises two kinds of issues. 

First, as far  as the voting right exercise  should be carried  out in the  sole interest of investors, the issue 
of possible  situations  of conflicts  of interest which may  arise  in exercising  shareholder rights by  asset 
managers  can  be raised  (e.g. when the  asset management  company  is part  of a financial  group  which 
could  have  various  financial  relationships  with  the  issuer  where  the  asset  management  company 
invested). The final investor and regulatory  authorities  should also be clearly  informed  about the  asset 
management  company  position/policy  related  to the  issuer  and  about the  final  behaviour  of the  asset 
management company. 

Second,  exercising  voting  rights  will  not  be  cost  free.  The  costs  might,  sometimes,  outweigh  the 
potential  benefits  of voting  for  the  funds  potentially  leading  to  "free  riding".  When  exercising  voting 
rights,  a  management  company  must  consider  the  sometimes  extensive  list  of  issuers  in  which  its 
funds  are  invested,  take  into  account  more  and  more  complex  resolutions,  attend  General  Meetings, 
expect timely and useful  information  from the issuers etc… This is even more relevant when the issuer 
is  based  abroad,  which  raises  the  question  of  vote  in  absentia  and  proxy  voting.  Considering  such 

38 “Institutional  Investment in the United Kingdom”: A Review by Paul Myners (March 2001) 
39 Report by the Group of  High-Level Company Law Experts, under the chairmanship of Professor  Jaap Winter, 
European Commission, Brussels, 10 January 2002 
40 Communication  from  the Commission  to the  Council  and  the European  Parliament,  “Modernising  Company 
Law and  Enhancing  Corporate  Governance  in the  European  Union,  a Plan  to Move  Forward”,  21 May  2003, 
COM (2003) 284 final 
41 UK FSA Combined  code on corporate governance (www.fsa.gov.uk) stipulates that “Institutional  shareholders 
have a responsibility to make considered use of their votes. Institutional shareholders should take steps to ensure 
their voting  intentions  are being translated  into  practice.  (…)  Major  shareholders  should attend  AGMs  where 
appropriate and practicable. Companies and registrars should facilitate this”. 
42  Cf.  French  Decree  2003-1103  of  23  November  2003  (on  eligibility  criteria  and  tracking  error  calculation 
methods  for  index  funds;  exercise  of  funds'  voting  rights  by  management  companies)  and  AMF  General 
Regulation  which specifies, inter alia, the conditions under which portfolio  management  companies report their 
policies  on  the  exercise  of  voting  rights  attaching  to  securities  held  by  the  collective  investment  schemes  that 
they manage. 
43  Collective  Investment  Schemes  as  shareholders:  responsibilities  and  disclosure,  Report  of  the  Technical 
Committee of IOSCO October 2003 

EN 

15 

EN 

costs,  some  AM  companies  delegate  the  exercise  of  voting  rights  to  specialised  providers  (voting 
agents offering  research, analysis, proxy or electronic voting and vote disclosure  services). 

Finally,  it  should  be  highlighted  that  the  Commission’s  services  are  considering  proposal  for  a 
directive on shareholders’ rights. It would include a system designed at EU level, which would address 
some critical issues attached to cross-border voting. 

1.2.2.  The management  company  passport 

•  UCITS  asset  management  company 

The  core  business  of  a  UCITS  management  company  is  the  collective  investment  business.  UCITS 
management  company  needs  to  be  authorised  in  its  Home  Member  State  in  accordance  with  the 
relevant  provision  of the  Directive.  The  introduction  of the  management  companies’  passport  would 
therefore  imply that a management  company would be empowered to manage  a UCITS constituted  in 
another  Member-State  by  the  means  of  a  branch  or  under  the  freedom  to  provide  services.  Cross-
border collective  investment  management  would therefore  encompass  setting  up or managing  UCITS 
in  another  EU-jurisdiction.  Until  now,  management  companies  have  not  been  able  to  avail  of  this 
possibility. 

•  The  option to  set-up  a UCITS  in  contractual  form  in  another jurisdiction  is clearly  excluded  by 
the  text  of  the  Directive.  The  Directive  sets  out  that  a  UCITS  shall  be  deemed  to  be  situated 
where the management company of a contractual fund  or a unit trust has its registered  office. 

•  With  respect to  corporate  type  of funds,  the text  of the  Directive  seems to  evoke the  possibility 
for  a management  company to  set up UCITS in another EU-jurisdiction.  However, the  Directive 
does not provide  for  the  necessary  set  of tools to  put  such  a  scenario  into  practice.  The  UCITS 
would  be  supervised  by  the  authority  of  its  Home  Member  State  whereas  the  management 
company would be under the supervision of the Member State in which it had been  authorised. 

Noting that the full  management company passport is not really functional,  respondents to the AMWG 
report’s  consultation  widely  agreed  with the  Expert  Group’s  recommendation  to broaden  its  scope. It 
is  difficult,  however,  to  assess  the  extent  to  which  this  will  deliver  significant  commercial  benefits 
(e.g. in terms of reduction of costs, acceleration of the market integration, supervision  difficulties…). 

So far, the  only  solution to  enable  a management  company to manage the  assets  of UCITS located in 
another jurisdiction  is through  delegation  arrangements.  But, this  solution  is  limited.  Under  a typical 
scenario,  the  UCITS  appoints  a  management  company  in  its  own  jurisdiction  which  delegates  its 
functions  to  a  management  company  in  another  Member  State.  Otherwise  the  UCITS  may  take  the 
form  of  a  self-managed  investment  company  which  delegates  functions  to  another  management 
company  located  in another Member  States. Delegation  arrangements have the  advantage  of  clear-cut 
legal  responsibilities  of  the  parties  involved.  The  delegating  entity  will  always  remain  legally 
responsible  for the  management  of the  UCITS  and  directly  vis-à-vis the  UCITS Home  Member  State 
authority.  This  includes  its  responsibility  in  case  of  misbehaviour  of  the  management  company  to 
which the relevant functions  have been delegated. Having  supervisory perspective, such solutions may 
ensure that  legal  responsibility  and  lead  supervisor  responsibility  remain  in jurisdiction  of  delegating 
entity. It is not clear how the  lead  supervisor will perform  the necessary  regulation  controls in respect 
of functions  that are delegated  cross-border. 

Despite providing  some welcome  flexibility,  delegation  is not a panacea. From a business perspective, 
delegation arrangements always require the involvement of a fully  equipped and completely  functional 
fund  manager  in the  Home  Member  State  of the  UCITS  which  would  then  delegate  the  functions  to 
the  management  company  which  genuinely  intends  to  provide  the  respective  service.  This  is  a  way 
round  which  is  likely  to  produce  additional  and  unnecessary  costs.  In  addition,  from  a legal  point  of 
view  delegating  would  never  allow  a  full  transfer  of  competences  to  the  delegated  management 

EN 

16 

EN 

company  intending  to  provide  the  service,  since  the  delegating  entity  must  not become  an  “empty 
shell”. 

In contrast, in the case of a “true” management  companies’ passport there would be no need to have a 
separate  entity  in place  in the jurisdiction  of the  UCITS.  The management  company  could  directly 
provide  its services to the fund in another jurisdiction.  Since  it would  be the genuine  manager  of the 
fund it could also provide all the services without any legal restriction.  Special know-how or expertise 
of  certain  management  companies  could  effectively  be exploited.  A  “true”  management  companies’ 
passport  could  therefore  contribute  to facilitating  the business  of fund  managers  and might  offer the 
prospects of a cost-efficient  business organisation. This might also be beneficial  for investors provided 
these advantages are passed on to them. 

On the other hand, the “true” management  companies’ passport would lead to a split of supervision of 
the  UCITS  and the  UCITS  management  company.  The Directive  does  not provide  for the  specific 
measures to address this  situation, e.g. to organise the joint collaboration of both  supervisors  involved 
or to resolve questions related to a potential misbehaviour of the management company.  Currently, the 
supervisory  authority  responsible  for the UCITS  would  have no legal  means to call the management 
company  directly  to  account  because  it  is  located  in  another  jurisdiction.  It  is  argued  that  spilt 
supervision  would  go  against  the  inherent  advantage  of  having  one  supervisor  responsible  for the 
manager and the fund (and its administration). 

•  Self-managed  investment  companies 

The  amendments  of the  UCITS-framework  aimed  at  harmonising  the  operating  conditions  for  self-
managed  investment  companies, i.e. those  investment  companies which do not appoint a management 
company.  In  particular,  the  Directive  aimed  at  aligning  the  operating  conditions  for  self-managed 
investment  companies  with 
those  of  management  companies.  Therefore,  minimum  capital 
requirements  and requirements  for the internal  organisation  of the  self-managed  investment  company 
were  introduced. 

However, in contrast to management  companies where the introduction  of these  requirements  entailed 
the  creation  of  an  activity-related  passport  and  an  enlarged  scope  of  permissible  activities,  self-
managed  investment  companies, by virtue  of their  construction,  do not benefit  from  further  freedoms 
as regards cross-border business. In this respect they are still considered  as a “product” which  benefits 
from  the product  passport.  The introduction  of minimum  requirements  for  self-managed  investment 
companies  was mainly  motivated  by investor  protection  considerations.  In parallel  to  other  types of 
UCITS  which  shall  only  be  marketed  if  the  management  company  complies  with  certain  pre 
requisites, it should be ensured that the management of a self-managed  invest company  equally  fulfils 
certain  qualitative  criteria.  Furthermore,  a  level  playing  field  regarding  the  conditions  for  market 
access for UCITS- managers should be ensured. 

For  the time  being;  it  is too  early  to  know  the  extent  to  which  the  model  of the  harmonised  self-
managed  investment  company  within  the meaning  of the  Directive  has been  substantially  availed  of. 
However,  experience  from  some  Member-States  suggests that the model  of self managed  investment 
company  is appreciated.  In particular,  self managed  company  allows  creation  of funds  with  a limited 
management capacity/cost component which can delegate the AM functions  to other entities. 

Accountability of AM companies: IAS 27 

IAS  27 (Consolidated  and Separate  Financial  Statements)  was issued  in  December  2003 and is 
applicable to annual periods beginning on or after 1 January 2005. It has the twin objectives of setting 
standards to be applied in the preparation and presentation of consolidated financial statements for a 
group of  entities  under the control of a parent; and in accounting  for investments in subsidiaries, 
jointly controlled entities, and associates when an entity elects, or is required by local regulations, to 
present separate (non-consolidated) financial statements. 

EN 

17 

EN 

IAS 27 applies to the preparation and presentation of consolidated financial statements for a group of 
entities under the control of a parent44. It also applies to accounting for investments in subsidiaries, 
jointly  controlled  entities  and  associates  in  the  separate  financial  statements  of  a  parent.  This 
accounting  norm  replaces  the former  fragmented  approach  whereby  funds  benefited  from  national 
exemptions in consolidation requirements. 

It seems that the AM industry does not support the concept of fund  consolidation and, hence, is not 
prepared to the current implementation. The industry, notably the private equity sector, argues that 
this new rule would be meaningless (NAV calculation under IAS 27 would only give a vague picture 
of the situation of the group) for most of funds and that its implementation is costly. 

1.2.3.  Other permitted activities of management  companies 

It  should  be  recalled  that,  originally,  in  order  to  ensure  investor  protection,  collective  investment 
management  should  only  be  carried  out  by  entities  specifically  dedicated  to  this  business  purpose. 
Therefore, the original Directive restricted the scope of activities to this business alone. This approach 
of specialisation  was intended to help prevent conflicts  between the management  companies’ business 
interests and those of  fund  investors. It was also meant to prevent management companies to carry out 
business activities whose risk-profile  would be detrimental to the fund  investors’ interest. 

To  date, the  Directive  allows  management  companies  to  carry  out  other  activities  in  addition  to  the 
collective  investment  management:  the  investment  services  of  individual  portfolio  management, 
advice  and  safekeeping  of  fund  units. Furthermore,  management  companies  are  now  empowered  to 
distribute the units of the funds  that they manage directly by themselves in a Host Member State via a 
branch or under the freedom  to provide services and without the need to rely on a third party. 

In contrast to collective investment business, the Directive provides for the necessary legal instruments 
to  give effect  to these  business  scenarios  on  a cross-border  basis. In  this  respect,  one  important  step 
towards  a  single  market  for  asset  management  was  made.  However,  the  cross-border  provision  of 
these  activities  may  encounter  further  obstacles  (e.g.  hurdles  resulting  from  the  notification 
requirements, tax  issues, etc.). Two potential  areas  which  might  impede  the  cross-border  business of 
management companies can already be  identified: 

•  Distribution  of  third  party  products:  The  possibility  to  market  funds  on  a  cross-border  basis 
encompasses  the  distribution  of  the  own  products  of  a  management  company.  Whether  this 
possibility also would encompass the distribution of  third party funds  is not clear according to the 
text of  the Directive: Distribution  of  third-party  funds  is not explicitly  mentioned as an  additional 
service  management  companies  are  allowed  to  provide. Annex  II  of  the  Directive  mentions  the 
function  “marketing”,  but  without  any  further  specification  (third-party  funds  or  only  “own 
funds”). Currently, this uncertainty  does not seem to cause an insurmountable hurdle to the cross-
border  business  of  management  companies:  at  present,  apart  from  developments  in  Italy  and 
Germany  the  cross-border  distribution  of  third-party  funds  does  not  play  a  major  role  for  the 
functioning  of  the  European  asset  management  industry.  To  the  extent  that  this  “marketing” 
entails a process of selection of funds  and assistance of offers  in choosing/promoting  certain  funds 
to individual investors, it needs to be considered whether this involves acting as an intermediary or 
UCITS manager. 

44  Summary  of  IAS  27:  A  parent  presents  consolidated  financial  statements  in  which  it  consolidates  its 
investment  in subsidiaries (those entities that  it controls), unless certain  conditions are met allowing it not to 
prepare  consolidated  financial  statements. The  consolidated  financial  statements  are  prepared  using  uniform 
accounting policies. The reporting date of the parent and its subsidiaries shall not be more than 3 months apart. 
When  separate  financial  statements  are  prepared,  investment  in  subsidiaries,  jointly  controlled  entities  and 
associates should be accounted for either at cost or in accordance with IAS 39. The same accounting should be 
applied for each category of investments. IAS 27 specifies disclosures to be made in consolidated and separate 
financial statements. (source www.iasb.org) 

EN 

18 

EN 

•  Lack  of  coherence  in  the  regulatory  framework  applicable  to  the  collective  and  the  individual 
portfolio  management  (UCITS-Directive, Markets in Financial Instruments directive - MIFID): In 
case  UCITS  management  companies  make  use  of  the  extended  business  opportunities  and  carry 
out  both  collective  and  individual  portfolio  management  they  are  subject  to  two  different  set of 
rules  regarding  the  organisational  structure  of  the  company.  For  the  management  of  UCITS  the 
provisions of the UCITS-Directive have to be observed whereas the rules of the MiFID have to be 
applied to the individual portfolio management. In certain similar areas such as the management of 
conflicts  of  interest45,  client  reporting  or  outsourcing,  the  regulations  in  the  MiFID  considerably 
deviate from  those of  the UCITS-Directive. The MiFID-Directive partly contains more elaborated 
or more demanding standards and – due to the fact  that it is a Lamfalussy-Directive-  also  features 
a  higher  level  of  detail.  For  legal  reasons,  the  UCITS  manager  might  therefore  be  obliged  to 
separate the two business segments although this might be hardly feasible in practice. 

A  question  remains  in  the  activity  of  setting  up  structured  and/or  guaranteed  funds.  Those  funds 
enjoyed  significant  growth and increasing popularity among retail investors since the mid-eighties. By 
September  2004  the  total  net  assets  of  some  2,668  guaranteed/capital  protected  funds  in  Europe 
amounted  to  €  174.3 billion.  France,  Spain, Netherlands, Belgium  and  Luxembourg  are  the  markets 
where these types of  funds  have acquired  a significant  market  share. Today’s  market  conditions  have 
only  amplified  the  role  of  fund  products  that  offer  an  investment  guarantee  or  a  capital  protection 
element  to  investors.  With  respect  to  the  type  of  guaranteed  funds  two  types  of  product  should  be 
distinguished: 

•  Guaranteed funds  in the economic sense, where by the means of  portfolio  management  techniques 
(employment of derivatives etc.) investors should be protected from the volatility of markets; and 

•  Guaranteed  funds  in the legal sense, with  an additional formal  guarantee provided  by an  external 

guarantor (either by the management company or a third party). 

The use of  hedging  or capital  protection  techniques is foreseen  in the UCITS III directive. However, 
the question  exists whether  these guarantee  techniques are properly  disclosed  in the sales  documents. 
The  provision  of  guarantees  in  the  legal  sense  (i.e. providing  an  additional  formal  guarantee  by  the 
management  company)  is  not  explicitly  mentioned  in  the  exhaustive  enumeration  of  services  a 
management  company  is  empowered  to provide. It  needs  to be  considered  that  providing  guarantees 
amounts  to  an  own  financial  service  separate  from  collective  investment  management  with  own 
characteristics  and  gives  rise  to  specific  risk-profile.  Such  an  activity  could  require  safeguards  to 
ensure  that  the management  company  is actually  able to fulfil  its obligations in case the guarantee  is 
called  upon. Where  the  guarantee  is  underwritten  by  the  management  company  any  inability  for  the 
company  to meet its engagement  could  give rise to significant  difficulties  for  investors and  questions 
of unfair  trading as well as misleading information. This could damage the reputation of the sector as a 
whole. Therefore,  appropriate  capital  adequacy  rules  for  the  management  company  may  need  to  be 
considered as a corollary to provision of guarantees. They are not considered by the current  framework 
and  suitable  convergent  methods  need  to  be  found  in  order  to  ensure  an  EU-wide  harmonised 
approach. 

Another  business  opportunity  which  is  occasionally  mentioned  as  an  activity  of  interest  for 
management  companies  is  the  reception  and  transmission  of  client  orders  related  to  other  financial 
instruments.  This  would  enable  management  companies  not  only  to  sell  investment  funds  to  their 
clients,  but  also  other  types  of  financial  products  such  as  transferable  securities  or  money  market 
instruments. This  could  be  interesting  with  respect  to institutional  clients  and  would  possibly  enable 
management companies to complete their range of services. 

45 As far as applicable, cf. point 2.1 

EN 

19 

EN 

In conclusion  of  the first  section, this portrays  a heavily  qualified  picture  of  progress  in  integrating 
European  markets for  UCITS products. The key-objective  of  the European  UCITS-framework  (i.e. to 
facilitate  the circulation of  fund-units  across Europe as a contribution  to a European capital market) is 
being  gradually  achieved.  Actually,  UCITS  is  the  only  retail  financial  product  which  is  subject  to 
substantial  cross  border  trade  in  the  EU.  The  UCITS  model  is  considered  well-established  within 
Europe  and  also  accepted  beyond.  Thus,  many  consider  important  to  maintain  a  so-called  “UCITS 
label”. 

However,  the  cross-border  offer  of  UCITS  is  frequently  hampered  by  administrative  obstacles:  the 
product  rules are sometimes divergently  interpreted  by the different  Member  States; the  management 
company passport has not materialised in practice; the simplified  prospectus has yet to prove its worth 
in helping investors to exercise informed  investment decisions. 

This  underlines  the  need  for  considering  whether  the  product  passport  could  be  improved  from  a 
practical  perspective  and  whether  the  competition  could  be  increased  in  order  to  promote  financial 
innovation  and  product  quality. Finally, delegation  has emerged  as a key-tool  in giving  management 
companies  flexibility  in  organising  their  business; it  has  permitted  the  development  of  cross-border 
out-sourcing  arrangements  under  the  ultimate  responsibility  of  the delegating  management  company. 
This solution  is probably  not  the optimal  one from  an economic point  of  view. What  further  steps, if 
any, are needed to allow management companies to manage a fund  constituted/administered  in another 
Member State? 

2. 

INVESTOR  PROTECTION 

Investor  protection  consists in the prevention  of  misleading, manipulative  and fraudulent  practices. It 
is  also  related  to  the  prevention  of  loss  due  to  malfeasance  or  negligence  on  the  part  of  those  that 
organize  and  operate  funds.  With  respect  to  market  risks,  the  goal  is  not  to  protect  investors  from 
suffering  any  market-driven  loss, but rather  to enable investors  to understand  the risks that pertain  to 
investments  in  a  specific  fund.  However,  to  some  degree,  the  UCITS  directive  attempts  to  limit 
investors’ exposures to excessive losses, for  instance by limiting investment  in derivative  instruments 
or by setting some diversification  requirements. 

In  order  to  limit  investors’  exposures  to  excessive  losses, the  directive  applies  a  formal/quantitative 
approach  rather  than  qualitative  risk  controls.  Nevertheless,  some  first  elements  of  a  risk-based 
approach  touch have been  introduced  in UCITS III directive. The latest  amendments  of  the  Directive 
impose an adequate risk-measurement  process for  UCITS, some basic principles to capture the overall 
risk  of  a  UCITS-portfolio  (market  risk,  counter  party  risk  or  issuer  default  risk). The  Commission 
recommendation on derivatives (2004/383/EEC) aims at specifying  some of these principles within the 
margins  of  the  current  framework  as  a  first  step  towards  the  development  of  a  risk-management 
system for  the area of  fund  management. Indeed, more flexibility  in quantitative terms (leverage of  2, 
use  of  derivatives)  is  accompanied  by  a  high-benchmark  in  qualitative  terms  (sophisticated  risk-
management systems). 

Apart  from  the  basic  investor  protections  inherent  in  the  product/investment  rules,  the  directive 
foresees  investor  protection  safeguards.  Beyond  the  product  approach,  the  investor  protection  from 
losses due to malfeasance  or negligence relies on the oversight of fund  operation by the depositary and 
on disclosure requirements. 

2.1.  Managing  conflicts  of  interests in asset  management 

Conflicts  of  interest  are inherent  in almost  all principal-agent  relationships. The collective  investment 
industry is no exception. The operation of a fund  potentially entails conflicts  of  interest between  those 
invest in the fund  and those who organise and operate it. 

EN 

20 

EN 

Some text-book situations which might give rise to conflicts of interest: 

Personal trading by staff  and investor interests (‘front running’); 
Management companies carrying out business activities whose risk-profile  might be detrimental to 
the fund investors 
Management  company  and  distributors/promoters  relationships:  The  choice  of  funds  that  the 
promoter offers to investors may be influenced by sales commissions (trailer fees, retrocession) paid 
by the management company which may not be disclosed to the investor. Alternatively, the choice 
of funds offered  to the investor might be subject to conflicts of interest if the promoter belongs to a 
parent undertaking which manages funds. 
Management  company  and  depositaries  relationships: Conflicts  of  interest  may also arise  in the 
relationships  between  the management  company  and  the depositaries. Both  must  act  in  the best 
interest  of  the investors. But, how does  the selection  of  depositaries  lead  to potential  issues  for 
independent oversight? 
Management  company  and  broker:  high  levels  of  portfolio  turnover  in  order  to  generate 
transactional  income  for  broker  (‘churning’).  Alternatively,  the  choice  of  broker  might  be 
influenced  by  so-called  “soft  dollar”  arrangements  or  bundling  which  benefit  the  management 
company but where payments in kind are not shared with or disclosed to investors. 
Management  company and placement agent/underwriter  relationships: entities which combine the 
activities  of  fund  management  with  underwriting  of  security  issues  may  be  faced  with  the 
temptation to “stuff” its funds portfolios. 
Etc. 

Conflicts  of  interest may be more pervasive in situations where a number of  functions  or  relationships 
are  internalised  in  a  single  entity  as  is  frequently  the  case  in  the  European  marketplace  where  fund 
management  is,  by  and  large,  undertaken  by  entities  which  are  subsidiaries  of  banking  or  bank-
assurance  groups  (90%  in  continental  Europe,  70%  in  UK).  However,  conflicts  of  interest  are  not 
confined  to companies  tied  to a universal  bank: independent  asset  managers  may  also  be  faced  with 
the need to manage conflicts  of  interest. 

The effective  management  of  conflicts  of  interest  is necessary  to ensure that  the interests of  the  fund 
manager are aligned with those of the investor and to minimize or otherwise address these conflicts of 
interest. 

The UCITS Directive46 provides that each home Member State has to draw up prudential  rules which 
require that each  management  company  is structured  and  organised  in such a way as to minimise  the 
risk  of  UCITS’ or clients’ interests being prejudiced  by conflict  of  interest  between  the company  and 
its clients, between  one of  its clients and another, between  one of  its clients and a UCITS or  between 
two UCITS. According  to the UCITS Directive, each management  company  shall not be permitted  to 
invest  all or  a part  of  the investor’s  portfolio  in units of  units  trusts/common  funds  or  of  investment 
companies it manages, unless it receives prior general approval from  the client. 

However,  conflicts  of  interest  arise  not  only  at  the  level  of  the  management  company.  They  may 
manifest  themselves elsewhere in the distribution chain. 

MiFID  provides  for  a  more  comprehensive  approach  to  the  policing  of  conflicts  of  interest  as  they 
arise  in  investment  firms.  The  approach  of  MiFID  is  that  all  conflicts  of  interest  that  could 
compromise  investor  interests  should  be identified.  Once identified,  structures  should  be put in  place 
to  manage  them. To  the  extent  that  they  cannot  be  managed  in  a  way  that  provides  confidence  that 
investor  interests  are  not  effectively  safeguarded,  the  conflicts  of  interest  shall  be  disclosed  to  the 
client.  MiFID  does  not  envisage  structural  solutions  (apart  from  designation  of  compliance  officer), 
such as ‘unbundling’ of  activities giving rise to conflicts. These requirements will govern conflicts of 

See  art.5(f) 

EN 

21 

EN 

interest  arising  between  different  activities  of  investment  firms  (as defined  in the  MiFID).  However, 
for the time being, the application of these MiFID provisions to UCITS management  companies is not 
foreseen  by the  legal  framework  - even  when  providing  individual  portfolio  management  services  in 
addition to their UCITS management activities47. 

2.2.  Organisational  controls on funds  and their  managers 

Functionally  separate  depositaries  are  one  of  the  pillars  of  the  UCITS  framework.  The  “UCITS  III” 
Directive  has  not  amended  the  applicable  rules  for  the  depositary, which  are  still  based  on  the  1985 
version of  the directive. Moreover, it requires that the depositary be located in the same Member State 
as  the  management  company/fund  thereby  excluding  the  possibility  for  a  UCITS  to  designate  a 
depositary in another Member State. 

From the beginning, the depositary has been entrusted with the double mission of safekeeping  of  funds 
assets and carrying out a certain  number  of  oversight  functions  to ensure that the assets are  managed 
legally  by the management  company  (cf.  Art. 7 and 14 of  the UCITS Directive). This covers  namely 
supervision  of  unit  issuance,  sale,  redemption  and  cancellation,  ensuring  that  instructions  of  the 
management  company  and calculation  of  unit value are carried  out in accordance with fund  rules and 
regulations  (for  contractual  funds  and  unit  trusts),  and  supervision  of  transactions  involving  fund’s 
assets  as  to  delivery  of  consideration  and  application  of  fund’s  income.  Beyond  such  provisions, 
Member States have followed  different  traditions in relation to oversight, sometimes strengthening  the 
role  of  the  depositary,  sometimes  empowering  auditors  or  independent  directors.  However,  we  will 
focus here on the depositary. 

2.2.1.  Depositary  as  custodian  of investor  assets 

The UCITS  Directive  simply  states that  the “unit  trust’s assets must be entrusted  to a depositary  for 
safekeeping”.  The  Directive  does  not  specify  the  contents  of  this  responsibility.  According  to  the 
Vandamme  commentary48,  safekeeping  naturally  encompasses  the  everyday  administration  of  the 
assets  (collection  of  dividends,  interest  payments,  subscription  charges…).  The  Directive  also 
expressly  provides  for  the  possibility  of  “sub-custody”  as  it  mentions  that  “the  depositary’s  liability 
shall  not  be  affected  by  the  fact  that  it  has  entrusted  to  a  third  party  all  or  some  of  the  assets  in  its 
safekeeping”. 

Even  if  it  is  relatively  easy  to  agree  on  the  rather  general  concept  of  “safekeeping”,  the  general 
provisions  of  the  Directive  in  this  respect  have  led  to  various  views  in  Europe:  “bare”  custody 
(safekeeping  +  administration),  surveillance  over  sub-custodians,  segregation  of  assets, more  or  less 
active role as to the administration  of  the assets… and lack of  clarity on liability  and compensation of 
investors. 

This may  imply  safeguarding  not  only  assets and  administering  them, but  also  dealing  actively  with 
the  preservation  of  rights  and  the  delivery  of  obligations  attached  to  assets  held  under  custody 
(shareholders’  rights, tax  returns…).  One  can  mention,  inter  alia,  the  following  examples  from  the 
Member States: 

47 It  should  be noted  that  Article  13 of  MiFID is applicable  to UCITS management  companies  carrying out 
investment services and that this it makes reference to Article 18 (conflicts of interest). 
48  “Toward  a  European market for  the  undertakings  for  collective investment  in  transferable  securities” 
1988Commentary on the provisions of Council Directive 85/611/EEC of 20 December 1985 It should be noted 
that this commentary is not an official  document of the Commission. It is an internal document which was made 
public at the time of the first UCITS Directive, but cannot be considered an official  position of the Commission. 
Thus, from a legal point of view, it is only of an academic and historical interest and shall in no event bind the 
Commission in its interpretation of the provisions of the current "UCITS III" Directive. 

EN 

22 

EN 

• 

Informing  clients  of:  relevant  corporate  actions,  items  needed  for  drawing  up tax  returns,  events 
affecting  the client’s rights in respect of the assets, and execution of trades on behalf of the client. 
Issuing at least a yearly attestation on the number and nature of securities held in custody. 

• 
•  Ensuring  that  assets  of  client  (management  company),  custodian  assets  and  UCITS  assets  are 

segregated with a Central  Securities Depositary. 

•  Performance  of a certain number of quality checks on the clearing & settlement of trades. 

These  additional  roles  imply  usually  additional  organisational  requirements  such  as  information 
processing  systems, accounting procedures and internal controls. 

2.2.2.  Depositaries’  control  over  operation  of  funds 

The UCITS directive  gave depositaries  a key role in ensuring high  standards of investor protection by 
exercising  certain  control  functions  over the  AM  company  and  ensuring  sound  administration  of the 
fund.  The  depositary  exercises  a  range  of  micro-controls  usually  at  the  level  of  the  fund  and  its 
administration  (check trades are compliant with  fund  rules, check valuation, reconcile  orders, monitor 
trade  errors,…). Because  of this essential  role for  investor protection, the  1985 Directive  provided  for 
protection against conflicts  of interest by way of two provisions: (i) impossibility  for a single company 
to act both as management company/ investment company and as depositary and (ii) both management 
company and depositary  shall in any event act in the best interests of the unit/share holders. 

As  explained  above,  Member  States  have  developed  different  approaches  for  oversight,  thus  for 
depositaries  fund  control  tasks.  Following  the  “a  minima” harmonisation  of  the  UCITS  Directive, 
different  depositaries  models have been  developed throughout the  Member  States. In certain  Member 
States, the depositary is thus performing  additional or reinforced  controls. One can take as examples: 

•  Core  role  in  “corporate  life”  of the  fund,  where the  depositary  is to  represent  investors’  interests 
(for  instance  at the  fund’s  creation, but also in case  of change  of investment manager,  mergers  or 
liquidation). 

•  Auditing  of fund’s  portfolio  and  accounting  methods,  approval  of assets  statement,  annual  report 

on the compliance of the fund  management with the applicable rules and regulations. 

•  Whistleblower  role  in  case  of  irregularity  (vis-à-vis  fund  manager,  fund  operator,  auditor  or 

regulator). 

•  Checks on execution prices, on negotiations, on the qualities of the counterparties. 
•  Other additional provisions like, for instance, faculty to introduce actions on behalf of clients. 

Thus, in many countries, the depositary can be compared to a gatekeeper,  i.e. a first line of defence  for 
the  investor.  This is for  instance the  case when  it is entrusted  with  a whistleblower  function.  In  some 
countries, it performs  functions  which in other countries are performed  by auditors, such as auditing of 
portfolio  and  accounting  methods  of  the  fund.  One  could  argue  that  the  day  to  day  relations  of  the 
depositary with the management company give it a unique insight into the functioning  of the fund  and 
the  best  opportunity  to  detect  and  address  anomalies.  On  the  other  hand,  the  development  of  sub-
custody agreements may give less weight to this argument. 

Recently  a  broader  question  has  arisen  as  to  the  coexistence  of  the  two  functions  (safekeeping  + 
control),  which  are  of  different  nature,  within  the  same  entity.  There  are  some  good  arguments  to 
allow  depositary  and  safekeeping  to  be  undertaken  by  the  same  entity.  The  depositary,  especially 
through  its  custody  mission,  is  involved  on  a  daily  basis  into  the  life  of  the  fund.  No  significant 
operation (trading, rebalancing) involving the assets of the fund  can be done without its assent (passive 
or active). This gives the depositary  a unique position to perform  its oversight controls. These  controls 
also occur on day-to-day basis as opposed,  for instance, to the auditor, who only intervenes  ex post. It 
can  be  said  that  this  daily  involvement  in  the  functioning  of  the  fund  provides  the  best  possible 
guarantee for investor protection and explains the relatively low record of high profile  funds  failures  in 
Europe  until  now.  The  development  of  alternative  investment  strategies  (see  part  4. below)  provides 
another good argument: more and more complex strategies can be better supervised if the depositary  -
or some  external  party -  is involved  in the  day to day monitoring  of the assets  controlled  by the  fund 

EN 

23 

EN 

manager. It can  be argued  that  an external  third  party  supervisor  for  such  strategies  (as opposed  to a 
depositary) would be technically more costly and might also entail, for instance, confidentiality  issues. 

However,  one  could  argue  that  the  “control  +  safekeeping”  model  is under  more  and  more  pressure 
due  to  market  trends.  The  emergence  of  global  players  providing  custody  services  has  lead  to  a 
concentration in the custody. Confronted  with increased competition (more pressure on prices from  the 
fund  managers, notably  due to bear  markets) and  investments  (notably  in the field  of  IT), custodians 
have indeed opted for  a race to size. The domination by “global custodians” is more and more evident 
(large investment banks, securities houses and trust companies). American custodians are expanding in 
Europe: in 2004 alone, Deustche Bank custody business was purchased by Citigroup, ABN AMRO by 
State  Street  and  ING  Barings  by  Northern  Trust.  Current  league  table  for  global  custodians  is  as 
follows (Source: www.globalcustody.net, January 2005): 

Ranking 

Provider 

Nationality  Worldwide assets ($ Bn) 

1 

2 

3 

4 

5 

6 

7 

8 

9 

State Street 

Bank of New York 

JP Morgan 

Citigroup 

BNP Paribas securities services 

Mellon Group 

UBS AG 

Northern Trust 

HSBC 

10 

Société Générale 

US 

US 

US 

US 

F 

US 

CH 

US 

UK 

F 

9,100 

8,906 

8,014 

6,640 

2,958 

2,946 

2,436 

2,400 

1,572 

1,352 

Concentration of  players can be first  seen as a chance for asset managers as economic of  scale savings 
should deliver lower costs. It could also be seen as a risk for competition – and, so, for the reduction of 
prices - as strategic barriers to entry will develop. However, some argue that there will always be room 
for  “niche”  custodians  who will be able to deliver  a more tailored  approach, better  expertise  on  high 
added  value  services  or  a  more  individualized  customer  relationship.  Moreover,  there  has  been  a 
recent  trend  among  asset  managers  for  solutions  involving  outsourcing49  of  activities  to  different 
service providers rather than the use of  one single outsourcer, which shows the limits of  the “custody 
+” model, as outsourcing to one single contractor might be seen as a risk in itself  for fund  managers. 

Finally,  it  should  be  noted  that  the role of  the  custodian  in  addressing  operational  risks is  extremely 
broad.  Studies50  carried  out  on  the  most  significant  or  probable  operational  risks  within  asset 
management  occupations  reveal  that  the main  operational  risks to which  management  companies  are 
exposed  can  be  limited  or  hedged  by  the  custodian,  with  the  notable  exception  of  misleading  the 
investor,  which  can  be  subject  to  consistency  control  or  warning  procedures  implemented  by  the 
broker. The surveyed firms’ perception is the following (Source: Oxera 2001 and Edhec 2003): 

49 In the 2001 OXERA survey, firms were asked to provide information on the proportion of clients’ assets that 
were held by custodians outside the firm’s  group. The mean percentage of  clients’ assets held by non-group 
custodians was 63%. The median percentage was 85.5%. 
50 « Edhec European Asset Management Practices Survey » 2003 EDHEC-RISK and OXERA survey 2001 

EN 

24 

EN 

leading operational risks in terms of the amount of potential losses 

Risks 

Breach of client guidelines 

Misdealing 

Unit trust mis-pricing 

Risks from new business (manager  transition) 

Possible mitigation by custodians 

Strong 

Weak 

Medium 

Strong 

Medium 

Fraud 

Risks 

Breach of client guidelines 

Misdealing 

Settlement  problems 

Unit trust mis-pricing 

Failure to reconcile assets 

leading operational risks in terms of  frequency 

Possible mitigation by custodians 

Strong 

Weak 

Strong 

Medium 

Strong 

2.3.  Regulation of sales process 

2.3.1.  General disclosure  requirements 

According  to  the  UCITS  directive  the  following  disclosure  requirements  have  to  be  observed: 
Simplified  prospectus,  full  prospectus,  financial  reports  (annual  and  half-yearly)  and  the  fund 
rules/instruments of  incorporation. 

The Directive  requires that the simplified  prospectus be offered  to investors free  of  charge before  the 
conclusion of the contract. The full  prospectus and the annual and half-yearly  reports shall be supplied 
to investors on request. The fund  rules or instruments of  incorporation  shall also be made available to 
investors (either as an integral part of the full  prospects or by informing  investors that they may obtain 
this information  on request). 

One  of  the  key-requirements  for  cross-border  distribution  according  to  the  amended  Directive  is  the 
simplified  prospectus.  The  requirements  for  the  simplified  prospectus  have  been  specified  by  the 
Recommendation  on the simplified  prospectus51 which has only recently entered into force. Thus, it is 
too early to assess its application. The report to be produced by CESR (see below) on this will provide 
a  good  basis for  that  assessment. Some concerns  expressed  that  some Member-States  implemented  it 
in a demanding way resulting in the inclusion of too much information  not relevant to investor. 

51 

2004/384/EC of 27th April 2004. 

EN 

25 

EN 

2.3.2.  Disclosure of fees and commissions 

An investor considering investing in funds  may be faced  with a wide array of  fees and charges. These 
include  not  only  management  fees  and  administration  charges  but  also  entrance  and  exit  fees, 
(possibly)  success/performance  fees  and  load  fees. In addition, the investor  may  ultimately  be  forced 
to foot  the bill for  hidden  costs in the management, trade-execution  and  distribution  chain. There are 
features  of  the remuneration  process for  management  companies and promoters which may amount  to 
higher  aggregate charges for  investors. This is notably  the case for  bundling, soft  commissions  at the 
level of brokerage services, and retrocession fees at the distribution end. 

A proscriptive approach to some of  these issues has been considered  by some regulators. However, in 
general,  it  has  been  preferred  to  place52  the  emphasis  on  disclosure  of  fees  and  commissions.  A 
disclosure-based  approach  may  be  particularly  appropriate  in  a  European  context  where  business 
models  and  distribution  architectures  are  beginning  to  open  up.  Interfering  with  management 
companies  revenue or incentive structures could  prevent  them from  developing  certain  market  access 
strategies. It also does not give sufficient  credit to investors who are becoming more aware of the costs 
and  charges associated  with  investing  in funds.  As investor  familiarity  with  these products  develops, 
management  companies  which  fail  to  provide  for  sufficient  fee  disclosure  may  find  themselves 
punished by investors voting with their  feet. 

Improved  transparency  -  in  particular,  as  regards  of  costs  and  fees  -  is  a  key  issue  which  must  be 
addressed  to maintain  investors’ confidence. Provisions  to this aim have been  included  in the  UCITS 
Directive  and  the  Recommendation  on  the  Simplified  Prospectus.  For  instance,  the  Prospectus  for 
UCITS  has  to  include  information  on  the  remuneration  payable  to  third  parties53. The  Commission 
Recommendation on the Simplified  Prospectus has sought to promote a composite measure of fees and 
charges.  Therefore,  based  on  IOSCO  standards,  the  total  expense  ratio  should  be  disclosed. 
Furthermore,  it  is  recommended  to  disclose  the  portfolio  turnover  rate, the  existence  of  fee-sharing 
agreements  and  soft-commissions  as  well  as  the  transactions  costs  when  they  are  deemed  to  be 
available. The Recommendation  also contains elements for the presentation of  past-performance. 

Nevertheless  the  question  of  to  what  extent  is  the  Recommendation  put  into  practice  remains. 
Additionally,  are  TER  figures  really  comparable  across  funds  and  countries?  Are  all  the  relevant 
charges  visible  to the investors?  Could  a clearer  break-down  of  fees  help to promote  investor-driven 
competition  between  different  players  in  the  distribution  process?  Hence, at  the  end  of  2004, CESR 
circulated  a  questionnaire  on  the  Recommendation.  Almost  all  of  the  supervisory  authorities  have 
responded. CESR will now analyse to what extent national authorities have given effect  to the UCITS 
Recommendations before reporting to the ESC in the course of this spring. 

Some  industry  initiatives  have  also  tried  to  address  potential  issues  that  may  undermine  investor’s 
protection.  In  many  Member  States,  the  industry  has  established  codes  of  conduct  which  include 
standards  for  the distribution  of  funds.  These  codes  of  conduct  may  complement  or  sometimes  even 
make  up  for  legislative  measures.  They  may  sometimes  specify  general  distribution  or  advice 
requirements  for  investment  funds.  However,  two  questions  remain:  1)  to  which  extent  are  these 
codes/self-regulations  respected? 2) What  is their  enforceability  (national authorities’ competence) in 
case of non compliance? 

52 Cf. Winter  report. 
53 1.18  “Information  concerning the manner, amount and calculation of remuneration payable by the unit trust to 
the management company, the depositary or third parties …”, Annex I, Schedule A 

EN 

26 

EN 

2.3.3.  Legal  uncertainties 

in  UCITS  distribution 

framework 

The  most  relevant  sets  of  rules  applicable  to  UCITS-distribution  are  the  UCITS-Directive  and  the 
MiFID54.  The  UCITS-Directive  primarily  focuses  on  the  public  marketing  of  UCITS,  i.e.  the 
placement  of the  product  on  the  market  and  on  disclosure  requirements  relevant  for  this  marketing. 
The MiFID governs cases where the  distribution  of collective  investment  schemes  or the provision  of 
advice  is undertaken  by an investment firm. The possibility  given to  Member  States by the  MiFID to 
exempt the reception/transmission  of orders and the advice exclusively related to collective  investment 
undertakings  from  the  obligations  of  the  Directive  creates,  however,  some  uncertainty.  In  addition, 
even  if UCITS-Directive  and  MiFID  are  closely  interconnected  with  respect to the  sales process, the 
concrete  implications  of this relationship  are not always easy to  determine: Which  documents have to 
be provided in case UCITS are distributed by an investment firm? What is the relationship between the 
“public  marketing”  referred  to  in  the  UCITS-Directive  and  the  distribution  activities  addressed  by 
MiFID? Which  rules  apply  in case  a management  company  wishes to  sell third-party  funds  (as far  as 
permissible)?  These  issues  beg  the  question  of the  need  of  clarification  on  the  interactions  between 
both directives. 

•  UCITS-Directive:  harmonisation  of the public  marketing  of  UCITS 

The  UCITS-Directive  focuses  on  the  public  marketing  of  UCITS:  in  this  respect,  the  Directive 
provides the  legal basis  for the  right of the  UCITS to be marketed  (i.e. to be placed  on the market) to 
the  public  in  its  Home  Member  State  (on  the  basis  of  its  Home  Member  State  authorisation)  and  in 
other  Member  States  of  the  EU  through  the  introduction  of  the  product  passport  and  the  related 
notification  procedure.  The  Directive  clearly  focuses  on  the  establishment  of  these  rights.  The 
disclosure  requirements  previously  mentioned  are  part  of this  process.  For  instance,  the  full  and  the 
simplified  prospectus  have  to  be  submitted  to the  Host  Member  State  authority  in  order to  complete 
successfully  the notification  procedure. 

The  rules  on the  sales documents  and the  related  disclosure  requirements  of the  UCITS-Directive  are 
also relevant for the promotion for sale of UCITS to individual investors themselves. For instance, any 
potential  subscriber of a UCITS needs to be offered  the  simplified  prospectus before the conclusion of 
the  contract.  This  document  shall  enable  investors  to  make  an  informed  judgement  of the  envisaged 
investment and the risks attached thereto. 

With  respect  to  the  efficiency  of  these  instruments  it  should  be  noted,  that  for  none  of  these  sales 
documents  the  Directive  requires  compulsory  delivery.  The  Simplified  Prospectus  is  the  only 
document  which  shall  be  offered  to  the  investor.  However,  even  in  this  respect,  the  Directive  is 
content with  a mere  offer  and  does not require  “hand” delivery.  The other documents have  only to be 
supplied on request. 

It  should  further  be  noted  that  the  addressees  of  the  obligations  to  offer  or  to  supply  the  sales 
documents  are  not  explicitly  mentioned.  There  are  certainly  strong  reasons  to  believe  that  any 
potential  fund  distributor  should  be  obliged  to  fulfil  these  obligations.  However,  the  drafting  of  the 
Directive  may  cause  some  uncertainty  as  regards  the  concrete  circle  of  addressees  of  these 
requirements. 

There  are  no  rules  in the  Directive  specifically  dedicated  to the  question  of how  the  sales process  of 
UCITS is organised  (i.e. the way  in which manager, promoter and adviser interface  with the  potential 
end investor), how advice related to funds  should be delivered or regarding suitable fund  promoters. 

54 The distribution  of  investment  funds  via Internet and the related legal framework  (e-commerce Directive etc.) 
will be addressed under point 3.2.2. 

EN 

27 

EN 

•  Advertisement  rules under UCITS  directive 

The  UCITS-Directive  harmonises  the  public  marketing  of  UCITS.  However,  it  has  refrained  from 
harmonising the  rules for the advertising  of UCITS. The advertising  rules are therefore  under national 
instance  concern  rules  on  promotion  or  misleading 
discretion.  Rules  on  advertisement  for 
advertisement  (rules on unfair  competition).  Some Member  States require an advance approval  for the 
advertising  material  or  establish  restrictions  as  regards  the  entities  which  are  entitled  to  carry  out 
advertisement. However, it should be noted that there are a number of developments which might lead 
to a further  harmonisation  of the advertisement  of funds:  For instance, it needs to be clarified  to what 
extent  MiFID  and  initiatives  such  as  the  Directive  on  unfair  business  to  consumer  commercial 
practices which is to be formally  adopted in June 2005 will lead to further  harmonisation. With respect 
to MiFID this will also depend on the final content of the Level 2 measures implementing  MiFID. The 
outcome of this process needs therefore  to be awaited. 

•  MIFID  rules 

The  execution  of  orders  or  provision  of  advice  in  respect  of  UCITS  to  individual  investors  as  a 
financial  activity  is  an  investment  service  subject  to  the  rules  of  the  MiFID.  The  reception  and 
transmission  of  orders  and  the  advice  related  to  other  collective  investment  undertakings  (real  estate 
funds,  hedge  funds  or private equity  funds)  also constitutes  an investment  service. In principle, all the 
rules  applicable  to  investment  firms  should  therefore  be  applied  to  fund  intermediaries/investment 
firms  involved  in  the  offer,  provision  of  advice  in  respect  of  collective  investment  schemes.  This 
includes  provisions  on  authorisation,  supervision,  requirements  for  the  internal  structure  and  the 
management  of  conflicts  of interest,  client  reporting  etc. Thus,  even  if  MiFID  does  not  contain  rules 
specifically  dedicated to the  distribution  of fund  units  it aims at ensuring that the  distribution  of  fund 
units  is  subject  to  the  same  quality  standards  than  the  distribution  of  other  financial  instruments. 
Whether these  rules of the MiFID  also apply to management  companies  distributing  third party  funds 
(as far as permissible, see point  1.2.3) might be subject to further  clarification. 

It  should  be  noted  that  the  Directive  grants  Member  States  the  option  of  exempting  the  business  of 
reception  and  transmission  of  orders  and  advice  exclusively  related  to  collective  investment 
undertakings  from  the  obligations  of  the  Directive.  In  these  cases,  the  Member  States  have 
nevertheless  to  ensure  that  the  activities  of  the  entities  carrying  out  these  investment  services  in 
relation to collective investment  schemes are regulated on a national level. The minimum  requirements 
are thus established at national level. 

Accordingly,  the  duties  set  out  by  the  MiFID  will  apply  to  those  distributors  and  advisors  which 
provide  their  services  not  only  in  relation  to  funds  but  also  in  relation  to  funds  in  combination  with 
other  financial  products.  For  reception/transmission  of  orders  and  advice  in  respect  of  collective 
investment  schemes,  it  will  depend  on  whether  Member-State  exercises  its  option  to  exclude  these 
services. 

With  respect  to  UCITS,  the  Directive  contains  a  further  derogation:  in  case  of  the  reception  and 
transmission  of  orders  related  to  non-complex  financial  products,  the  Directive  allows  that  the 
investment  service  is  provided  on  an  execution-only  basis,  i.e.  there  is  no  need  to  undertake  a 
comprehensive  test  of  whether  the  envisaged  product  is  appropriate  for  the  client.  UCITS  are 
explicitly  mentioned  in  this  context.  However,  UCITS  products  can  rather  diverge  as  regards  their 
complexity  and  their  risks  (for  instance,  plain-vanilla  products,  more  sophisticated  products  using 
leverage through derivatives etc.). This might beg the question of whether there is a need to consider a 
more  differentiated  approach  to these  investment  services  related  to  UCITS. In  addition, there  might 
also  be  a need to  clarify  the  application  of the  execution-only  rule  to  non-harmonised  funds  such  as 
real-estate funds, hedge funds  or private equity  funds. 

EN 

28 

EN 

2.4.  Investor confidence 

In  2002,  the  Basel  Committee’s  quantitative  study  pointed  out  that  internal  fraud  events  in  asset 
management  business  were less than  1% of  internal  fraud  events in financial  services. Two  OXERA 
studies55 show  that  fraud  is one of  the least  frequent  risks in the industry  ranking. However, fraud  is 
the fifth  risk in the ranking of potential impact in terms of loss. 

A Bank of  New-York  study56 reveals that 60% of  the financial  firms  surveyed  reported  that the  level 
of  client’s trust  had  deteriorated  over  the  past  10  years. Overall  44% of  participants  believe  that  the 
mutual fund  industry has lost business over the last five years directly as a result of lack of trust. Mis-
selling is believed to be an important factor  having damaged trust by 65% of  contributors, where only 
37%  think  late  trading  is  an  important  factor.  Hedge  funds  are  identified  as  an  area  of  particular 
concern  by  over  50%  of  respondents. Long  only  mutual  funds  are  viewed  as  an  unlikely  source  of 
problems with just 5% of  respondents expressing concerns. Investors are not reporting increased cases 
of fraud  in asset management business. 

The  UK  financial  ombudsman  report  shows  that  complaints  in  the  area  of  portfolio  and  fund 
management  decreased  to  921  in  March  2004  from  1,044  in  March  2003.  In  France,  the  AMF 
mediateur noted an increase in complaints on collective investment schemes, mainly due to complaints 
about  guaranteed  funds.  These  figures  are,  of  course,  not  representative  of  the  EU-market. 
Unfortunately, data on fraud  in asset management on a European basis are not readily available. 

An explanatory factor  may be that industry does not want to incur “reputational  risk”. In case of  fraud, 
the AM companies or banking group to which the former  belong may prefer  to compensate  customers 
from their own assets via out-of-court  settlements. 

Market  timing57  and  late  trading58  have  been  found  to  be  relatively  rare  practices  in  EU.  CESR 
members  conducted  extensive  investigations  to assess  whether  these  mis-practices  were  prevalent  in 
Europe’s investment fund  industry, following  the US regulatory  authorities’ findings  in autumn  2003, 
in which they found  evidence of  abusive practices in the US mutual fund  market. In November 2004, 
CESR reported  that abusive business practises which exploit the mutual funds  for  the benefit  of  some 
privileged  investors  (such  as  late  trading  or  market  timing)  are  rare  in  Europe.  Nevertheless,  a  key 
finding  of  the  investigation  was  that  internal  processes  of  the  management  companies  should  be 
improved as this may be a source of potential weakness in the future  which could lead to cases of mis-
practices developing. Finally, some Member-State  authorities have undertaken  national  investigations 
resulting in changes to regulatory/supervisory  practices. 

55 “Risks and Regulation in European Asset Management: Is There a Role for Capital Requirements?” OXERA, 
in conjunction with Professors Julian Franks (London Business School) and Colin Mayer (University of Oxford) 
January  2001 and  Description  and  assessment  of  the  national  investor  compensation  schemes  established  in 
accordance with Directive 97/9/EC, January 2005 based on BIAIS and alia (2003), ‘Operational  Risk and Capital 
Requirements in the European Investment Fund Industry’, a report prepared for the FEFSI 
56 “Restoring broken trust” Bank of New York survey. July 2004 
57 Market  timing refers  to practises  where investors place trades (subscription  or redemption  orders) for  unit 
prices determined  with  stale  prices of  the funds  assets which  do not  fully  reflect  recent  market movements. 
Inefficiencies  in  investment  fund  pricing  are  exploited  by  the  practise  of  short  term  buying  and  selling of 
investment fund units. Market timers can use the information about market movements which are not reflected in 
the previous unit price to predict the movement of the following day’s price to advantageously buy or sell units. 
58  Late  trading  can  be  described  to  be  a  practise  where  the  fund  manager  accepts  to  receive  and  carry  out 
subscription  or  redemption  orders  from  certain  investors  after  the  deadline  set  for  these  transactions  in  the 
regulations  of  the  jurisdiction  in  question  or  in  the  fund  rules.  This  gives  them  the  opportunity  to  utilize 
information received after the fund is closed and that has an influence on the market. 

EN 

29 

EN 

It  should  be  noted  that  some  EU-countries59  have  set  up  investor  compensation  schemes  in  case  of 
asset losses, despite the fact  that the 1997 investor compensation  schemes Directive does not apply to 
collective asset  management. These schemes  protect  investors’ monies and  securities  against  the risk 
of theft, embezzlement, other forms  of  fraudulent  misappropriation  or the loss of  investor assets in the 
event  of  firm  default  resulting  from  negligence  or  breakdowns  in  the  firms’  systems  and  controls. 
However,  there  are  a  range  of  risks  that  do  not  qualify  for  compensation  cover,  at  least  in  some 
Member  States, or where compensation  is not certain (e.g. bad advices, third-party  default  no leading 
to the AM company default,  poor investment  management, etc…). This raises the question of  whether 
ex-post compensation of investors’ losses should be improved in EU in the field of AM. 

In  conclusion  of  the  second  section,  the  figures  show  that  asset  management  sector  is  so  far  less 
affected  by  fraudulent  activities  than  other  sectors.  This  does  not  amount  to  consider  that  AM  is 
exempt of fraud, conflicts of interest or  dysfunctions. 

The  UCITS  investor  protection  framework  would  thus  appear  quite  complete  and  well  adapted. 
Nevertheless,  considering  the  paramount  importance  of  investor  confidence,  investor  protection 
remains  a  permanent  regulatory  concern.  In  order  to  maintain  continued  confidence  in  the  asset 
management  industry,  there  will  be  a  need  for  unwavering  commitment  to  effective  controls  which 
ensure that decisions taken by fund  managers are motivated  only by the interests of  the investor. The 
crux  of  the  issue  will  probably  be  to  ensure  the  effective  management  of  conflicts  of  interest  which 
might  affect  decisions  taken  by  management  companies  and/or  promoters  and  an  effective  and 
independent oversight on fund  operation. 

A second area for consideration concerns the fair  disclosure to investors of fees and charges relating to 
investments  in  funds.  The  Recommendation  on  the  simplified  prospectus  advocated  that  Member 
States provide for  clear disclosure of  all relevant costs, charges and soft  commissions to investors. An 
assessment  of  the functioning  of  simplified  prospectus could consider whether regulatory principles to 
avoid investor abuse are sufficiently  clear in terms of substance and addressee. 

The  sales  process  of  UCITS  is  mainly  governed  by  the  UCITS-Directive  and  MiFID.  UCITS 
provisions  focus  on  the  sales  documents  and  related  disclosure  requirements.  MiFID  governs  cases 
where the distribution of collective investment  schemes or the provision of  advice is undertaken by an 
investment  firm.  The  possibility  given  to  Member  States  by  the  Directive  to  exempt  the 
reception/transmission  of  orders  and  the  advice  exclusively  related  to  collective  investment 
undertakings  from  the  obligations  of  the  Directive  creates,  however,  some  uncertainty.  In  addition, 
even  if  UCITS-Directive  and  MiFID are closely  interconnected  with  respect  to the sales process, the 
concrete implications of  this relationship  are not always easy  to determine. This begs the question of 
the need to clarify  the interactions between both the directives. 

3.  CHANGING  FEATURES OF EU  FUND  INDUSTRY 

This section will consider three broad sets of issues: 

needs in AM industry for more single market  freedoms; 
new  distribution  patterns leading  to new  risks and  to needs for  legal  certainty  related  to new 
EU-texts; 
and changing risk patterns which are emerging in AM business. 

For instance, Sweden and Denmark 

EN 

30 

EN 

3.1.  Additional single market  freedoms? 

3.1.1.  Greater freedom of choice of depositary? 

The  UCITS  Directive  requires  that  the  depositary  be  established  in  the  same  Member  State  as  the 
management  company  of  a  contractual  fund  or  of  the  UCITS  itself  in  the  case  of  an  investment 
company. This restriction was originally justified  by two considerations: due to the very close relation 
between the depositary and the management  company/ investment  company, it was considered  logical 
that  the  same  competent  authority  be  in  charge  of  authorizing  and  supervising  both  entities  and, 
accordingly, that the two entities be in the same location. 

However, more and more players, including industry and national authorities are promoting the idea of 
freedom  of  choice  of  depositaries  for  European  management  companies.  This  could  increase 
competition on a fragmented  market and lower costs for the investors. Thus, the AMWG report evokes 
the  question  of  whether  the  depositaries  should  have  passporting  rights, i.e. be  able  to  provide  their 
services  on  a  cross-border  basis,  or,  alternatively,  to  promote  greater  freedom  of  choice  of 
depositaries. It is argued that the current fragmented  state of  the depositary market throughout  Europe 
entails increased costs for  management  companies and for  investors and impairs the development  of a 
pan-European  investment  fund  business. The possibility  to be  able to choose  one’s  depositary  cross-
border is also perceived by the industry as an additional flexibility  in the way management  companies 
organise  their  activity.  Many  respondents  to  the  public  consultation  which  took  place  following  the 
release of the AMWG report showed a consensus on the merits of such a passport. 

However, due to the current discrepancies in national regulations, supporters of this idea usually agree 
on the prior need to better define  the role, the missions and the liability  of  the depositary  at European 
level.  Indeed,  the  rules  of  the  UCITS  I  Directive  have  left  ample  room  for  discrepancies  in  the 
depositaries  regimes  from  one  Member  State  to  the  other.  There  is, for  instance,  a  great  variety  of 
institutions  performing  this  role  (credit  institutions,  investment  firms,  central  banks,  insurance 
undertaking, “other  regulated  legal persons”…), even if  credit institutions have a leading share of  the 
market.  The  AMWG  report  and  the  Commission  communication  on  depositaries  both  insist  on  the 
prior  need  for  convergence  on prevention  of  conflict  of  interest, control duties and liabilities. IOSCO 
has  launched  a  work  to  analyse  risks  associated  with  AM  functions  and  examine  the  possible  risk 
control  solutions  which  might  be  appropriated.  A recent  IOSCO  report60  describes  oversight  of  fund 
managers in the different  jurisdictions. It stresses that the independent  entities responsible for  such an 
oversight  should  be  empowered  with  sufficient  tools  to  exercise  its  functions  in  an  effective 
independent  manner.  This  debate  thus  leads  to  questions  without  “off  the  shelves”  answers. 
Furthermore, depositary  is often  some kind of  “pre”-supervisor  in its oversight  functions  and it might 
be difficult  to passport these oversight  functions. 

3.1.2.  Cross-border  mergers  and  pooling 

techniques 

The number  of  funds  in Europe  is relatively  high. It is some three times  higher  than  in the  US for  a 
market  size  which  is  about  the  half  of  the  US  one. Consequently,  it  is  considered  that  the  average 
European  fund  size is sub-optimal. This would  impede fund  managers and administrators  to properly 
benefit  from  lower  costs  derived  from  economies  of  scale.  It  is  also  argued  that  a  greater  fund 
rationalisation within the EU would considerably reduce fund  management and administration costs. 

The  reasons  for  this  proliferation  of  funds  are  varied.  Often,  the  creation  of  new  funds  responds  to 
cultural  preferences  or  marketing  reasons (“new  is better”). Sometimes, it  is just  due to the desire of 
asset  managers  (in particular  those belonging  to banking groups) to enlarge  their offer  of  products to 

60  “Examination  of  governance  for  collective  investment  schemes”,  Report  of  the  Technical  Committee  of 
IOSCO, February 2005 

EN 

31 

EN 

clients. Image  concerns  may  lead to  a situation  where  a bank  resulting  from  the  merger with  another 
one maintains the range of products offered  by each of them. 

There  are many  obstacles to merging  investment  funds  on a cross-border basis. Most  of the  obstacles 
are  of  fiscal61  or  regulatory62  nature.  The  obstacles  to  asset  pooling  and  cross-border  fund  mergers 
were highlighted by the AMWG as important barriers hindering the efficient  functioning  of the market 
for  investment  funds  and  preventing  the  industry  from  reaping  economies  of  scale  that  could  drive 
costs down. 

•  Cross-border  fund  mergers 

The UCITS-Directive  itself is silent on the  conditions under which funds  could be merged  on a cross-
border basis. It contains rules for the replacement of the management company and the depositary of a 
fund  (approval  of  the  competent  authority);  however  it  does  not  explicitly  mention  the  issue  of 
mergers of either domestic funds  or of funds  with different  nationalities. Even if cross-border mergers 
are  not  explicitly  excluded,  the  Directive  does  not  seem  to  put  in  place  the  necessary  safeguards  to 
carry  out  such type  of operation  and to  address  issues  related to moving  a fund  from  a jurisdiction  to 
another. This has, however, not prevented individual instances of cross-border merger. 

According  to  some  industry  research63  there  is  a  potential  for  annual  savings  through  cross-border 
fund  mergers ranging between  5 and  15 basis-points (i.e. between € 3.1 billion and €  8.6 billion for the 
whole  European  industry).  Increasing  the  size  of  funds  by  the  means  of  mergers  would  allow 
benefiting  from  economies  of  scale  which  should  also  lead  to  a  lower  average  TER.  This  cost-
reduction  would  be  beneficial  to  investors  provided  that  these  potential  advantages  are  passed  on  to 
them. 

Managers experience  cost/economic obstacles. According to them64, fund  mergers can be an expensive 
and  time-consuming  project.  Regarding  consumer  behaviour,  there  is  the  danger  that  investors  will 
pull  their  money  out  of  the  fund  which  should  be  merged.  Furthermore,  a  merger  is  costly  and 
demanding  in terms  of the  associated technical processes  related to transfers  and  custodian/depositary 
services.  However,  it  seems  that  according  to  industry  experience  these  issues  are  not  critical.  If  a 
merger is well prepared and communicated to investors, there should be less risk of withdrawals. 

Fund  mergers  face  also  tax  hurdles65  and  some  regulatory  obstacles.  For  instance,  many  Member 
States apply a rather strict66 approach in case the fund to be merged is under their jurisdiction  and is to 
be transferred  to another Member  State. Heterogeneity  of institutions  acting as depositary  and the lack 
of  convergence  regarding  their  operation  conditions  might  also  have  a  negative  impact  on  the 
possibilities to merge UCITS  cross-border. 

61 The  most  common  example  for  a  fiscal  one  is  the  fact  that  some  EU-countries  consider  fund  mergers  as  a 
taxable event. 
62 An example for a regulatory one is the requirement that a change of nationality (of  a corporate fund)  supposes 
unanimous shareholder  approval. 
63  “Building  of  an  integrated  European  Fund  Management:  cross  border  merger  of  funds,  a  quick  win?”, 
INVESCO, January 2005 
64 “Towards  a single market in asset management” (Heinemann-report), ZEW, May 2003. 
65 Member States apply varying approaches to the question of whether a merger of two funds with a similar asset 
structure qualifies  as a taxable event, for instance whether it is considered as a realisation of  capital gains. In this 
respect,  many  Member  States  discriminate  cross-border  mergers; whereas  mergers  of  domestic  UCITS are  tax 
free, a tax charge at the investor level occurs for mergers between a domestic and a foreign  fund. 
66 For instance, some Member States require 100% consent of the investors holding the fund  to be merged which 
is practically impossible to achieve. 

EN 

32 

EN 

Fund  mergers  may  not  be  the  magic  potion  that  their  advocates  suggest.  Although  domestic  fund 
mergers  are  certainly  much  easier  to  carry  out,  it  seems  that  they  have  not  yet  brought  a  greater 
rationalisation  of  the  local  markets.  Apparently,  local  companies  do  not  make  frequent  use  of  the 
possibility  to  merge  funds  even  if  provided  for  by  local  legislation.  The  reasons  for  this  might  be 
rather  complex  and  certainly  deserve  further  exploration.  The  question  of whether the  costs  and  the 
time needed to organise a merger constitute one of the reasons should also be considered. 

•  Cross-border  pooling  techniques67 

Pooling  is  the  technique  by  which  several  investment  funds  or  sub-funds  of  an  umbrella  fund  pool 
their assets. It enables participating  funds to invest through one or several pools, the objective  being to 
benefit  as  if  invested  directly  in  the  portfolio  of  pooled  assets.  In  case  of  cross-border  pooling  the 
participating  funds  are  established  in  different  jurisdictions.  There  are  two  different  ways  in  which 
pooling  can  be  achieved:  “virtual  cross-border  pooling68”  and  “entity  pooling69”  (or  master-feeder” 
funds).  Certain  IT-based  “virtual”  pooling  techniques  are not per  se  excluded  by the  current UCITS-
framework. 

However, there are de facto,  a number of obstacles to these techniques: 

•  Taxation  barriers:  entity  pooling  is  confronted  with  specific  problems  regarding  withholding 
tax.  These  issue  can  be  resolved  if  a pool  is  considered  transparent  for  taxation  purpose.  As 
each  country  uses  different  criteria to  determine  whether  an  entity  is transparent  or not,  it is 
difficult  to create a structure which is considered transparent by all Member States. 

•  Different  accounting regimes. 
•  Custodial arrangements: requirement that the custodian needs to be domiciled or established in 

the same jurisdiction than the investment  fund. 

•  No  harmonised  approach  to  master-feeder-structures:  entity  pooling  and  master  feeder 
structures  are  particularly  difficult  to  establish  because  they  are  not  recognised  under  the 
current UCITS regime70. 

•  Barriers  resulting  from  reluctances  from  supervisors  in  relation  to  operational  risks,  spam  of 

control, and split of nationality71 between the pool and the participating  funds. 

Noting that a more  suitable framework  for pooling techniques  is not insurmountable  task, the  industry 
advocates that pooling techniques should be promoted. 

See  in  annex  A  the  description  of  these  two  techniques,  their  potential  advantages  and  the  risks 
resulting  therefrom. 

67 Cf. also “Pooling”, Report IMA December 2004 (draft version only!) 
68 At present, virtual pooling between sub-funds  of  an umbrella  fund  is common in Luxembourg, but also in 
most other Member States. Pooling of single entity funds has proven to be more difficult, particularly on a cross-
border basis. 
69 Entity pooling for investment funds in Europe is still uncommon; in particular master-feeder-structures  are not 
permitted under the UCITS-Directive. There are some Member States which permit master feeder  funds on the 
domestic level (e.g. France, Spain and Luxembourg). In contrast, entity pooling is already common in the area of 
pension funds  mainly due to tax reasons. Some Member States like Luxembourg and Ireland have introduced 
specific vehicles for this purpose. 
70  The  UCITS-Directive  does  not  allow  funds  which  are  exclusively  invested  in  the  units  of  another  fund. 
Therefore, even if the master-fund  is compliant with the UCITS regime, the feeder funds are deprived from the 
passport. 
71 The master fund  which determines the investment policy of the overall structure is located in Member State 
other  than  that  of  the  feeder  funds.  Hence,  the  authorities  which  are  responsible  for  the  authorisation  and 
supervision of the feeder funds are not empowered to monitor directly the investment policy of the feeder funds. 

EN 

33 

EN 

3.2.  New  distribution  pattern 

3.2.1.  Changing  conflicts  of  interest? 

•  Conflicts  of interest in integrated  architecture 

In  the  integrated  architecture,  which  is  still  dominant  in  many  European  countries  (particularly  in 
continental Europe), banks and insurance companies distribute  only in-house products. In other words, 
investors  are  being  offered  funds  designed  and  managed  by  the  AM  company  belonging  to  the 
banking  or insurance  group that  distributes them.  This  raises the  question  of whether  such  integrated 
distributors advise investors on the basis of the group’s interests or the investor’s own interest.  On the 
other  hand,  commercial  banks,  as  well  as  insurance  companies  distributing  in  house  products 
emphasise  their  eagerness  to  protect  the  house-reputation  (reputational  risk)  and  their  good 
awareness/knowledge  of client situation and needs. 

•  New  conflicts  of interest  in fund  distribution 

Integrated  architecture  is  losing  ground  to  “open  architecture”  whereby  two  new  kinds  of  actors 
distribute  funds:  more  or  less  independent  (not  capitally  linked)  advisory  marketing  structures72  and 
individual  financial  advisors73,  which  are  generally  not  tied  to  a  particular  product  provider.  Both 
categories  act  on  behalf  of  the  investors  and  advise  them  on  the  most  suitable  product.  Open 
architecture  represents  a  broader  offer  for  investors  who  can  really  access  to  the  best  funds  in  the 
market.  Moreover,  some  reduction  of  costs  can  be  expected  from  a  specialisation  of  the  fund 
manufacturer  in asset management and of the distributor in the marketing of the  fund. 

In  this  case,  the  risk  of  conflict  of  interest  relating  to  in-house  product  (i.e.  advising  only  in-house 
product,  even  if they  are not the  most  suitable  for  investors) takes  another possible  form.  Indeed, the 
non-tied  distributor  offer  might  be  influenced  by  remuneration  considerations  (i.e. they  might  advise 
investors  on funds  from  which  it/he/she  receives  a higher  “retrocession”.  Refer  to  “considerations on 
distributors  commissions”  below).  68% of  respondents  to  the  BoNY  study  mentioned  in  section  2.4 
above  agree  that  intermediaries  are  more  interested  in  earning  commission  than  genuinely  advising 
their clients. 

Distribution of investment funds  is also influenced  by the contractual relation between distributors and 
management  companies.  This  relationship  has  been  in many  cases  specified  by  domestic  laws.  Most 
Member  States  require  a written  contract  between  the  distributor  and  the  management  company  and 
some  of  them  have  also  introduced  requirements  regarding  the  contents  of  the  contract74.  In  some 
Member  States  these  contracts  have  even  to  be  approved  by  the  competent  authorities.  This  is 
sometimes  flanked  by  additional  requirements  such  as  an  obligation  of the  management  company  to 
supervise  the  distributors.  As  regards  the  respective  responsibilities,  the  management  company  is 
responsible  for  the  prudent  selection,  instruction  and  supervision  of  the  fund  distributors  in  many 
Member States75. 

The internet is growing in importance as a distribution vehicle. This distribution channel reinforces the 
market  integration  into  an  open  architecture.  Nonetheless,  it  could  exacerbate  the  risk  of  conflict  of 

72 Fund  distributors, fund  supermarkets  and, to a  lesser  extent, retail  banks  proposing  third-party  funds  to their 
clients 
73 Essentially in the UK where IFAs provide advice on products from  the whole market and offer  their clients the 
possibility  to pay  fees  for  the advice  they  receive, in  Germany  and  to a lesser  extent  in  France  (Conseillers  en 
investissement  financier). 
74 “The distribution of investment funds”, FEFSI Fact Book 2004 
75 Idem 

EN 

34 

EN 

interest  specific  to distributor’s  remuneration  considerations, if transparency  on commissions  and  fees 
is  not  adequate.  75%  of  the  BoNY  study’s  respondents  say  that  greater  transparency  in  the  costs, 
charges and fees for mutual funds would greatly improve investor confidence  in the products. 

Finally,  open  architecture  is not perceived  by  manufacturers  and  distributors  as  being  risk-free.  This 
kind  of  outsourcing  leads  the  manufacturer  to  loss  of  know-how  and,  hence,  little  control  over  the 
distributor.  Mis-selling  by  the  distributor  can,  even  more,  affect  the  asset  manager’s  image.  On  the 
other hand, distributors  of third-party  funds  have to cope with a loss of control  over the  quality  of the 
product,  with  an  incomplete  and/or  slower  access  to  the  product  information  and  with  potential 
reputation risks in case of fraud  (or failure) by the fund  manufacturer.  Partner selection is, therefore,  of 
particular importance in order to make open architecture work  efficiently. 

•  Considerations  on  distributor  commissions 

Remuneration  may  clearly  influence  advice  when  distributors  are  paid  through  manufacturer’s 
commissions.  Not  all  distributors  provide  investors  with  the  full  range  of  products  available  in  the 
market. 

Their offer  may  be  determined  by their links to  a particular  fund  provider  (tied  distributors), by their 
particular  specialisation  or  by  remuneration  considerations.  Remuneration  frequently  comprises 
commissions  from  the  manufacturer  (part  of  the  fund’s  entry  fee/annual  management  fee).  The 
distributor has, therefore,  an important incentive to offer  its client those funds  from  which it receives a 
higher “retrocession”. 

Their  offer  may  be  also  determined  by  marketing  costs  considerations.  The  fund  manufacturer  can 
cover all of part of the marketing  costs. Additionally,  even  if it includes  in its offer  third-party  funds, 
the  distributor  may  have  an  interest  (or be  compelled)  to  suggest  own  funds  to  the  client.  Likewise, 
funds  with a higher marketing budget may be easier to sell  (independently  of the fact that they  are the 
suitable for the client). Finally, a common  selling technique  seems to be “new is best” which is used to 
gain  clients  for  newly  launched  products  in  detriment  of  “old”  ones  with  well  established  track 
records. 

There  are, on the  other hand, distributors76 charging  only fees  which remunerate the advice  itself  (this 
being,  thus,  in  principle  more  independent  and  objective).  The  BoNY  study  shows  that  66%  of 
respondents  say that  distributor  remuneration  based  on  fees  for  advice  rather than  commission  (from 
fund  producer)  is  an  important  factor  in  regaining  trust  by  offering  transparency  on  costs  and  fees. 
However, this business model may not yet be welcomed by investors even if it is translated into lower 
fund’s  entry and management fees  (which are often  costs less visible for them). 

Current trends in distribution may lead to higher aggregate  charges for investors, particularly when the 
manufacturer  is eager to increase  its market  share. It is reported that distribution  cost make up to 70% 
of  the  total  fund  costs.  Fund  manufacturers  wishing  to  enter  a  new  market  face  high  sales  and 
marketing costs in order to gain room on the shelves of the local distributors. These costs are said to be 
four times bigger than the costs the industry pays on average on sales and marketing77. 

76  Mainly,  individual  financial  advisors  in  UK  It  should  be  noted  that  France  recently  implemented  a 
“Conseillers  en investissements financiers” (CIF)  framework. 
77 “High fund  distribution costs exposed”, 2nd November 2004, FT 

EN 

35 

EN 

3.2.2.  Clarification  of rules for  new  distribution  channels 

For  marketing  UCITS  and  non-UCITS  by  means  of  modern  communication  media  (Internet, 
telephone, fax  etc.), i.e. without  simultaneous physical presence  of the  supplier and the investor the e-
commerce Directive and the Distance Marketing Directive have to be applied. 

•  E-commerce  and  distance  marketing 

Sale/offer  of UCITS and non-UCITS when undertaken  solely via internet is subject to the  e-commerce 
Directive.  This  horizontal  Directive  is not  specifically  dedicated  to  financial  services. It is  applicable 
to  services  of  any  type  and  aims  at  removing  obstacles  to  the  free  movement  of  services  which  are 
normally  provided  for  against  remuneration  at  a  distance  by  electronic  means  (Information  Society 
services). It therefore  covers  all fund-related  services provided  via internet.  In contrast to the UCITS-
Directive  which  requires  a  notification  procedure  for  UCITS  to  be  publicly  marketed  in  another 
Member  State  and  confers  some  residual  competences  to  the  Host  Member  State,  the  e-commerce 
Directive  is  based  on  a  strict  “country-of-origin”  principle.  According  to  the  Directive,  service 
providers  are therefore  entitled  to  provide  their  services  by the  means  of  Internet throughout  the  EU 
exclusively  on  the  basis  of  the  rules  of  the  Home  Member  State  without  any  further  restriction. 
Ultimately, a strict application of the e-commerce  Directive could lead to the consequence that UCITS 
where marketing  and  sales process  is organised  on Internet  can be marketed  in another Member  State 
without any need to pass through a registration process. 

In  addition,  the  Directive  captures  not  only  UCITS  but  also  non-UCITS.  Therefore,  even  non-
harmonised  products  could potentially be distributed  in a Host Member  State via Internet in case they 
comply  with  the  rules  in  their  country  of  origin  without  any  further  restriction,  even  if  the  public 
distribution  of  the  product  would  be  restricted  or  even  prohibited  in  the  Host  Member  State. 
Eventually, UCITS and non-UCITS could therefore  theoretically  be publicly marketed under the  same 
conditions via Internet. 

The  Directive  on  distance  marketing  of  consumer  financial  services  is  also  applicable  to  the 
distribution  of fund  units on a remote basis. It applies in case funds  are  sold by the means of distance 
communication,  i.e.  those  means  which  do  not  require  the  simultaneous  physical  presence  of  the 
supplier  and the  consumers  such  as  fax,  telephone  and  again  Internet.  In  contrast to the  e-commerce 
Directive  and  similarly  to  the  UCITS-Directive  the  Distance  Marketing  Directive  recognises  certain 
residual competences of the Host Member State. 

The  Distance  Marketing  Directive  also  regulates  the  information  which  has  to  be  provided  to  the 
investor.  They  are  partly  similar  than  those  of  the  UCITS-Directive,  however  there  are  also  some 
deviations:  for  instance,  according  to  the  Distance  Marketing  Directive  the  investor  should  be 
communicated  the  contractual  terms  and  conditions  before  the  contract  is  concluded  whereas  the 
UCITS-Directive  only  requires  that  the  investor  is  informed  about  possibilities  to  consult  the  fund 
rules/instruments  of incorporation. 

• 

Listing  of investment  funds 

All type of investment funds,  UCITS, non-UCITS  and closed end funds  can be admitted to trading  on 
a  regulated  market;  open-ended  funds  which  are  admitted  to  trading  are  usually  designated  as 
Exchange  Traded  Funds  (ETF)78. By the  end  of 2003 assets  under management  under this vehicle  in 
Europe have risen to over €  14 billion79. 

78 The designation of ETF usually only refers to open-ended investment funds and unit trusts; it does normally 
not cover closed end funds admitted to trading. 
79 Source: Morgan Stanley, PWM 11/2003. 

EN 

36 

EN 

Most  exchange  traded  funds  pursue  index  tracking  strategies;  however,  there  are  also  actively 
managed  investment  funds  which  are traded.  In case of the admission to trading  investors  can  acquire 
fund  units like any other security admitted to trading, i.e. by executing buy or sell orders through their 
bank  or  a  broker.  Whether  end-investors  have  the  additional  possibility  to  subscribe  or  redeem  the 
fund units with the fund management company varies from  Member State to the other. 

The  admission  to  trading  of  funds  is  subject  to  the  MiFID  rules  (Art.  40).  Regarding  the  question 
whether the  regulated  market  to  which the  funds  shall  be  admitted  to  trading  has  to  observe  UCITS 
requirements  (for  instance,  notification  according  to  Art.  46  of  the  UCITS-Directive)  or  other  local 
registration  requirements  in case of non-UCITS, Member  States have developed  different  approaches: 
some Member  States consider the admission to trading on a regulated market and the public marketing 
of units of the  fund  as two  separate  areas which are not interlinked; therefore  in their view, there is no 
need  to  apply  the  requirements  of  the  UCITS-Directive  (notification  requirements)  or  similar 
requirements  in case of non-UCITS  as a pre-condition to be admitted to trading.  Some other  Member 
States  require  the  fund  to  be  notified  or to  be  compliant  with  the  local  registration  provisions  in the 
jurisdiction  of the regulated  market; these  Member  States are concerned that  otherwise the  provisions 
of the UCITS-Directive  can be bypassed. 

These  issues  reflect  the  difficulties  to  determine  the  relationship  of public marketing  as  addressed  by 
the UCITS-Directive with other ways of placing UCITS and other investment funds  on the market. 

3.2.3.  Needs  for  clarification  of private  placement 

Unlike UCITS (which are per definition  publicly marketed), most non-harmonised  funds  (hedge  funds, 
private  equity  funds,  real-estate  funds,  etc.)  are  largely  circulated  by  way  the  private  placement.  For 
instance, approximately  75% of private equity funds  are marketed through private placement. In some 
Member  States  single  hedge  funds  are  also  only  allowed  to  be  privately  placed.  However,  even 
UCITS-like  products  which  fulfil  all  the  criteria  of  the  Directive  apart  from  being  marketed  to  the 
public can potentially be privately placed. 

There is no EU-legislative  definition  and framework  applicable to the private placement of investment 
funds.  Funds  which  are  not  publicly  marketed  are  outside  the  scope  of  the  UCITS-Directive.  The 
Prospectus  Directive  provides  for  a  definition  of  public  offer.  It  further  contains  some  provisions 
circumscribing  situations  in which no public offer  takes place  such as in case  of an offer  of  securities 
addressed  solely to  qualified  investors. The  Prospectus  Directive  also defines  the  concept of  qualified 
investors. 

However, the Prospectus Directive  only applies to closed end funds. Non-harmonised  funds  which are 
open-ended  are excluded  from  its  scope of application.  Therefore,  due to the absence of a harmonised 
approach  to  private  placement  for  investment  funds  on the  European  level the  relevant  provisions  in 
the  Member  States  can  vary  considerably.  In  particular,  Member  States  are  not  prevented  from 
imposing local authorisation or registration requirements on funds which are not publicly  marketed. 

The absence of an EU-wide  common  set of rules for private placement  applicable to investment  funds 
might constitute a further  hurdle to their cross-border marketing. 

•  First,  a privately  placed  fund  has to  face  different  regimes  for  private  placement  in the  different 

Member States. 

•  Second, there is also uncertainty as to what private placement for funds  actually means and as how 
to  draw  a practicable  border-line  between  public distribution  and private placement.  Questions to 
be  answered  are  numerous:  is  a fund  privately  placed  because  there  is no public  distribution  (no 
active promotion, no advertisement in communication media)? In this case the product will be also 
accessible  for  any  retail  investor who  disposes  of the  necessary  means  and  knowledge  to  acquire 
the  product  in  question  (e.g. high-net  worth  individuals).  Or  is the  concept  of  private  placement 

EN 

37 

EN 

targeted  to  a  specific  group  of  investors  fulfilling  certain  criteria  such  as  “institutional”  or 
“sophisticated”? How can these concepts be better  defined? 

3.3.  Changing  risk  patterns 

3.3.1.  Potential  conflicts  of interest  and fund  governance 

Investor confidence  is a key  issue  in cross-border marketing  of investment  funds  and  is a prerequisite 
for  a  well  functioning  internal  market.  As  mentioned  earlier,  the  record  so  far  in  terms  of  investor 
protection has been broadly  satisfactory.  Fraud has been relatively  rare and no evidence  of widespread 
abuses  linked  to  practises  such  as  market  timing  and  late  trading  has  been  found  by  European 
regulators. 

However,  recent investigations have pointed  out some  structural weaknesses  in internal procedures  of 
management  companies  when  it comes to dealing with potential  abuses  “Improvements must be made 
to  internal  processes  of  the  management  companies  and  they  must  rise  to  the  challenge”80: 
Furthermore,  operational  risks,  such  as  breach  of  client  guidelines,  misdealing  or  failure  to  best 
execute  are  still  the  most  significant  source  of  risk  for  a management  company.  New  risks  of  abuse 
might  result  from  the  development  of  open  architecture  (cf.  section  3.3.3  below):  retrocession  fees 
may  potentially  prevail  over  fiduciary  obligations;  outsourcing  could  undermine,  for  instance,  the 
control functions  of the depositary. 

•  Debate  on fund  governance  and  fund  management  oversight 

In  spite  of  a  relatively  good  track  record,  the  current  EU  fund  governance81  agenda  is  undergoing 
external pressures. 

First  of  all,  the  governance  agenda  is  influenced  by  market  developments,  notably  a  deteriorating 
investor confidence  in certain Member  States in the  context of bear markets and well publicized  cases 
of  product  mis-selling82.It  is  also  influenced  by  recent  development  in  the  United  States,  where  the 
industry has undergone  in 2003 and 2004  some of the most extensive  reforms  since WWII  (improved 
disclosure,  role  of  independent  directors,  compulsory  compliance  function  and  adherence  to  code  of 
conduct, stricter trading rules…). 

Numerous  self  regulation  initiatives  have  resulted  from  the  implementation  of the  new  UCITS  “III” 
Directive,  regulators  acting  sometimes  in  cooperation  with  national  industry  representatives.  Even  if 
the  industry  often  considers  that the  supervisors  should  focus  in priority  on competing  products, that 
investment  funds  are already heavily  regulated,  and that they  should not  “foot  the  regulatory  bill”  for 
others.  Nevertheless,  fund  managers  seem  ready  in  certain  cases  to  anticipate  possible  regulatory 
initiatives  in  certain  Member  States  by  upgrading  their  rules  of  conducts  and  other  professional 
standards,  notably  on  disclosure  and  transparency.  As  noted  by the  AMWG,  there  is  a  longstanding 
tradition  of  self-regulatory  action to  deliver  sound  governance  and high  levels  of investor  protection. 
Self-regulatory  Codes  and Principles  are developed by different  bodies  and  fund  governance  is under 
examination  in  various  fora  (e.g.  Investment  Management  Association  in  the  UK,  European 
Federation  of  Asset  Management  Associations).  Codes  of  Conduct  and  Market  Disciplines  are  also 
developed by management  companies  and  funds  themselves  inter alia in the field of categorisation  of 

80 see CESR report on the investigations of  mis-practises in the European fund  industry, 4 November  2004,  Ref: 
CESR / 04-407 
81 Fund  Governance  refers  to the rules, principles, practices and behaviour  that  affect  the way  in which  powers 
are exercised by those who market and operate funds. Fund Governance, control and oversight  are crucial to the 
maintenance and improvement of investor confidence  in the asset management  industry. 
82 See “Restoring broken trust”, Bank of New York survey, July 2004 

EN 

38 

EN 

funds,  calculation  of fund  performance,  and fund  advertising. However,  at European  level, there  is no 
widely-recognised  industry  or  co-regulatory  code  which  commands  general  compliance  from  the 
investment  fund  community.  It  should  be  mentioned  that  one  broad  issue  arising  from  the  AMWG 
report  is  the  relative  role  of  regulatory  and  self-regulatory  instruments  in  defining  conditions  under 
which management  companies behave. Questions  of to what extent can  self-regulation  substitute fully 
or largely  for  regulatory  prescriptions  and  of which  are the  main  advantages  and/or  disadvantages  of 
these  instruments  remain.  The  Expert  Group’s  conclusion  on this  last  point  is  worth  recalling: “Self 
regulation will only make sense if the industry itself is comprehensively and unconditionally  adhering 
…  If  voluntary  self-regulation  by  the  industry  does  not  live  up  to  high  expectations  -  and  unless  a 
mechanism  is found  to  ensure  that  such  self-regulatory  rules  are  “enforceable” throughout  the 
industry -  appropriate regulatory intervention will be inevitable”. 

One  should also mention the new  standards brought by the MiFID on organisational  requirements  and 
conduct  of  business  which  are  directly  applicable  to  management  companies  offering  individual 
portfolio  management  services.  Initiatives  in  this  field  also  result  from  the  progresses  made  in  the 
corporate  governance  agenda:  in  this  respect,  the  current  work  of  IOSCO  on  fund  governance  is 
revealing83. However, it should be made clear that corporate governance initiatives cannot be extended 
to  funds  per  se.  Recent  Community  measures  recommending  solutions  -  independent  boards  -  or 
creating  obligations -  audit committees  - for all companies with a listing proved problematic for  listed 
funds.  The  envisaged  measures  would  have  proved  inappropriate  or unhelpful  for  listed  funds  which 
are not trading companies and do not have a true corporate  life  which would warrant the imposition of 
some  of  the  general  corporate  governance  provisions.  This  is  not  to  say  that  the  governance  or 
reporting  requirements  for  listed  funds  do  not  warrant  attention:  on  the  contrary,  they  are  crucial  in 
maintaining  investor  confidence  in the  business. However,  solutions  which  can  be  found  should  take 
account  of the  specificities  of the  fund  industry  as  a whole  and  not  impact  on  it  via  only  one  of  its 
segments (i.e. listed  funds). 

•  What  impact  on the  current governance  framework? 

Do emerging risks and the above debate make a convincing  case for an extensive  overhaul of the fund 
governance  arrangements  of the  UCITS  Directive?  Probably  not.  The  implementation  of the  UCITS 
III directive  is still recent. However, this does not mean that the current framework  should not be kept 
under review. 

Ensuring that the right structures  and tools to identify,  manage and/or disclose conflicts  of interest are 
in  place  is  the  crux  of  the  matter.  There  is  probably  a  need  for  a  general  understanding  of  where 
conflicts  of interest arise in the European asset management business and how best to ensure that these 
do not compromise the asset manager’s obligation to put the unit-holder’s/investor’s  interest first in all 
circumstances.  In this  respect,  it is  interesting  to note that the  AMWG  identified  the  need to  develop 
convergent approaches, as far as possible, on the following  matters: 

• 
• 
• 
• 
• 

identification  and management of possible conflicts  of interests; 
high level principles of corporate governance for the industry; 
adequate disclosure of all information  material to investor’s decisions; 
investor education and financial  literacy; and 
cross-border redress. 

It can  be  anticipated that the  completion  of  IOSCO’s  work  on fund governance  will provide  a  useful 
point of reference  on the above issue. 

83 See  “Examination  of  governance  for  collective  investment  schemes”,  Report  of  the  Technical  Committee  of 
IOSCO February  2005, follow  up report expected  for  Autumn  2005 following  public  consultation. 

EN 

39 

EN 

3.3.2. 

Increasing 

operational 

risks 

In  the  fund  management  industry,  operational  risk  is  the  most  significant  source  of  risk  in  terms  of 
potential  losses  for  the  management  company,  while  credit  or  market  risks  are  either  inexistent  or 
much  less  significant84. 

The  survey  “Risks and Regulation  in European Asset  Management ” 85 of  January  2001, presented 
all the operational risks that may occur in asset management. They include: 

•  Breach  of client guidelines:  this refers to a violation  of the guidelines86 as  set out by  the 

client in their contract with the asset management company. 

•  Misdealing:  this refers  to  generally  unintentional  errors, for  example  in issuing  orders to 

brokers (e.g. confusion between a buy-order and a sell-order). 

•  Risks  arising  in  the process  of  taking  over new  business: operational  failures  may  occur 
when a client  mandate  has been acquired from  another asset management  company.  The 
previous asset manager may not have maintained current records, which implies that there 
may  be  discrepancies  between  what  is  reported  and  what  is  actually  held  in the  client’s 
account. 
IT systems failure:  this occurs as a result of a breakdown in the computer system. 

• 
•  Failure to reconcile assets under custodianship and internal records: this may arise when 
an  asset  manager  is  unable  to  reconcile  the  assets  according  to  its  own  internal  records 
with  those  according  to  the  reports  from  the  custodian.  In  order  to  minimise  the 
probability  of  such a failure  occurring,  asset  managers  may  conduct  daily  reconciliations 
of clients’ accounts. 

•  Failure to best execute: this refers to a failure to obtain the best price for a client. 
• 

Settlement  problems:  these  may  occur,  for  example,  when  the  asset  management 
company  has already  paid the cost of purchasing  stocks, but the broker, for  some  reason, 
is unable to deliver the stocks. 

•  Failure to collect all income: an obvious example87 of this type of risk occurs in the event 

of a corporate action failure. 

•  Fraud:  this  occurs  as  a  result  of  dishonest  behaviour  conducted  by  employees  or 

managers. 

Regarding  the  efforts  to  increase  the  integration  of  the  European  investment  funds  markets,  a  lot  of 
attention  has  been  given  to  the  product  in  order  to  create  a  simple  investment  vehicle  for  investors 
across  the  EU.  Less  has  been,  however,  done  to  improve  the  working  environment  for  key  actors  and 
functions  of  the  AM  business.  Basic  parts  of  the  AM  infrastructure  have  been  so  far  rather  neglected 
by the  regulator.  This  has  lead to  a  situation  where  the  existence  of  different  operational  protocols  and 
systems  (sometimes  even  within  the  same  country)  by  increasing  operational  risks88,  costs  and  delays 
may  hinder market  integration. 

84  Source:  FEFSI  “Operational  Risk  and  Capital  Requirements  in  the  European  Investment  Fund  Industry” 
Bruno Biais, Catherine Casamatta and Jean Charles Rochet IDEI Université de Toulouse; January 2003 
85 “Risks  and Regulation in European Asset Management:  Is There a Role for Capital Requirements?”  OXERA, 
in conjunction  with Professors  Julian Franks (London Business School) and Colin Mayer (University of  Oxford) 
January 2001; Source: www.oxera.com. 
86  For  example,  a  client  may  specifically  request  that  their  portfolio  does  not  contain  any  tobacco  companies’ 
stocks. Inadvertently purchasing tobacco stocks for this client would therefore  contravene the client’s guidelines. 
In  order  to  reverse  the  transaction,  the  asset  management  company  must  sell  the  shares. In  the  meantime,  the 
price of the share could have fallen, which could result in a loss for the asset manager. 
87  For  example,  a  client  may  hold  stock  in  company  A,  which  is  being  taken  over  by  company  B. Failure  to 
complete  the  relevant  documentation  before  a  specified  deadline  may  result  in  failure  to  transfer  stock  in 
company  A  into  stock  in  company  B. This could  lead  to losses, for  example, in  cases of  depreciation  of  stock 
value. 
88 
inadequate or failed  internal processes, people and systems. 

Operational  risk refers  to the risk of  losses incurred by the company, in the course of  its business, because of 

EN 

40 

EN 

Some technological/organisational  improvements  can, however,  reasonably  be  expected  as an  outcome 
of the  action  of market  forces  (e.g. outsourcing)  and/or  industry  voluntary  arrangements. 

EU  asset  managers  surveyed  by  OXERA  ranked  the  potential  (amount  of  possible  losses)  impact  of 
risks  in  exactly  the  same  order89  in  200190  as  in  200491.  The  ranking  of the  frequency  of  occurrence92 
has  not  change  between  2001  and  2004.  Thus,  it  appears  that  breach  of  client  guidelines  and 
misdealing  are  both  the  most  frequent  operational  risks  in  asset  management  and,  furthermore,  the 
most  costly  in  terms  of  induced  losses.  On  the  other  end,  settlement  problems  arise  frequently,  but 
their  financial  impact  is  small.  Stock  lending  failures  arise  infrequently  and  their  impact  is  the  less 
important. 

Nevertheless,  the  costs  of  operational  failures  have  not,  to  date,  been  borne  by  investors.  The  2001 
OXERA  study  shows  that  the  five  most  frequent  risks93  reported  from  surveyed  firms  led  to  losses  of 
37.5%  of the  firm  capital  in  one  case  and  losses  largely  inferior  to  5%  of the  firm  capital  in  all  other 
cases.  Importantly,  none  of the  losses  was  borne  by  clients;  instead  losses  were  covered  by  incomes  or 
by  capital.  The  2003  survey  seems  to  confirm  this  point.  The  five  largest  losses  in  2003  in  the 
surveyed  firms94  ranged  between  2.8% and  7.8% of the  firm  capital.  However,  one  firm  experienced  a 
loss  as  high  as  74%  of  its  capital.  In  both  surveys,  respondents  confirmed  that  the  primary  source  of 
financing  losses  is  profits.  Regulatory  capital95  has  a  secondary  role.  Both  studies,  therefore,  suggest 
that  although  operational  failures  occur  relatively  frequently,  losses  tend  to  be  small,  and  can  in 
general  be  absorbed  by  the  AM  company  (out  of  cash  reserves).  Naturally  these  results  should  be 
carefully  considered  because  they  are  very  dependent  on  the  sample  chosen  and  include  an  obvious 
self-reporting  bias  from  surveyed  firms96. 

Operational  risks  and  costs  fall  mainly  at the  level  of the  management  companies.  This  may  lead  them 
to  outsource  administration  functions  to  specialised  and  professionalized  entities. 

• 

Is  outsourcing  a  solution? 

Back-office  functions  have  been  traditionally  integrated  with  the  other  AM  functions  in  the  same 
structure  (or within  the  same  financial  group). However,  there  are  reasons  why  this  may  change.  First, 
these  functions  are  an  important  source  of  costs  for  the  AM  activity.  They  are  sometimes  low-margin, 
intensive  in  human  capital  and  require  important  investments  to  keep  the  IT  systems  up-to-date. 
Additionally,  outsourcing  these  functions  to  specialised  Third  Party  Administrators  (TPA)  allows 
firms  to  concentrate  in their  core  business,  where  they  have  a  competitive  advantage,  and to  “smooth” 
the  costs  related  to  them97.  For  some  the  growing  complexity  of  transactions  also  makes  the  case  for 

89 From the most  important  potential  impact  to the less one : Breach  of  client  guidelines, Misdealing, Unit  trust 
mis-pricing, Risks from  new business, Fraud, Failure to meet guarantees, IT systems failure, Failure to reconcile 
assets, Failure to best execute, Counterparty failure, Settlement problems, Failure to collect all income, Financial 
insolvency, Stock lending failures. 
90 See above –mentioned study 
91  Draft  of  final  report  on  “description  and  assessment  of  the  national  investor  compensation  schemes  in 
accordance with Directive 97/9/EC”, prepared for the European Commission by OXERA. October 2004. 
92 Frequency of occurrence: Breach of client guidelines, Misdealing, Settlement problems, Unit trust mis-pricing, 
Failure to reconcile assets, Failure to collect all income, IT systems failure, Failure to best execute, Counterparty 
failure, Risks from  new business, Fraud, Stock lending failures, Failure to meet guarantees, Financial insolvency. 
93 1) misleading, 2) breach of client guidelines, 3) failure to collect income (including corporate action failure, 4) 
settlement problem, 5) mis-pricing 
94 The sample is composed of 46 management  companies. 
95 Actually, capital exceeded even the largest losses in the two surveys. 
96  For  reputational  reason,  AM  companies  could  not  be  keen  to  report  the  exact  nature  of  their  operational 
losses. 
97 The fixed  costs linked to an internal back-office  are replaced by a variable regime which  is more flexible  and 
allows the firm to better plan its costs and to adapt quicker to changes in the business environment. 

EN 

41 

EN 

outsourcing.  Finally,  the  fact  that  most  investment  managers  already  operate  front  and  back  office 
activities separately make easier the replacement by a service provider98. 

Outsourcing seems to be gathering pace in Europe with more firms seeking to outsource some of  their 
operations and with an increasingly  greater  range of  functions  being the object  of  outsourcing99. This 
trend  is  expected  to  continue  as  Europe  catches  up  with  the  US  where  nearly  80%  of  the  fund 
managers’  back-offices  are  outsourced. The  range  of  outsourcing  possibilities  for  firms  is,  however, 
not  large. The  number  of  TPAs  is  rather  limited  with  the  bulk  of  the  business  concentrated  in  the 
hands of a few of them (State Street Bank, BNP Paribas, JP Morgan…). 

EU firms  generally outsource within the confines  of the EU but the search for reducing costs may lead 
them  to  third  countries. For  instance,  some  UK  firms  have  outsourced  activities  to  India  where  the 
workforce  is  cheaper  but  skilled  enough  to  take  over  those  activities.  However,  there  may  be 
regulatory limits to this movement, such as data protection rules. 

The market  for  fund  administration  outsourcing  remains  an area  of  strong  potential  growth. In 2001, 
according to responses to a survey questionnaire100, 59% of the surveyed firms had delegated  functions 
within their group and 68% of  companies had delegated some activities to parties outside their group. 
It  should  be  noted  that  the  functions  that  may  be  delegated  in  the  survey  included  settlement,  fund 
administration,  and  custody.  In  2004,  another  survey101  asked  surveyed  firms  whether  they  had 
completely  outsourced  the  valuation,  administration  and  accounting  functions.  Hence,  this  survey 
excluded  custodian  functions.  Nevertheless, it worth to note that 53% of  surveyed  companies had not 
delegated  such functions  and  handled  those functions  themselves, 25% had delegated  those  functions 
within their group and 17% to parties outside their group. 

Institutional  managers  have  been  enjoying  the  benefits  of  outsourcing  for  some  time.  Retail  fund 
managers, however, have been slower  to relinquish  control over  their non-core  operations. Primarily, 
they  outsourced  custody  and  fund  accounting,  for  example.  However,  there  has  been  a  general 
reluctance  to outsource  other  aspects of  the business  process. The  coming  months should  see  further 
activity around the outsourcing of retail fund  administration102. 

Outsourcing is, however, not necessarily a panacea. Asset managers who outsource key functions  must 
maintain  adequate  oversight,  as  ultimate  responsibility  remains  with  the  asset  management  firm. 
Furthermore, remains the question  of  the risk that  raises growth in outsourcing. For instance, the UK 
FSA noted  that the number of  firms  to whom substantial  functions  have been outsourced  is not large. 
This concentration might create a wider/different  type of  risk. 

By  eliminating  internal  functions  firms  reduce  their  capability  and  skills  to  control  the  third-party 
administration  services. Even if  financial  penalties are often  negotiated  in the contract  with  the  TPA, 
the eagerness  to  outsource  and  the  limited  number  of  TPAs, does  not  provide  high  incentives  to  the 
TPA  to  respect  its  commitments.  Some  are  concerned  that  TPAs  are  probably  more  interested  in 
attracting  new  business  than  keeping  current  clients  happy. Additionally,  “one size fits  all”  solutions 
may  not  be  the  most  efficient  in  the  case  of  small  boutiques  or  specialised  managers  which  require 
specialised procedures. 

98 “Edhec European Asset Management Practices Survey”, March 2003 
99 These include, among others, unit dealing, calculation of net asset values, fund administration, pricing… 
100 See above-mentioned OXERA 2001 survey 
101 See above-mentioned «Edhec European Asset Management Practices Survey» 2003 EDHEC-RISK 
102 Source: “Retail Fund Administration Outsourcing” PricewaterhouseCoopers Corporate Finance practice. 

EN 

42 

EN 

•  Capital  requirements 

In  view  to  ensure  the  stability  of  management  companies  the  amended  UCITS  Directive  has 
introduced  requirements  for the  initial  capital  of a management  company.  Furthermore,  an  additional 
amount  of  own  funds  in  relation  to  the  portfolios  under  management  has  to  be  provided  for  by  the 
management company. 

The initial capital  should be at least €  125,000; the  additional amount  should be equal to  0.02% of the 
amount  by  which the  value  of the  portfolios  exceeds €  250 million.  This  additional  amount  shall  not 
exceed €  10 million. In any case, the own funds  of the management company  should never be less than 
one quarter of the management companies' preceding year's fixed overheads. 

The  Directive  also  contains  capital  requirements  in  case  the  management  company  carries  out 
investment services. These requirements have to be reconciled with those for the collective  investment 
management.  Finally,  for  self-managed  investment  companies  an  initial  capital  of  at least €  300,000 
EUR is required. 

The debate on capital  requirements  is going  on within the AM industry. However,  as a matter of  fact, 
most  of  operational  risks  fall  on  AM  companies  which  run  more  and  more  services.  They  cover 
operational losses first by profits  and, then, by capital. In that view, the capital requirements  should be 
assessed  in  order  to  know  if  they  are  suitable  with  the  new  AM  company  patterns  and  still  protect 
adequately investors. 

In  conclusion  of  the  third  section,  it  seems  that  the  AM  industry  calls  for  more  single  market 
freedoms: 

•  Industry  broadly  supported  the  proposal  for  greater  freedom  to  appoint  depositary-custodian-
administrator in another Member State as a way to increase competition in a fragmented  market and 
lower costs  for  investors. Due to the  current  discrepancies  in national  regulations, progress  on this 
front  may  require  a clearer definition  of the role, the missions  and the  liability  of the depositary  as 
regards  oversight  of  the  management  company  and  safe-keeping  of  assets.  It  also  may  require  a 
throughout  assessment  of  the  risks  entailed  by  such  approach  and  the  means  to  address  them, 
notably as to oversight. 

•  The obstacles to asset pooling and cross-border fund  mergers were highlighted by the Expert Group 
as  important  barriers  hindering  the  efficient  functioning  of  the  market  for  investment  funds. 
Nevertheless,  there  remain  regulatory  concerns  associated  with  pooling  and  cross-border  fund 
mergers and on whether these obstacles could be effectively  tackled by EU level legislation. 

Distribution  structures are also changing. There is a slow but gradual move towards open  architecture. 
However,  open  architecture  is  not  always  having  a  positive  impact.  Quite  often,  distributors  are 
directly  remunerated  by  fund  manufacturers  (typically  via  a  “retrocession”  of  part  of  the  entry  or 
management fees). In view of these incentives it is unsure whether distributors’ advice is always in the 
best interest of the client. Thus, a greater disclosure  of the total  costs and information  about particular 
manufacturer-distributor  arrangements  would  help  investors  to  make  a  more  informed  decision. 
Improved transparency  is also a key in order to maintain investors’  confidence. 

Finally, the risk patterns  are  changing. It is essential to  ensure that the  different  links within the  asset 
management value  chain  incorporate the right structures  and tools to identify,  manage  and/or  disclose 
changing  conflicts  of  interest.  In this  respect,  it  is  interesting  to  note  that  IOSCO  working  group  on 
fund governance considers independent oversight as a starting point for considering these issues. Thus, 
views on the role of the depositary are currently the object of extensive discussion in the context of the 
‘fund  governance’  debate.  The  discussions  are  on  whether  it  remains  appropriate  to  conflate  the  two 
“core”  functions  of  the  UCITS  depositary,  i.e.  asset  safekeeping/custody  and  oversight  of  fund 
management, taking into account the capacity  of many depositaries to perform  the controls that would 
be needed to detect things going wrong. 

EN 

43 

EN 

As  regards  to  operational  risks,  although  well  known  by  the  industry  and  unchanging  in  substance, 
they  continue  to  affect  AM  companies.  When  operational  risk  occurs,  generally,  the  involved  AM 
company  covers  losses  with  its  cash  reserves  or  its  capital,  because  of  legal  requirements  or 
reputational concerns. Hence, although they have a cost in terms of fees for investors, operational risks 
have to date rarely led to losses for investors. 

Outsourcing  is  a  way  to  improve  profitability  of  AM  companies,  by  replacing  a  fixed  cost  by  a 
negotiable cost. Yet, even when outsourcing administration functions  or operational risk  management, 
AM companies  remain  legally  accountable  if  something  goes wrong. Outsourcing, hence, could  lead 
to  new  kind  of  “operational”  risk  in  AM  business. As  in  financial  services  industry,  outsourcing  of 
some activities  may  increase complexity  of  managing  operational  risks due to the loss of  control  and 
know-how  over those activities and, hence, suppose  to define  at contractual  level a clear  relationship 
between the outsourcing company and the provider. 

In  order  to  better  understand  costs, trends  and  risks  in  the  AM  business,  the  Commission  launched 
calls for  tenders for  two quantitative and qualitative studies, i.e. “Current trends in the European  asset 
management industry”103” and “Ootential cost savings in a fully  integrated European investment  funds 
market104”. 

4.  OVERALL  ASSET MANAGEMENT  LANDSCAPE 

UCITS  do  not  exist  in  isolation.  They  compete  with  many  other  products  for  the  private  savings  of 
European  investors.  Some  of these  other  products  may  incorporate  some  additional  service  element 
resulting  in them being  subject to a very different  regulatory or tax treatment. The creation of separate 
regulatory  ‘boxes’  for  different  families  of investment  product  may  lead to  arbitraging  problems  and 
distort  investment  decisions.  It  may  also  create  regulatory  hurdles  for  asset  managers  who  seek  to 
transfer their expertise across families  of investment product. 

4.1.  Other  collective  investments:  non-harmonised  products 

4.1.1.  Development  of non-harmonised  products  competing  with  UCITS 

Collective  investment  products  which  do  not  meet  the  investment  rules  of  the  UCITS  Directive 
currently  account  for  around  25-30% of  assets  under  management  in the  EU.  Segments  of  the  non-
harmonised  sector  are  amongst  the  fastest  growing  segments  of  the  fund  industry  -  in  contrast  to 
stagnation  or  even  net  outflows  from  some  UCITS  segments.  Examples  include:  private  equity 
funds105, hedge funds,  structured and guaranteed106  funds  and real estate  funds. 
•  Private  equity  funds107  invest  in  firms  which  are  generally  non-listed  companies.  Private  equity 

103 The purpose is to provide the Commission with a sound analysis of the degree of inefficiency  in the European 
investment funds market. It will present a detailed comparative description of the main sources of cost in the EU 
investment fund value-chain. 
104 The purpose is to achieve a better understanding of the functioning of the market for investment funds and of 
the current trends which could affect the future development of this market. 
105 Private equity provides equity capital to enterprises not quoted on a stock market. Private equity encompasses 
both venture capital (Venture capital is a subset of private equity and refers to equity investments made for the 
launch, early development, or expansion of a business.) and investment in buyouts (Buyout investment refers to 
the acquisition  of  a company  or business  unit. It includes  replacement  capital, management  buyouts (MBO), 
management buyins (MBI) and leveraged buyouts (LBO).). 
106 It should be noted that the term “guaranteed funds” is used in a generic way since some Member-States deny 
the use of this term to structured funds which do not offer a guarantee on 100% of the initial capital (invested by 
the investor) or external guarantee. 
107 Private equity funds managed roughly € 155 billion at the end of 2004 (from € 59 billion at the end of 1999). 

EN 

44 

EN 

investments  fund  the  targeted  company  and  provide  it  with  the  help  and  expertise  of  a 
management team. They often  use leverage  (senior, junior, mezzanine  debts). Since private  equity 
funds  are  most  often  closed-end  funds,  they  do  not  target  individuals  and  concentrate  on 
sophisticated  investors (75% of funds  raised). 

H H e d ge  Funds  differentiate  themselves  from  plain-vanilla  collective  investment  schemes  because 
they  use  of  a  wider  range  of  instruments,  techniques  and  strategies  (such  as  derivatives,  short-
selling,  arbitrage  and  leverage). They  are, therefore,  not  only  more  flexible  than  other  traditional 
investment vehicles  but also offer  investors the  possibility to  obtain  investment  returns which  are 
in principle uncorrelated with the market. 

•  Guaranteed  Funds  are  products  offering  a protection  against  the  full  volatility  of  markets  in  the 
form  of either a guarantee of capital or income. However, the investment techniques in guaranteed 
funds  can  be  used  in  a way  that  complies  fully  with the  UCITS  directive.  Therefore,  guaranteed 
funds  might be UCITS or non-UCITS, depending on the designer’s aim. 

•  Real  Estate  Funds  are  a type  of investment  funds  that  allow  investors to  have  an exposure  to  the 
property  market  without  buying  directly  a  property  holding.  Some  of  them  are  open-end  with 
various  redemption  dates.  In  this  case,  they  are  often  called  quasi-UCITS,  due  to  the  similar 
features. According to the industry108, harmonisation of these funds  would be  feasible. 

This  description  can be  completed  with  ‘quasi-UCITS’. De facto,  they  comply with  almost  all of the 
requirements  of  UCITS  law but they  are  nevertheless  denied  the  benefits  of  recognition  as  a  UCITS 
product. A widely documented  example  concerns (open-ended)  real estate funds.  These are  authorised 
for  offer  to the  public  in  several  Member  States.  Due to the  categorical  prohibition  of investment  by 
UCITS in real estate, these funds  cannot benefit  from the UCITS passport. 

UCITS legislation does not provide  any solutions to the market access and regulatory  issues presented 
by  non-harmonised  fund  products.  They  have  been  omitted  from  the  scope  of the  UCITS  Directive 
because of (perceived) complexity or greater potential risk for investors. 

Fund  market  consolidation  seems  to  have  been  more  intense  for  the  non-harmonised  funds  segment 
whose  average  size has nearly  doubled  during the  1993-2003 period; probably  reflecting  the  growing 
interest  of  investors  (especially  institutional  entities)  in  diversifying  their  portfolios.  Meanwhile, 
financial  innovation  continues  to  develop  new  products  that  fall  outside  the  scope  of the  current  EU 
framework. 

While  not  subject  to  EU  legislation,  many  of  non-harmonised  products  will  be  subject  to  national 
regulatory regimes or divergent national rules on their  offer/placement. 

For example, in the private  equity  sector, although both funds’  raising109 and investments110 in private 
companies are made on a pan-European basis, fund promoters must set up legal structures according to 
the  national  legislation  of the  country  in which the  fund  aims to  invest  (e.g. UK:  limited  partnership, 
France:  FCPR/I  , Belgium:  PRICAF,  Luxembourg:  SICAR,  etc.). The  existence  of 25  different  legal 
structures  and  bilateral  tax  treaties  prevents  the  private  equity  industry  from  achieving  its  full 
potential. Indeed, the complexity of the various vehicles and  structures that are used increases the cost 
of  setting up and  operating private  equity  funds,  notably  on venture  capital  side  (fragmented  market). 
The different  structures  reduce the commercial transparency  of these funds  to investors, hence  making 
them less able to compare  funds  and their performance.  On the investment  side, when considering the 

108 Source: FEFSI (EFAMA) Real Estate Funds Workshop. December 2004 
109 Between 1999 and 2003, 51.9% of  these funds  were raised  on the domestic (where the fund  is registered) 
market, 16.3% on other European markets and 28.3% from non-EU countries (mainly USA). 
110 For example, in 1999, the UK managed 45.8% of  private equity funds  and was the destination country for 
36% of  the  investments  (France: 8% and  Germany: 10%). In  2003, UK managed  46.5% of  private 
equity funds but was the destination country of 25.3% of the investments (France: 16.7% and Germany: 
14.2%). 

EN 

45 

EN 

country  of  destination, it seems that the cross-border  aspect  of  this sector  has increased, although  the 
country where the funds  were raised remains the first  destination of  investments in private companies. 
In addition, private equity and/or  venture capital funds  experience difficulties  at the moment they exit 
the  investee  company.  As  the  investment  in  a  non-listed  company  is  for  a  limited  period  only,  they 
must divest  all their investments. A financial  return is only  generated  when a private equity fund  can 
realise  its  gains  –  and  distribute  them  to  the  investors  –  through  an  exit,  either  an  IPO  or  by  an 
acquisition  by  another  firm.  Currently,  there  is  no  liquid  pan-European  market  adapted  to  young, 
growing companies to support secondary trading and easy divestment of such investments. 

As regards  to  hedge  funds,  the  EP  report111 has  called  for  the  treatment  of  hedge  funds  from  an  EU 
regulatory perspective to be considered as part of the UCITS review. Indeed, the European market has 
not  remained  unaffected  by  the  impressive  growth  of  the  Hedge  Fund  (HF)  industry  world-wide. 
Although  the  size  of  the  European  HF  industry  is  still  modest  (only  3%  of  the  EU  assets  under 
management  (AuM),  it  continues  to  grow  vigorously.  Recent  figures112  estimate  at  more  than  $256 
billion (€ 187 billion at 31/12/2004) the size of European AuM at the end of 2004. 

US$ billion in alternative  management 
figures are estimated (source: www.hedgefundintelligence.com  + 
Van Hedge Fund Advisors International + Hedge Fund Research) 

Europe 

Global 

972,00 $bn 

820,00 $bn 

600,00 $bn 

650,00 $bn 

480,00 $bn 

520,00 $bn 

125,00 $bn 

168,00 $bn 

255,85 $bn 

216,32 $bn 

1200 

1000 

800 

600 

400 

200 

N.A. 

0 

20,50 $bn 

64,00 $bn 

N.A. 

end 1999 

end 2000 

end 2001 

end 2002 

mi-2003 

end 2003 

mi-2004 

end 2004 

In the EU, the development  of  HFs has not been homogeneous. As a result, the HFs business shows a 
rather  concentrated  picture. Two HF centres have clearly emerged: one for  the fund  management  and 
another for fund  administration. In the first  case, the UK has an indisputable place in the European  HF 
scene.  At  the  end  of  2004,  74%  of  the  AuM  of  all  European  HFs  are  managed  from  the  UK.  As 
regards  administration,  Ireland  is  the  leader  with  a  not  negligible  percentage  of  HF  global  assets 
administered in Dublin. However, a strong competition from Luxembourg can be expected. 

Fund managers are allowed to manage HFs in most EU countries. However, they have often  to comply 
with minimum capital requirements (up to € 1 million in the case of  Italy), in some cases demonstrate 

111 

(Rapporteur: John Purvis) on “the future of Hedge Funds and Derivatives” (2003/2082 (INI)) 
Source: www.hedgefundintelligence.com 

EN 

46 

EN 

that  they  have  enough  resources  and  competence  and  sometimes  are  allowed  to  manage  only 
nationally domiciled HFs. 

Distribution  of  offshore  HFs  may  be  completely  prohibited,  limited  to  certain  types  of  investor 
(sophisticated, expert…) or in practice hindered by an unfavourable  tax treatment. 

Some  countries  have  also  allowed  the  creation  of  nationally-domiciled  HFs  although  subject  to 
restrictions regarding minimum  subscription amounts, minimum fund  sizes and portfolio  investment. 

The particular situation in some EU countries is described in more detail in annex B. 

4.1.2.  Policy  issues  regarding  non-harmonised 

products 

•  Market  fragmentation  and  risk  of regulatory  arbitrage 

From the point  of view  of a single market  for  funds  in Europe, divergences  of regulatory  approaches, 
particularly  with  regard  to  HFs,  could  lead  to  higher  market  fragmentation  and  an  increased  risk  of 
regulatory  arbitrage.  Substitute  collective  investment  products,  subject  to  less  onerous  regulatory 
requirements,  may  be  able  to  compete  to  an  extent  that  undermines  investor  protection  or  market 
functioning.  Nevertheless,  it  should  be  further  reflected  whether  these  different  products  actually 
compete since they may have different  investor bases. 

Although  examples of this form  of arbitrage  are evident in some Member  States, the question  remains 
whether  this  is  a pan  European  issue  calling  for  a  common  approach.  Regulation  at  EU  level  could 
contribute to  smooth regulatory divergences -  but would  only be justified  if it can effectively  enhance 
business efficiency  or address demonstrable  sources of risk having a cross-border  dimension. 

•  Retail  investor  protection 

Traditionally  sold to professional  or qualified  investors, the HFs base is now in a “retailisation”  course 
in  some  Member-States.  The  development  of  funds  of hedge  funds  (FoHFs),  in particular,  has  made 
hedge  funds  more  broadly  available  to  investors.  Some  of  them  are  listed  on  exchanges,  further 
increasing  their  availability113  to  investors.  Furthermore,  retail  investors  might  get  access  to  hedge 
fund  exposure  by  means  of  structured  bonds114.  This  may  present  some  regulatory  concerns  for 
unqualified  investors, typically  in relation to diversification  and disclosure: information  on underlying 
funds  may be less accessible for investors. 

If HFs  are being  made  available  to  retail  investors, there  may  be a need to  consider  specific  forms  of 
protection  for  these  less  sophisticated  investors.  This  protection  should  be  assured,  first,  by  the 
Member  States  supervisors/authorities,  which  are  better  positioned  to  understand  and  to  take  into 
account  customs,  preferences  and  other  cultural  aspects  which  influence  investors’  decisions. 
Nevertheless, Member  States protection may not be  sufficient.  Investors can have  access nowadays to 
HFs and  FoHFs  even  if they  are not authorised to be distributed115  in their country  of origin.  In  some 
jurisdictions,  authorities  consider  that  making  investors  responsible  for  their  decisions  is  a  medium-
term  strategy  to  protect  them.  However,  investors  are  not  always  aware  of what  is  in their  portfolio 

113 In  February  2004, the estimated  total of  assets managed  under  exchange-listed  funds  of  hedge funds  was 
around $4 billion in the world. 
114 Structured bonds enable investor to participate in the performance of a certain underlying without the need to 
invest directly into the underlying. 
115  Listed  funds,  pension/insurance  products  or  wrapper  vehicles  such  as  certificates  are  accessible  to  all 
investors. 

EN 

47 

EN 

(e.g.  if  invested  in  a  pension  fund  with  x  %  in  HFs  or  if  badly  advised  by  their  bank  or  IFA). 
Additionally, financial  literacy levels among EU investors are quite diverse and often  rather low. 

In  relation  to  private  equity  funds,  it  should  be  noted  that  they  may  be  listed  as to  offer  investments 
more widely. A few funds  are directed towards retail investors. Again, this would  raise the question of 
the investor literacy regarding this often  complex and technical  product. 

•  Financial  stability  concerns 

Because  of high  degree  of leverage  borrowed  from  systemically  relevant banks, HFs may  represent  a 
source  of  financial  instability.  In  a  rather  integrated  financial  market  the  risk  of  contagion  in  the 
advent of a failure  of a HF and its counterparties  is higher. 

To date, leverage  in HFs is thought to be lower (3 times total assets116) than in  1998. Nevertheless, the 
growth  of  the  business  is  prompting  renewed  concern  as  to  whether  HFs  -  and  more  particularly, 
lending by large banks to HFs -  represents  a source  of potential  financial  instability.  Typically  recent 
years’ often mediocre HFs performances  may push managers to increase leverage to maintain previous 
returns levels. 

Around  15 hedge  funds  collapse  per  year  out  of  a universe  of  2,500  open  to  investment  funds.  This 
represents  a  high  failure  rate  of  0.6%.  According  to  one  academic  study117,  collapses  are  related  to 
investment  risk  in  38% of  cases, to  business  risk  in  6%, to  operational  risks  in  50% and to  multiple 
risks  in  6%.  That  means  that  at  least  56% of the  hedge  fund  collapse  due  to  operational  processes, 
which adds a significant  failure  risk to the market risk. 

Because of their role as prime broker providing  leverage  and credit lines, credit institutions  are at risk 
in  case  of  HF  failure.  Data  points  out  a  strong  concentration  of  prime  brokerage  business  with  a 
limited  set  of  global  market  players.  It  also  seems  that  this  business  has  become  increasingly 
competitive over time, with a number of second-tier players aggressively trying to gain market share. 

Furthermore,  irrespective  of  whether  they  deal  with  onshore  or  offshore  hedge  funds,  EU  regulated 
counterparties  are  integrated  in  the  EU-wide  financial  market  (counterparties  in  OTC  derivatives 
transactions, short-term lender of funds  or securities, long-term lender or provider of capital, execution 
agent,  responsible  for  buying  or  selling  on  behalf  of  a  HF,  clearing  and  settlement  agents  or  prime 
brokers). However, data on EU-banks  exposure to offshore  funds  are often  not available. Hence, even 
if there is no conclusive  evidence  on the  impact of HFs on financial  markets, some risks may  emerge. 
Finally,  since most of the threats posed  by HFs  on financial  stability  would  have  a global  dimension, 
the risks of an uncoordinated response by EU financial  authorities may exacerbate its negative  effects. 

The ECB 2004 review highlighted  the bank exposures towards hedge funds  which are most likely to arise 
from  their  prime  brokerage  relationships.  Direct  credit  exposures  include  loans,  credit  lines  and  trading 
exposures in OTC markets (including credit risk, derivatives markets and others). 

According  to  the  ECB,  for  some  euro-zone  banks,  the  income  stream  from  prime  brokerage  services 
constitutes  a  very  significant  share  of  total  trading  and  commission  income,  ranging  between  25% and 
40%.  Increasingly  banks  are  also  investing  in  or  setting  up  hedge  funds.  Prime  brokerage  is  a  rather 
concentrated  industry  and  it  is  primarily  dominated  by  US  entities, although  certain  euro-zone  banks  are 
also among the established  players. However, prime  brokerage  business  is becoming  more competitive  as 
new  banks  enter  the market. As hedge  funds  may  use the  services of  several  different  prime  brokers  it  is 

116  Source:  HFR  and  BIS  Quarterly  Review  March  2005  –  “International  Banking  and  Financial  Market 
Developments” 
117 Source: Edhec  Risk  and Asset  Management  Research  Centre, based  on  publicly  available  information  only: 
“The  Management of Hedge Funds’ Operational Risks” Jean-René Giraud; April 2004 

EN 

48 

EN 

possible that a single bank  lacks sufficient  information  on the full  risk profile  of  its customer. In  addition, 
the  prime  brokerage  industry  may  become  less  resilient  as  a  number  of  new  entrants  aggressively  try  to 
gain  market  share, which  could  also allow  hedge  funds  to  negotiate  better  access  to  credit. Indirect  risks 
may also materialise, for  example, through credit risk on counterparties that have large exposures to hedge 
funds. In addition, since hedge funds  are active traders in financial  markets, banks’ trading book  positions 
could be exposed to market volatility, potentially caused by hedge funds realigning their positions. 

Furthermore, market data show that a number of large EU-credit institutions are taking on more market risk 
and engaging in “hedge fund”-like  strategies. Under these conditions, negative market events may not only 
have  an  impact  on  the  direct  relationship  between  credit  institutions  and  hedge  funds  but  may 
simultaneously affect  the proprietary market positions of credit institutions. More detailed data,  specifically 
on the value at risk (VaR) break-down, would be needed. 

In its resolution  on HFs and derivatives, the  European  Parliament  (EP) considers, inter alia, that there 
is  a  risk  of  systemic  damage  to  the  global  financial  system  if  these  investment  vehicles  proliferate 
without  quantification  or  control.  It  also  reckons  that  some  hedge  funds  may  be  directly  accessible 
anyway  to  retail  investors  without  any  specific  protection,  via  European  market  listings  or  third 
country  jurisdictions  or  indirectly  via  funds  of  funds  or  structured  notes.  Therefore,  the  EP 
recommends  addressing  the  risks  that  represent  HFs  for  financial  stability  and  for  investors.  It 
suggests,  hence,  that  a  regulatory  regime  for  sophisticated  alternative  investment  vehicles  be 
established  in EU. Considering the fact that many hedge funds  operate  offshore  and are not subject to 
Community  regulation, the  EP calls  on the  Commission  to  introduce  EU-legislation  in order to  make 
the lending by EU financial  institutions to offshore  hedge funds  more transparent. Last, that regulation 
should also concentrate on provision of information  to investor. 

•  Depositary  role in respect  of alternative  investment  strategies 

Generally  speaking,  EU  countries  wishing  to  create  hedge  funds  accessible  “onshore”  to  local 
investors have  opted for the depositary  model on the basis of the UCITS Directive  (France,  Germany, 
Ireland,  Italy, Luxembourg…). In contrast to the  USA, administration  of European  HFs is undertaken 
by  entity  other than the  HF  manager.  Due to the  specificities  of  alternative  investment  management, 
additional  missions  for  the  depositary  have  been  added  to  the  traditional  UCITS  model.  This  is  the 
case  for  funds  of  hedge  funds:  in  France,  for  instance,  the  depositary  shall  check,  inter  alia,  the 
eligibility  of underlying  funds  and the  quality  of information  provided to the  public  and  of registrars, 
as well  as the  eligibility  of the  investors.  This  is  also the  case  for  hedge  funds,  where  the  depositary 
has  been  seen  as  a fundamental  pillar  for  investor  protection  in the  development  of  European-based 
hedge  funds. 

As opposed to UCITS, the picture  is made more  complex  in the  case  of hedge  funds  by the  existence 
of  an  additional  actor,  the  prime  broker.  In the  case  of  European-based  hedge  funds,  it  is  generally 
provided  that  relations  between  the  prime  broker  and  the  depositary  must  be  formalised,  including 
specific  reporting  and  control mechanisms. The depositary  is indeed given  a supervision  role over the 
prime broker,  as the  investor is to be protected by rules of conduct and risk  spreading  rules  applicable 
to the prime broker as counterparty to the  fund.  In Ireland  for  instance, the  depositary/custodian  has a 
supervisory  duty  over  the  prime  broker  with  regards  to  the  assets  held  by  the  latter.  The 
depositary/custodian  is obliged to receive daily and monthly reports from the prime broker, to monitor 
them  and to  ensure that  regulations  are  being  complied  with.  The  daily  report  must  include  the  daily 
mark  to  market  of  the  assets  held  by  the  prime  broker  as  well  as  an  evaluation  of  all  outstanding 
liabilities of the hedge fund to the prime broker. 

The  role  of  depositaries  when  confronted  with  alternative  investment  strategies  means  more  controls 
over the  inner procedures  of the  fund  and more  supervision  over underlying  funds  investments  using 
more  and  more  complex  investment  techniques.  Hence  there  is  a  need  for  more  sophisticated 
evaluation tools, more  sophisticated  reporting tools and new  expertise  within  controlling  teams of the 
depositary. Developing hedge funds  capability  is a costly exercise for depositaries. The new  European 

EN 

49 

EN 

regulatory  regimes  have  thus  not  been  exempt  of  criticisms  in  the  current  economic  context,  which 
remains difficult  for depositaries. 

The prime broker usually assumes clearing  and  settlement when processing  an order. It is thus  logical 
that it may be able to act as custodian. Furthermore, it is on the basis of the data collected as custodian 
that  the  prime  broker  is  able  to  evaluate  its  risks  when  financing  the  fund’s  positions.  A  difficulty 
created  by the  alternative  management techniques  is the  potential  overlap between the  depositary  and 
the  prime broker in the field of custody.  In  some jurisdictions, the  solution  chosen  is to provide  for  a 
sub-custody  agreement between the depositary and the prime broker, ultimate  legal liability  remaining 
with the  depositary,  as under the  UCITS model, and contractual  liability  being with the prime  broker. 
Some  regulators  consider that the  sub-custody  agreement  may  create  substantial  operational  risks  for 
both  parties  in  the  case  of  hedge  funds,  even  if  this  problematic  already  existed  under  the  UCITS 
model. It must provide  for  adequate  supervision tools  from  the  depositary, where  we encounter  again 
the  issue  of the  technical  challenges.  To  meet this  challenge,  considerable  resources  are needed,  and 
global players are best placed in this respect. 

Thus,  some players  consider to merely  merge  o the  depositary  and  of the  prime  brokerage  activities. 
This  could  be technically  possible  on the  custody  side, but  raises  a lot  of  questions  on the  oversight 
side. 

4.2.  Level  playing  field  with  other  financial  products  competing  with  funds 

As frequently  highlighted by the asset management industry, investment funds,  in particular the highly 
regulated  product  of  UCITS may  be  competing  in certain  cases  with  other types  of financial  savings 
products which appertain to a different  regulatory environment  such as investment certificates  or some 
life-insurance  products.  They  claim  there  is  also  a  level-playing-field  issue  regarding  occupational 
pension provisioning. 

4.2.1.  With pension  funds  (Fund  schemes  as  occupational  pension 

schemes) 

This is one  of the main  issues put forward  by the  fund  industry  also outlined  in the AMWG’s  report. 
The  institutions  for  occupational  retirement  provision  (IORPs)  Directive118  excludes  institutions 
covered  by  Directive  85/611/EEC  from  the  scope  of  application119.  Thus,  management  companies 
under Directive  85/611/EEC  are not “institutions  for occupational  retirement provision”  and  therefore 
cannot operate pension schemes. 

Fund  management  companies  are  explicitly  allowed  by  the  Directive  (Article  19) to  manage  IORPs 
assets. This can be done e.g. by : 

•  Creation of funds  (UCITS and Non-UCITS) to pool assets held by IORPs or 
•  Management  of  IORPs  as  external  manager  by the  means  of  delegation  (individual  portfolio 

management for an institutional client120). 

The  fund  industry  considers  investment  funds  (UCITS)  as  an  appropriate  vehicle  for  occupational 
pensions because in their view they are “flexible,  easily transferable and transparent ”. Therefore, they 
highlight  the  necessity  of  a  review  of  the  IORP  Directive  as  provided  for  by  its  Recital  12: “The 
Commission should  carefully monitor  the situation  in the occupational pension  market and assess the 
possibility  of  extending  the  optional  application  of  this  Directive  to  other  regulated  financial 
institutions”. 

118 Directive 2003/41/EC of  the European Parliament and of the Council of  3 June 2003 on the activities and 
supervision of institutions for occupational retirement provision (IORPs) 
119 cf. explicitly Art. 2 paragraph 2 point b of Directive 2003/41/EC 
120 Art. 5 paragraph 3 point a) of the UCITS-Directive 

EN 

50 

EN 

It  should, however,  be noted  that  occupational  retirement  provisioning  includes  much  more  than just 
asset  management.  In  particular  the  insurance  elements  in the  pay-in  phase  (premiums), the  pay-out 
phase (annuities) and the Asset Liability Management are part of the specific  characteristics of IORPs. 

Nevertheless,  if  investment  funds  were  to  be  made  fully  suitable  for  pension  provisioning  further 
problems  should  also  be  resolved:  for  instance,  the  questions  of  how  to  ensure  the  protection  of 
investor contributions and of appropriate  capital adequacy  rules, as well as compliance with social and 
labour law provisions aimed at protecting members of the pension scheme. 

4.2.2.  With 

life-insurance 

•  Regarding  disclosure  requirements 

UCITS are subject to a set of disclosure requirements  such as two prospectuses, disclosure of TER and 
turnover  rate,  indication  of  fee-sharing  agreements,  disclosure  of  NAV  etc.  The  disclosure 
requirements  for  all  life-insurance  contracts  include  information  before  concluding  and  during  the 
contract121. In particular provisions apply concerning  cooling-off  periods, tax arrangements  applicable, 
indication  of  surrender  and  paid-up  values  and  the  extent  to  which  they  guaranteed.  For  unit-linked 
policies, the  definition  of the  units  to  which the  benefits  are  linked  and  the  nature  of the  underlying 
assets  shall  also  be  disclosed.  Most  of these  requirements  also  apply  in  case  of  changing  the  policy. 
The  insurer  shall  also provide  information  for  handling  complaints.  For both,  life  insurance  contracts 
and  UCITS,  different  requirements  demand  administrative  efforts  which  produce  additional  costs.In 
the  view  of the  fund  industry the  requirements  applicable  to  UCITS might  entail the  risk that  UCITS 
are put in a competitive  disadvantage with certain other products  such life-insurance  contracts. On the 
other hand, if UCITS are made a highly transparent financial  product thanks to these requirements this 
might be possibly rewarded by investor choice so that the related cost might pay off in the long-term. 

• 

In particular:  regarding unit-linked  insurance  products 

The  issue  of  transparency  concerns  particularly  unit-linked  insurance  contracts122.  According  to 
European  legislation  on life  assurance123 the benefits  of an insurance  contract  are  allowed  either to be 
linked to UCITS or to internal funds held by the insurance undertaking.124 The disclosure  requirements 
for  this  type  of  contract  are  fairly  generic.  In  particular  there  are  no  detailed  rules  on  the  cost-
transparency  of  the  product,  but  some  information  requirements  regarding  the  risk-profile  and  the 
investment  policy  of  the  underlying  investment  funds,  although  not  as  extensive  as  applicable  to 
UCITS. UCITS disclosure  requirements  do not apply to internal  insurance  funds  linked to  unit-linked 
insurance  contracts. For that  reason  life  insurers  can not  sell these  funds  to the  general  public  as it is 
possible for UCITS. 

The  management  of internal  funds  by  an  insurer  is  an  activity  allowed  by  insurance  legislation.  It  is 
similar  to  the  management  by  the  insurer  of  its  assets  covering  technical  provisions.  Together  with 
managing  risks  related  to  life  and  death,  asset  management  is  an  important  activity  of  a life  insurer. 
Without  this  activity  it  would  not  be  able  to  fulfil  its  commitments  towards  policyholders.  In 
comparison with the management of UCITS, it may be regarded  as less densely regulated.  This might 

121 Annex II of Directive 2002/83/EC 
122 According to industry research investments in unit-linked  products amounted  to EUR 1020 Billion at the end 
of  2001, equivalent to about 20% of  the assets under management  at European life insurers. The most important 
markets  are  in  the  UK  and  NL, for  instance  the  value  of  unit  linked  funds  under  management  in  UK  was  ca. 
£ 348 billion in 2002. 
123 Directive 2002/83/EC concerning life  assurance 
124 Not all Member States’ legislation  provide for  the possibility of  linking insurance contracts to internal  funds. 
Insurance products linked to “Internal funds”  are for instance rather common in NL or UK. 

EN 

51 

EN 

make  the  management  of  internal  funds  by  insurance  companies  less  expensive  than  that  of UCITS, 
but can also give rise to uncertainties since certain aspects such as regular NAV-calculation  are neither 
regulated  nor  standardised.  However,  although  internal  funds  may  be  less  expensive,  they  do  not 
provide insurers with the option to sell these internal investment funds  directly to the general public as 
UCITS can. 

It should be noted that an insurance  contract (be it unit-linked  or other) is first and foremost  a contract 
that  insures  some  unexpected  events  during  a certain  period.  The  assets  are  owned  by the  insurer. A 
unit-linked  life  insurance  contract  is not a pure investment product that can be  sold at any time. From 
the  perspective  of  a  life  insurer,  unit-linked  life  insurance  is just  a  better  way  of  risk  management 
concerning market risk and an instrument to provide optimal profit  sharing with policyholders. 

•  Regarding  tax  treatment 

Tax  treatment  is  another  issue  highlighted  by  the  AMWG  which  might  impact  the  competitive 
situation  of investment  funds  in comparison  with  insurance  and  pension  products.  In this  respect, the 
“Directive on taxation of savings income in the form  of interest payments”125 has to be mentioned. The 
Directive aims at enabling  savings income in the form  of interest payments made in one Member State 
to beneficial  owners who are individuals resident for tax purposes in another Member State to be made 
subject to effective  taxation  in that latter Member  State. For this purpose  a paying  agent reports to his 
local tax  authority  payments  of  interest  to  individual  investors.  The  local tax  authority  will  pass  this 
information  to  the  country  of  residence  of this  individual.  The  Directive  has  explicitly  extended  the 
concept of interest payment to investment funds  holding interest-bearing  assets: distributions from  and 
proceeds  of  sales  or  redemption  of  investment  funds  that  hold  interest-bearing  investments  above  a 
certain  threshold  are  subject  to  reporting  or withholding.  In  contrast,  insurance  and  pension  benefits 
are  expressly  excluded  from  the  scope  of  application  of  this  Directive.  The  Directive  will  have 
significant  implications  for  the  administration  of  investment  fund;  it  is  expected  that  it  will  affect  a 
large number of investment funds  in Europe.126 

4.2.3.  With  investment 

certificates 

Investment  certificates  are  structured bonds which enable investor to participate  in the performance  of 
a  certain  underlying  without  the  need  to  invest  directly  into  the  underlying.  Similarly  to  investment 
funds,  in case they  refer to  a diversified  pool  of assets, they  can  enable  investors to participate  in the 
performance  of  a  diversified  range  of  assets  and  thus  to  spread  their  risks  by  acquiring  one  single 
security. Even  if some  certificates  are  exclusively  designed  for  institutional  investors  as a response to 
their  regulatory  and/or  tax  needs,  they  are  mainly  marketed  to  retail  clients  and  are  becoming 
increasingly  popular in  some  Member  States. Most  certificates  are  admitted to trading  on a  regulated 
market127.  Certificates  fall  under the  rules  applicable  to  other bonds  such  as the  Prospectus  Directive 
and  MiFID. They  can therefore  be bought and  sold  like  any other bond  admitted to trading. They  are 
not subject to specific  disclosure requirements as regards their cost-structure, their strategy or the risk-
profile  of the product. This issue not only raises concerns with the investment industry  for  competitive 
reasons but also regulators increasingly look at this issue as a matter of investor protection. 

Directive  2003/48/EC 

126 Ernst & Young, EU Savings Directive – An overview, 5/2004 
127  By  the  end  of  2003,  66%  of  the  worldwide  volume  traded  in  certificates  accounted  for  German  stock-
exchanges, 12% for  Hong Kong, 7% for  Switzerland  5% for  Italy and 3% for  the stock  exchanges of  Euronext. 
The  turnover  in  certificates  including  warrants in 2003 was €154.77 billion  at the stock  exchanges in  Germany 
whereas e.g. the turnover in Italy was only €10.83 billion and at the stock exchanges of Euronext €6.29 billion. 

EN 

52 

EN 

In conclusion  of the fourth  section, it is worth to note that the cost/benefit  associated with EU action 
aimed  at  developing  a  common  regulatory  treatment  for  non-harmonised  funds  should  now  be 
assessed.  Actually,  extending  access  to  non-harmonised  products  and  facilitating  their  distribution 
could achieve the following  benefits: 

• 

• 

• 

• 

increasing  the  options  available  to  retail  investors,  enabling  them  to  diversify  their  portfolios, 
whilst adding to the potential for investors to achieve positive returns in falling markets; 
leveraging the level of innovation in the EU asset management  sector, thereby enabling the market 
to fulfil  its potential, and reducing operational costs; and 
assisting the  efficient  operations  of the EU markets, through  increased  capital  available to  exploit 
mis-pricing opportunities, in addition to increasing commercial transparency. 
creating  clearer  distinctions  between  those  investments  that  are  packaged  for  institutional  clients 
only, and those which could be suitable for retail  consumption. 

However, these benefits  cannot be taken as given, and must be measured against the following risks: 

•  maintaining  an appropriate level of investor protection, especially  considering that retail investors, 
even  if  denied  access  to  HFs  or  FoHFs  in  their  country  of  origin,  may  gain  exposure  through 
instruments offered  in other EU jurisdictions; and 
a  potential  threat  to  financial  stability:  failure  of  hedge  funds  could  potentially  give  rise  to 
difficulties  for  counterparties  with  significant  exposures,  including  financial  institutions  in  other 
EU countries. 

• 

Finally,  UCITS  are  not  only  competing  with  non-harmonised  funds  but  also,  potentially  with  other 
financial  products  (e.g.  life-insurance  products,  investment  certificates,  etc.). It  should  be  considered 
to  what  extent  there  are  level-playing  field  issues  which  might  need  to  be  addressed  by  action  on  a 
European  level.  . Nonetheless,  such an action would  only be justified  if it can effectively  enhance the 
efficiency  of the business or to address demonstrable  sources of risk having a cross-border dimension. 

EN 

53 

EN 

Annex A: POOLING  TECHNIQUES,  ADVANTAGES,  RISKS 

1.  Which are the two pooling  techniques? 

Virtual  cross-border  pooling 

By the  utilisation  of information  technology  virtual  pooling  enables two  or more  funds  (or  sub-funds 
of  an  umbrella)  to  commingle  their  assets  in  investment  pools.  The  investment  pool  has  no  legal 
personality.  The  participating  funds  retain  the  legal  and  beneficial  ownership  of  their  assets.  The 
commingled  assets are held in one account serviced by the custodian (omnibus account). 

Contractual  arrangements  between  the  participating  funds  and  the  custodian  ensure  that  the 
participating  funds  have the right to contribute/withdraw  cash or assets to/from  the account, to exclude 
other participating  funds  etc. These  contractual  arrangements  ensure that the  quality  of the  ownership 
of  assets  of the  participating  funds  remains  as  if these  assets  were  held  in  a  separate  account  to  the 
order  of the  respective  participating  fund.  The  holders  of the  account,  i.e. the  participating  funds  (or 
sub-funds)  contractually  appoint an investment manager.  This investment manager executes the trades 
of  the  assets  held  in  the  account  on  behalf  of  the  participating  funds.  The  custodian  and/or  the 
administrator,  which are usually but not necessarily the  same entity, keep on the one hand the  custody 
records  of the  pool  in  an  omnibus  account,  but  also  on the  other  hand  the  ownership  records  of  the 
participating funds  with respect to the assets held in the omnibus account.  128 

“Entity pooling”  (“master-feeder”  funds) 

Entity pooling  utilises  legal entities to undertake  pooling. There  are two  forms  of pools which  can be 
used for this purpose, “opaque” pools or “transparent pools”: 

An  opaque  pool has a separate  legal personality  of its own.  The participating  funds  are the  owners  of 
units  in the  pool  which  in turn  is the  legal  and  beneficial  owner  of an  underlying  portfolio  of assets. 
Therefore,  although the participating  funds  retain the  same  economic  risks  and benefits  as if they  had 
directly  invested  in that underlying  portfolio,  their legal entitlement  is the units of the pool and not to 
the underlying  portfolio  itself. This  structure  is more  or less equivalent to the master-feeder  structures 
known  in the USA, whereby the master fund  holds the underlying  portfolio  of assets whilst the  feeder 
funds  exclusively  invest  in  the  units  of  the  master  fund.  With  respect  to  cross-border  business  two 
basic scenarios regarding these structures are conceivable: 

•  The  master-fund  is  domiciled  in  one jurisdiction,  and the  feeder  funds  which  are  exclusively 

invested in this master fund  are domiciled in another jurisdiction 

•  Both the master and the feeder  funds  are located  in the  same jurisdiction; the  feeder  funds  are 

distributed  on a cross-border basis. 

A transparent  pool  has no  legal  personality  of  its  own.  The participating  funds  contract  between  one 
another  for  common  ownership  of  an  underlying  portfolio  which  is  managed  through  a  partnership-
type agreement. In certain respects  (particularly  for fiscal  purposes) the participating  funds  are deemed 
to  remain  the  legal  and  beneficial  owners  of the  underlying  portfolio  of  securities. An  example  for  a 
transparent  pool  is the  common  contractual  fund  (CCF)  Ireland  has recently  permitted  by  law  for  the 
area  of  pension  pooling.  Similar  structures  are  apparently  less  common  for  the  area  of  investment 
funds.129 

128 Pooling, Report IMA December 2004 p. 8-9 (draft version only!). 
129 Pooling, Report IMA December 2004 p. 2-8 (draft version only!). 

EN 

54 

EN 

2.  Potential advantages of pooling 

Reduction of administrative costs 

According  to  some  industry  research  European  investment  fund  managers  are  unable  to  enjoy 
significant  economies  of  scale  because  small,  local  markets  restrict  the  average  size  of  investment 
funds.  Pooling  would  help  to  realise  those  economies,  since  the  average  size  of  the  pool  would 
necessarily  be  larger  than  that  of  the  participating  funds.  Those economies  might  be shown  between 
fund  managers  and  investors,  provided  that  these  benefits  are  passed  on  the  investors.  It  should  be 
noted  that  although  pooling  can  approximate  economies  of  scale,  these  are  somewhat  offset  by 
diseconomies of  administration. 

Qualitative  benefits 

Some  qualitative  benefits  from  the  investment  management  perspective  are  also  cited  which  are, 
however,  difficult  to  quantify.  For  instance,  consistency  of  performance  could  be  improved:  the 
performance  of  the participating  funds  would  vary; however, it  would  be clear  that  these  differences 
arise because of  local taxes or other  local  particularities, since the performance  of  the pool would  be 
necessarily  common  to  all  the  participating  funds.  Similar  aspects  would  also  apply  regarding  risk-
management  because  the risks of  the  pool would  be submitted  to the same risk-management  process 
independently  of  whether  the assets belong to an Italian SICAV, a German  Sondervermögen  or a UK 
unit trust. Furthermore, the risks of  volatile  performance  of  smaller  funds  could  be reduced  since  the 
pool, due its size, tends to be less volatile over time. 130 

3.  Risks related to these techniques 

Operational risks: 

Pooling  mainly  gives rise  to operational  risks. For  instance, in case  of  virtual  pooling  there are  risks 
related  to  a  potential  segregation  of  the  pooled  assets. Assets  belonging  to one  participating  fund  or 
sub-fund  are not  segregated  from  the assets of  the other  funds  or sub-funds  participating  in the  same 
investment  pool. In certain situations (e.g. in case of  the liquidation of  one of  the participating  funds) 
there  is  the  requirement  for  the  specific  assets  of  the  fund  or  sub-fund  to  be  segregated  into  a 
designated  account  to  the  order  of  the  respective  fund  or  sub-fund.  There  is  the  risk  that  e.g.  due  to 
insufficient  IT- and control system this segregation process is not properly  carried out or delayed. For 
all  types  of  pooling,  risks  related  to  the  smooth  and  timely  exchange  of  information  and  reporting 
between the participating funds  and the pool are relevant. 

Dilution  risk  and  associated  risks  regarding  allotment/re-allotment  of  assets  and  transaction 
costs 

These risks are relevant for all types of pooling: pooling can result in a dilutive effect  at the expense of 
existing shareholders and to the benefit  of  the incoming shareholders. Due to a subscription  the share 
of  the existing shareholders in the portfolio  is temporarily diluted with cash until such time as the cash 
is  invested.  Though  there  is  conceptually  no  difference  to  what  happens  within  an  existing  fund  it 
should also be taken into account in the case of pooling. 

Furthermore,  there  is  the  need  to  carry  out  a  double  allotment  process:  one  allotment  process 
“distributes”  the proceeds  of  the investment  decisions  taken  by  the  investment  manager  amongst  the 
participating funds; another allotment process adjusts the participating fund/sub-fund  portfolios  further 
to subscriptions, redemptions, conversions  or distributions. Particularly  in this latter  case, there is the 
risk  that  undue  transactions,  costs  or  settlement  expenses  have  to  be  borne  by  one  or  several  of  the 
participating  funds/sub-funds  through  the  acquisition  or  disposal  of  assets  to  meet  a  subscription  or 
redemption in another participating  fund/sub-fund. 

130 Pooling, idem, p. 15-17 (draft version only!). 

EN 

55 

EN 

Risk of circumvention of investment policy of the participating  funds 

There  is the  risk  for  all  type  of  pooling  that  the  investment  restrictions  imposed  on  the  participating 
funds  (by law and by sales documents) are circumvented by the management of the pooled assets. 

Legal, regulatory and supervisory risks 

Closely  related  to the risk of  circumventing  the investment  policy of  the participating  funds  are those 
risks which  result  from  the fact  that the pool of  assets and the participating  funds  fall  under  different 
jurisdictions. This  is particularly  relevant  in  case  of  entity  pooling, i.e. master-feeder  structures. The 
master  fund  and  the  feeders  might  be  supervised  according  to  different  regulatory  and  supervisory 
structures. This scenario also gives rise to the question of legal responsibility: the investment decisions 
are taken  by the master  fund  which  is located  in one jurisdiction  whilst  the feeder  funds  which  fully 
depend  on  these  decisions  fall  under  another  jurisdiction.  In  case  something  goes  wrong  with  the 
master  fund  there is the risk that the legal responsibilities  remain unclear and that the investors of  the 
feeder  funds  do not have the necessary  protection  because the national authorities of  the feeder  funds 
have no direct legal means to take necessary action against the master  fund. 

In addition  there might  be a need to consider  the role of  the joint-liability  of  the holders of  the  funds 
participating  in  a  pool, i.e.  whether  investors  in  a  given  fund  should  be  liable  for  the  obligations of 
another  fund.  Such  joint-liability  seems  to  be  problematic  because  the  investor  might  be  exposed  to 
risks  of  funds  which  he  has  not  selected  for  his  investment.  It  should  be  clarified  to  what  extent 
pooling  techniques  rely  on  the  joint-liability  of  the  investors  of  the  participating  funds  and  what 
practical safeguards could be applied in order to ensure adequate investor  protection. 

EN 

56 

EN 

ANNEX B: SOME NATIONAL FRAMEWORKS RELATED TO ALTERNATIVE FUNDS 

•  UK 

Despite  being  a  key  player  in  the  HF  arena131,  there  is  no  specific  regulatory  regime  for  the 
marketing of hedge fund  products in the UK. As unregulated collective investment schemes they 
are, however  not  allowed  to  be freely  offered  to  retail investors  but  to  intermediate  customers, 
market counterparties or to private customers where a firm  has taken reasonable steps to ensure 
that  the  fund  is  suitable132.  On  the  other  hand,  FoHFs  that  are  officially  listed  are,  therefore 
marketable to the general public. 

Following a public consultation on the basis of a discussion paper on HFs133, the UK  authorities 
noted  that, there  does not  seem to  be a significant  demand  from  retail investors to  access  HFs 
and  concluded  that  it  was  “not  appropriate  to  change  the  regulatory  regime  to  allow  easier 
marketing of HFs to retail consumers”134. 

More  recently, the  Qualified  Investor  Scheme  has been  introduced  as an attempt  to  encourage 
the  establishment  onshore  of  HFs.  This  scheme,  available  only  for  sophisticated  investors, 
permits managers to engage in many of the strategies which would be available for single HFs135. 

Concerning  HF  managers,  there  is  a  continuous  important  growth  in  their  number.  In  fact, 
according to the FSA, some two thirds of  the request for  authorisation  received  corresponds  to 
HF managers. 

•  France 

France has reviewed the framework  for  alternative investments (“gestion alternative”) in November 
2004. There  are  now  four  kinds  of  new  collective  investment  schemes  (CIS): the  funds  ARIA 
(Agrées  à  Règles  d’Investissement  Allégées136),  leveraged  ARIA  (ARIAEL),  contractual  funds  and 
FCIMT (Fonds communs d’intervention sur les marchés à terme). Those funds  can be offered  to  qualified 
investors  (without  any  quantitative  restriction)  and  to  retail  investors  subject  to  investment 
thresholds which vary according to the perceived risk of  the fund  (€ 0 for  guaranteed  FoHFs, € 
10.000 for FoHFs and FCIMT, € 125.000 for other ARIA funds, € 250.000 for contractual  funds) 
and the net worth and experience of the investor. 

•  Germany 

The entry into force on 1st January 2004 of the new Investment Act established a legal framework 
for HFs and FoHFs. For single HFs (domestic or foreign), distribution is only allowed via private 
placement  but  under  certain  conditions  (e.g.  that  the  offeree  be  able  to  fend  themselves). 
Domestic domiciled HFs are permitted  to use leveraging techniques and short selling. As regard 
to FoHFs, both  domestic and foreign  FoHFs can be distributed  publicly. In  the case of  foreign 
ones,  there  are  allowed  to  do  so  only  if  they  are  subject  to  public  supervision  in  their  home 
country  and  if  the  relevant  regulatory  authorities  show  willingness  to  collaborate  with  the 

131 An estimated  15 to 20% of the global HFs assets is managed  by firms authorised  in the  UK. 
132 “Hedge Funds and the FSA”, UK Financial Services Authority, August  2002, p.13 
133 “Hedge Funds and the FSA”, UK Financial Services Authority, Discussion  Paper 16, August 2002, p.13 
134 “Hedge Funds and the FSA: Feedback  statement  on DP16”, UK Financial Services Authority, March 2003, p.5 
135 QIS investment  powers  are, however,  limited. For  instance,  borrowing  and  the exposure  to  derivatives  must  not 
exceed the net asset value. 
136 Registered  funds  with less stringent  investment  rules. These rules allow funds  to use leverage  (but limited  in  most 
cases) and more flexible  investment  ratios. 

EN 

57 

EN 

German Financial Services Supervisory Authority. If  this is not the case, foreign  FoHFs can still 
be  distributed  in  Germany  but  via  private  placement.  Furthermore,  both  domestic  and  foreign 
FoHFs have to comply with investment limits137 and minimum disclosure requirements. 

•  Luxembourg 

The Grand  Duchy is, behind  Dublin, one of  the first  centres in terms of  volume of  HFs  under 
administration. HFs assets serviced from  Luxembourg are reported to amount to € 10 billion for 
single HFs and to be in excess of € 40 billion for FoHFs138. Part of the recent years’ rapid growth 
of  the  HFs  industry  in  Luxembourg  seems  to  have  been  supported  by  the  issue  of  the 
Commission  de  Surveillance  du  Secteur  Financier  (CSSF)  circular  of  5th  December  2002  on 
Alternative  Investments  (Circular  2002/80).  This  circular  which  set  for  the  first  time  the 
regulatory  framework  for  HFs  in  Luxembourg139,  permits  regulated  HFs  to  engage  in  short 
selling, to borrow securities, to have a much greater flexibility in the use of derivative instruments 
and  to  use leverage. The  Ministerial  decree  of  5th July 2004 and  the  CSSF Circular  04/151 will 
facilitate  the  listing  of  offshore  funds  on  the  Luxembourg  Stock  Exchange.  This  legislative 
change  is believed  to  be  an  opportunity  for  Luxembourg  to  reduce  the  distance  with  its  main 
competitor (Dublin). 

• 

Ireland 

Ireland is the leading European  centre for  HF administration. Estimates point to $200 billion of 
administered assets. The possibility to list HFs on the Dublin stock exchange is said to be one of 
the reasons for this. 

Single  manager  HFs  can  be  created  as  Professional  Investor  Funds  (minimum  investment 
amount is € 125.000; investment restrictions can be relaxed on a case by case basis) or  Qualifying 
Investor  Funds  (€  250.000  minimum  investment  amount;  no  restriction  regarding  the  fund’s 
investment  policy). Retail  FoHFs  are  permitted  as  from  December  2002. Their  diversification 
requirements  have  been  relaxed  in  June  2004  and  their  minimum  investment  requirement 
abolished.  Current  discussions  between  IFSRA  and  the  HF  industry  aim  to  review  the  prime 
brokers’ regulatory environment and the access of retail investors to single HFs. 

• 

Italy 

The Ministerial Decree 228 of  24 May 1999 and the Bank of  Italy decree of  20 September 1999 
introduced  a  new  type  of  funds,  the  “fondi  speculativi”.  Those  funds  can  be  single  manager 
funds  or  FoHFs. In  April  2003 the  minimum  investment  amount  for  both  types  of  fund  was 
reduced from  € 1 million to € 500.000 and the maximum number of investors per fund  increased 
from  100 to 200. 

•  Spain 

A  draft  Decree  prepared  by  the  Ministry  of  Economy  is  at  present  under  consultation.  If 
adopted, this new regulation will set the framework  for the establishment and distribution of  HFs 
in  Spain.  According  to  the  draft,  HFs  which  will  be  allowed  to  offer  their  parts  only  to 
institutional  investors, will not  be  subject  to  the  investment  limits imposed  to  other  collective 
investment  schemes. They will have, however, to respect  the principles of  transparency  liquidity 
and risk diversification. On the other hand, FoHFs seeking authorisation will have invest at least 
60% of  their assets in Spanish or non tax haven-based HFs and limit to a maximum of 5% their 

137 FoHFs should invest only in HFs, have no more than 20% of  its assets in a single target fund,  not use leveraging 
techniques or engage in short-shelling… 
138 “Boom in Luxembourg HFs “, Association of the Luxembourg Fund Industry, Newsletter October 2004 
139 Prior to the issue of this circular, HFs were authorised by the regulator on a case by case basis. 

EN 

58 

EN 

investment in an only HF. They will be available to retail investors. Both HFs and FoHFs should 
calculate the portfolio value daily and allow for at least monthly  subscriptions/redemptions. 

Country 

Manager Capital 
Requirements1 

Regulated Products 

RetailDistribution? 

UK 

€50.000 own funds + liquid 
capital of 3 months annualised 
expenditure 

Qualified  Investor Scheme 

FoHFs 

Ireland 

€50.000 initial capital + 3 months 
annualised  expenditure 

Professional  Investor Fund 

Qualifying  Investor Fund 

Italy 

€ 1.000.000 

FoHFs 

HFs 

FoHFs 

ARIA 

France 

€  125.000 

ARIAEL 

Luxembourg 

€  125.000 

Germany 

€ 730.000 

Spain3 

€ 300.000 

FoHFs 

HFs 

FoHFs 

HFs 

FoHFs 

HFs 

FoHFs 

Threshol 
d 

None 

€  125.000 

€ 250.000 

None 

€ 500.000 

€  125.0002 

€ 250.0002 

€  10.0002 

None 

No 

Yes 

No 

Yes 

No 

Yes 

Yes 

Yes 

Yes 

Yes, but only on a private 
placement basis 

None 

Yes 

No 

Yes 

None 

1  capital requirements for HFs managers are often  the same as those for other asset managers. Capital requirements for some countries as at May 
2003. 
2 minimum investments is € 0 for qualified  investors 
3 draft  regulation, not yet in force 

EN 

59 

EN