White paper white paper on enhancing the single market framework for investment funds    {SEC(2006)1451} {SEC(2006)1452}
Date: 2006-11-15
Institutions: European Commission
Subjects: financial instrument, financial market, investment, investment company, investment policy, securities

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 15.11.2006 
COM(2006) 686 final 

WHITE PAPER 

WHITE PAPER ON ENHANCING THE SINGLE MARKET FRAMEWORK FOR 
INVESTMENT FUNDS  

{SEC(2006)1451} 
{SEC(2006)1452} 

(presented by the Commission) 

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WHITE PAPER 

WHITE PAPER ON ENHANCING THE SINGLE MARKET FRAMEWORK FOR 
INVESTMENT FUNDS 

Introduction: 

Investment  funds  provide  retail  investors  with  access  to  professionally  managed  and 
diversified investments on affordable terms. European investors will need a capable and well-
regulated  asset  management  business  as  the  ageing  of  society  requires  them  to  take  more 
responsibility for their long-term financing needs. This is already driving huge growth in this 
business – within Europe and globally. Institutional investors, including funds, are responsible 
for a growing share of household investment in all G-10 countries. Investment funds account 
for  12.6%  of  European  household  financial  assets.1  EU  investment  funds  have  experienced 
five-fold  growth  in  assets  under  management  over  the  space  of  12  years.  Growth  rates  of 
around  10%  per  annum  are  expected  in  the  period  to  2010  -  bringing  total  assets  under 
management  by  funds  to  over  8  trillion€.  The  cornerstone  of  the  EU  framework  for 
investment funds is the 1985 UCITS Directive. The UCITS Directive2 has provided the focal 
point  for  the  growth  of  a  vibrant  European  fund  industry.  This  market  is  increasingly 
organised on a pan-European basis. The UCITS product passport is in widespread use. Cross 
border fund sales represented some 66% of the total net industry inflows in 2005.  

The  challenge  for  EU  policymakers  is  to  ensure  that  this  regulatory  framework  remains 
effective  in  the  face  of  changing  market  dynamics  and  investor  needs.  Profound  structural 
changes  in  European  financial  markets  are  putting  new  strains  on  the  UCITS  regulatory 
system. This White Paper sets out the views of the European Commission on ways to simplify 
the  European  legislative  environment  while  providing  attractive  and  secure  investment 
solutions to investors.  

Box: Investment funds, UCITS and non-UCITS: 

Investment funds are specially constituted investment vehicles, created with the sole purpose 
of gathering assets from investors, and investing those assets  in a diversified pool of assets. 
Investors  buy  securities  issued  by  the  fund  against  the  underlying  assets,  and  the  value  of 
those securities fluctuates with the value of the underlying assets. In this way, small investors 
can  buy  exposure  to  a  professionally  managed  and  diversified  basket  of  financial  or  other 
assets. Overheads are spread over the pool of investors, reducing average cost for the investor. 
Investors may be able to sell their shares back to the open when they want (open-ended funds) 
or their assets may be locked up for a fixed period (closed-end). 

UCITS  (Undertakings  for  Collective  Investment  in  Transferable  Securities)  are 
investment funds established and authorised in conformity with the requirements of Directive 
85/611/EEC.  This  Directive  lays  down  common  requirements  for  the  organisation, 

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EFAMA Fact Book, 2006. 
Directive  85/611/EEC  of  Council  as  amended  by  Directives  2001/107/EC  and  2001/108/EC  of  the 
European Parliament and Council. 

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management  and  oversight  of  the  fund.  It  imposes  rules  relating  to  fund  diversification, 
liquidity and use of leverage. The UCITS Directive defines a list of eligible assets in which 
the fund can invest. Once authorised, a UCITS fund can be marketed to the public across the 
EU subject to notification in each Member State where it is sold. 

"Non  UCITS"  is  a  catch-all  term  referring  to  all  non-harmonised  funds  whether  subject  to 
national regulation or not. This comprises a wide range of investment styles and products – 
ranging  from  retail-oriented  products  such  as  open-ended  real  estate  funds  to  more  volatile 
products such as commodity and private equity funds. 

European investment fund industry

Private Equity
2%

Hedge Funds
4%

Other non-
UCITS
20%

UCITS
74%

Introducing greater efficiency in the current framework: 

The  UCITS  Directive  is  no  longer  sufficient  to  support  the  European  fund  industry  as  it 
restructures  to  meet  new  competitive  challenges  and  the  changing  needs  of  European 
investors.  Core  elements  of  the  Directive  are  not  functioning  effectively.  The  freedoms 
conferred by the Directive come at the price of unnecessarily high compliance costs. It does 
not  allow  fund  managers  with  funds  or  activities  in  different  Member  States  sufficient 
flexibility  to  organise  or  restructure  businesses.  These  inefficiencies  and  constraints  are 
reflected in higher costs and lower returns that are borne by the fund investors. Independent 
research estimates that a reduction in European fund operating costs to US levels costs would 
boost  nominal  investment  returns  by  3%.3  The  steps  envisaged  in  this  White  Paper  are  of 
potentially significant importance to the millions of households which have invested in funds. 
For  these  benefits  to  trickle  down  to  end-investors,  there  will  be  a  need  for  effective 
competition all along the fund value chain. 

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CRA (2006).  

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Tackling broader challenges: 

The current EU framework is faced with new challenges to its scope and approach: 

(1) 

(2) 

(3) 

There  is  a  widening  gap  between  the  UCITS  sector  and  market  reality:  Many 
retail funds cannot comply with the prescriptive investment rules of the Directive: they 
are available to retail investors at national level but not cross-border. The Directive has 
already  been  amended  once  to  include  a  wider  range  of  investment  policies.  The 
Commission is currently clarifying whether a wider range of investments policies are 
compatible  the  Directive  provisions.  However,  continued  innovation  means  that  we 
are  continually  forced  to  revisit  this  issue.  The  White  Paper  foresees  a  systematic 
review of investment rules and fund performance used by both harmonised and non-
harmonised funds. 

Investment fund managers will be in the front-line in providing individuals with 
options to save for retirement. Investment funds provide an established vehicle for 
accumulating capital throughout working life. The challenge now is to transform those 
savings into a predictable and secure income for investors in retirement. The race to 
develop those products is on.  

Competition  from  other  forms  of  financial  product.  Many  market  practitioners 
argue  that  it  is  more  expensive  and  restrictive  to  manage  a  UCITS  fund  than  to  sell 
other types of investment product – such as (unit-linked) life insurance or structured 
notes and certificates. Because of different regulatory and product features, this is like 
comparing apples and pears. The Commission does not believe that the answer lies in 
extending UCITS-type regulation to all long-term savings vehicles. It does see a need 
for  constant  regulatory  engagement  to  ensure  that  all  investment  products  are  sold 
subject to clear rules that protect investors from excessive charging or mis-selling. The 
Commission will publish the result of market research on this point in mid 2007.  

(4)  Meeting  the  challenge  of  global  competition.  UCITS  authorisation  has  won  wide 
global recognition as a guarantee of sound product structuring and effective regulation. 
An innovative and soundly regulated European fund industry is already exporting its 
know-how  to  other  regions.  However,  competition  from  other  fund  jurisdictions  is 
starting to build. Constant efforts will be needed to remain in the global vanguard.  

Building on the existing framework: 

This White Paper foresees a progressive development of the existing framework. It proposes 
to  modernise  and  complement  it  in  a  number  of  specific  and  targeted  areas  –  notably  by 
eliminating  procedures  and  costs  that  do  not  materially  enhance  investor  protection.  It 
recognises  uncertainty  about  the  appropriateness  of  the  scope  and  design  of  the  present 
Directive.  It  concludes  that,  on  balance,  there  are  insufficient  grounds  to  undertake  a 
fundamental revision of the Directive at this stage. Instead, it envisages a structured review of 
the need for changes to the scope and regulatory approach of the Directive as the contours of 
the fund market evolve.  

The White Paper foresees actions to: 

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(1) 

(2) 

(3) 

(4) 

Strengthen  single  market  freedoms,  thereby  enabling  the  fund  industry  to  serve 
European and global investors more efficiently; 

Ensure that investors are in a position to make informed investment decisions and rely 
on qualified intermediaries for objective expert assistance; 

Assess whether a single market framework should be created to allow the cross-border 
sale  of  some  types  of  non-UCITS  to  retail  investors  and  how  this  could  most 
effectively be done; 

Launch  work  on  a  European  'private  placement'  regime  to  facilitate  the  sale  of  non-
harmonised funds and financial instruments to institutional and sophisticated investors 
in other Member States. 

This White Paper has been developed on the basis of extensive consultation and debate with 
consumers,  industry  practitioners  and  policymakers  over  a  period  of  two  years.  It  builds  on 
responses  to  the  Commission  Green  Paper  of  July  20054;  three  reports  from  specially-
constituted  industry  expert  groups  and  stakeholder  responses5;  series  of  ad  hoc  initiatives 
including two workshops on simplified prospectus. It also responds directly to the important 
concerns  raised  in  the  report  of  the  European  Parliament.  The  steps  proposed  in  this  White 
Paper have also been the object of rigorous impact assessment. 

1. 

SUPPORTING A MORE EFFICIENT EUROPEAN FUND INDUSTRY:  

In  July  2005,  the  Commission  Green  Paper  identified  the  following  shortcomings  in  the 
existing legislative framework: 

–  Bottlenecks  and  failures  of  the  product  passport.  Procedures  for  cross-border  marketing 

take too long, are too costly and subject to too much supervisory interference; 

–  Sub-standard  investor  disclosures:  the  simplified  prospectus  does  not  help  investors  or 

their advisors to make sound investment decisions.  

–  Proliferation of small inefficient funds: The Directive provides no mechanisms to facilitate 
the amalgamation of funds or pooled management of assets. The European fund market is 
populated by small and relatively expensive funds, driving up costs. 

–  Obstacles to functional and geographic specialisation. The Directive requires concentration 
of all value chain activities in one Member State: only the fund can be 'pass-ported'. These 
legislative restrictions prevent the fund industry from taking full advantage of all locational 
and specialisation benefits on offer in the single market.  

The  Commission  services  have  examined  these  supply-side  inefficiencies  and  assessed  the 
positive and negative  impacts of different options  for  their  removal.  The  impact assessment 
provides a clear-cut expectation that action on a number of areas will deliver benefits which 

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COM(2005) 314 , final, 14.07.2005. 
Reports of the expert group on investment fund market efficiency and the expert group on alternative 
investments  (hedge  funds  and  private  equity).  Reports  and  conclusions  of  an  open  hearing  on  these 
reports are available at http://ec.europa.eu./internal market/securities/ucits/.  

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outweigh  costs  or  risks  of  action.  It  also  finds  little  evidence  in  support  of  a  number  of 
actions.  This  section  introduces  those  points  where  the  Commission  will  quickly  come 
forward  with  proposals  to  change  the  existing  Directive.  Some  of  these  freedoms  are 
complementary.  They  provide  fund  managers  and  administrators  a  menu  of  options  for 
harnessing the efficiency benefits of a single market through a number of business models. 

1.1. 

Removing administrative barriers to cross-border marketing:  

Before  marketing  a  fund  in  another  Member  States,  the  UCITS  Directive  requires  the  fund 
manager  to  file  extensive  documentation  with  the  relevant  local  authority  and  wait  for  two 
months while the latter verifies compliance with local advertising rules. The deadline of two 
months  is  not  always  respected.  Cases  have  been  reported  where  it  has  taken  eight  to  nine 
months  to  complete  the  notification  process.  There  are  few  identifiable  benefits  from  the 
present notification system. It is a pure cost for market participants. It severely hampers the 
roll-out of new products across the single market. 

Extensive efforts to remove the most important sources of administrative friction have been 
undertaken,  culminating  in  CESR6  guidelines  in  June  2006.  However,  these  worthy 
improvements  cannot  overcome  the  administrative  and  procedural  obstacles  that  have  their 
origin on outmoded provisions of the Directive.  

The  Commission  will  table  proposals  to  amend  Articles  44-47  of  the  Directive.  The 
existing administrative procedures that must be satisfied before a fund can be marketed in 
another Member State – notably detailed ex-ante verification of fund documentation by 
the host authority and the current 2 month maximum waiting period - will be scaled back. 
Documentation  and  other  exchanges  shall  take  place  on  a  regulator-to-regulator  basis. 
Supervisory-cooperation  mechanisms  will  be  introduced  to  ensure  speedy  resolution  of 
identified problems. Host supervisors should focus compliance with local marketing and 
advertising rules on the intermediaries directly responsible for those activities in the host 
jurisdiction rather than the partner country fund manager. 

1.2. 

Facilitating cross-border fund mergers. 

The  UCITS  market  is  populated  by  funds  of  sub-optimal  size:  some  54%  of  UCITS  funds 
have less than 50million€ in assets under management. Consequently, important economies of 
scale  remain  unexploited  and  the  end  investor  bears  unnecessarily  high  costs.  Research  has 
estimated that costs could be annually reduced by 5-6 billion€.  

In  the  absence  of  a  facilitating  EU  framework,  fund  mergers  are  complex,  time  consuming 
and  expensive  –  where  at  all  possible.  Cross-border  fund  mergers  are  faced  with  particular 
hurdles  –  arising  from  differences  between  national  legal  and  supervisory  arrangements.  In 
2005,  only  3.5%  of  mergers  were  cross-border.  Cross-border  fund  mergers  should  not  give 
rise  to  adverse  tax  consequences  for  investors.  Many  Member  States  already  operate  tax 
arrangements which ensure that mergers between domestic funds take place in a tax-efficient 
way. It is essential to ensure that such benefits are extended to mergers involving funds from 
another Member State. 

6 

Committee of European Securities Regulators 

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The Commission will propose additions to the UCITS Directive to create the appropriate 
legal and regulatory conditions for the merger of funds. These provisions will ensure that 
fund mergers take full account of the needs of investors in the merging funds. There will 
in  particular  be  a  need  to  ensure  effective  advance  disclosure  on  the  merger  and  to 
provide the possibility for the unit-holder to redeem free of charge.  

As  far  as  taxation  of  cross-border  UCITS  mergers  is  concerned7,  the  Commission 
considers  it  preferable  to  build  on  relevant  case-law  of  the  European  Court  of  Justice. 
This route seems more promising than tabling proposals for tax harmonisation which will 
require  unanimous  support  of  27  Member  States.  On  the  basis  of  European  Court  of 
Justice  (ECJ)  case-law,  the  Commission  will  come  forward  with  a  Communication  to 
clarify  that  national  tax-neutral  arrangements  should  be  extended  to  mergers  involving 
funds domiciled in another Member State.  

1.3. 

Asset pooling8: 

Asset pooling allows simultaneous management of assets gathered by different funds – while 
maintaining  a  local  fund  presence  in  different  target  markets.  The  skills  and  costs  of 
successful management teams can be spread over a wider pool of assets. These techniques are 
not only relevant for investment funds but also as a possible model for pension funds. Pooling 
is increasingly used in some Member States. However, there are significant barriers to cross-
border asset pooling.  

A  technically  and  legally  straightforward  approach  to  'asset  pooling'  is  known  as  'entity 
pooling'.  This  approach  is  currently  ruled  out  by  the  diversification  requirements  of  the 
UCITS  Directive.  However,  there  is  a  strong  support  and  extensive  experience  regarding 
some  entity  pooling  structures  (e.g.  master-feeders).  A  second  approach,  known  as  'virtual 
pooling', does not require the legal transfer of assets to a receiving fund. But it places heavy 
demands on fund administration and back-office functions. Some regulators have reservations 
about  this  relatively  new  and  untested  technique  –  particularly  as  regards  transparency  and 
contract enforceability, but also as regards robustness of IT and risk management controls.  

The  Commission  will  propose  amendments  to  the  diversification  rules  and  other 
provisions of the Directive in order to allow an expansive approach to 'entity pooling'. In 
preparing legislation, the Commission will also further explore the soundness of virtual 
pooling  techniques  and  the  need  for  Directive  amendments  Directive  to  provide  legal 
certainty and underpin effective management and supervision of such structures.  

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8 

Most UCITS do not qualify for the "Tax merger Directive" (Council Directive 90/434/EEC)  
Asset  pooling  refers  to  the  aggregation  of  assets  of  different  investment  funds  with  a  view  to  co-
managing  those  assets  as  a  single  pool  –  thereby  reaping  scale,  liquidity  and  other  trading  benefits. 
Pooling  can  take  the  form  of  'entity  pooling'.  The  assets  of  participating  funds  are  aggregated  in  a 
separate  legal  entity.  Master-feeder  structures  are  a  form  of  entity  pooling  in  which  the  feeder  funds 
transfer all assets received to the master fund. Virtual pooling uses information technology to aggregate 
the assets of participating funds as if there were an underlying pool, but without constituting the pool as 
a legal entity. 

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1.4.  Management company passport: 

Currently, management groups need to establish a fully functional management company in 
each  country  where  they  domicile  a  fund:  these  must  satisfy  costly  local  substance 
requirements.  This  pushes  up  costs  and  prevents  scale  and  specialisation  gains.  The  2001 
amendment  failed  to  introduce  an  effective  management  company  passport  for  corporate 
funds. It is time to complete this unfinished business and to extend these rights to contractual 
funds. The Commission is confident that solutions can be found to meet supervisory concerns 
about splitting responsibility for  supervision of fund administration from  fund  management. 
There  will  be  a  need  for  careful  consideration  of  the  scope  of  pass-portable  management 
services and attention to ensure that the management company passport does not complicate 
the  tax-efficient  structuring  of  the  fund  chain..  The  management  Company  passport  should 
not empty control in the country of domicile of all substance. This would undermine effective 
oversight  of  the  fund  by  the  depositary  –  one  of  the  mainstays  of  investor  protection  in  the 
UCITS Directive. 

The  Commission  will  propose  amendments  to  the  Directive  to  allow  an  authorised 
management  company  to  manage  corporate  and  contractual  funds  in  other  Member 
States. The scope of passport-able services will need to be carefully tested and validated 
during the preparatory phase.  

1.5. 

Strengthening supervisory cooperation:  

The above changes to the single market framework for investment funds will pave the way for 
cross-border  operations,  platforms  or  structures  which  may  be  legally  and  technically  more 
complex.  Different  enforcement  authorities  may  be  responsible  for  different  actors  in  the 
reconstructed value chain. Effective supervision of cross-border structures and functions will 
need  to  be  underpinned  by  full  and  timely  cooperation  between  the  relevant  national 
authorities.  For  example,  the  desired  streamlining  of  fund  notification  procedures  will  be 
accompanied  by provisions imposing an obligation  on  the  fund's  home  authority  to  respond 
effectively  to  partner  country  concerns  in  a  timely  fashion.  Other  amendments  –  such  as  a 
management  company  passport,  pooling  structures  and  mergers  –  will  all  require  clear 
specification  of  respective  responsibilities  of  different  supervisory  authorities,  and 
clarification  of  the  duties  that  the  different  supervisors  owe  to  their  colleagues.  This  will 
increase confidence in the soundness of cross-border structures. The Commission is confident 
that effective supervisory co-operation can be found for UCITS as they have been found for 
other  sensitive  areas  of  securities  law  enforcement  (e.g.  market  abuse).  The  CESR  expert 
group  on  investment  management  is  already  proving  its  worth  as  an  effective  network  for 
finding pragmatic solutions to common supervisory challenges. 

The  Commission  will  table  proposals  to  strengthen  the  provisions  of  the  UCITS  Directive 
relating to competent authorities and supervisory cooperation. Amendments will be modelled 
on  the  relevant  provisions  of  more  recent  securities  legislation  (e.g.  MiFID9  and  the 
Prospectus  Directive).  Enforcement  authorities  will  be  required  to  provide  timely  assistance 
and  intervene  where  necessary  in  the  event  of  difficulties  originating  in  their  jurisdiction. 
They  must  be  equipped  with  comparable  powers  when  it  comes  to  pursuing  and  punishing 
improper conduct by fund managers.  

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Markets in Financial Instruments Directive 2004/39/EC of 21 April 2004 

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1.6. 

Efficiency improvements that do not require changes to the Directive: 

–  Strict  deadline  for  authorisation  in  country  of  domicile:  Delays  of  six  weeks  before 
obtaining  UCITS  authorisation  are  not  uncommon.  This  constitutes  a  significant 
disadvantage for UCITS compared to other investment products and individual securities. 
The Commission therefore urges national authorities to expedite fund approvals. However, 
there is no need for the EU legislator to intervene. 'Competition between systems' should 
be allowed to operate. Those national authorities with an interest in building a successful 
domestic  fund  business  have  a  clear  incentive  to  implement  efficient  and  reliable 
authorisation procedures. 

–  Message routing and fund order processing/settlement: Fund order-processing has not 
kept  pace  with  the  growth  of  the  market,  and  changes  in  distribution  systems.  It  is 
characterised by higher operational risks, longer processing delays and, inevitably, higher 
costs.  However,  these  inefficiencies  are  not  rooted  in  regulation  or  public  sector 
intervention  –  but  arise  from  private  sector  inertia  and  the  difficulties  of  coordinating  a 
transition  to  superior  technologies  or  more  efficient  business  models.  The  Commission 
calls  on  the  European  industry  to  develop  a  coherent  strategy  to  phase  in  the  necessary 
improvements in these functions.  

–  Depositary passport: The freedom to appoint a depositary in another Member State does 
not seem to hold out the prospect of significant gains. Depositary functions account for a 
low proportion of total fund costs and have been largely exhausted through extensive use 
of delegation. Any marginal benefits seem to be considerably outweighed by the scale of 
adjustments  that  would  need  to  be  undertaken  to  the  Directive  to  harmonise  the 
responsibilities  and  functions  of  the  depositary.  The  Commission  will  recommend  that 
Member States take a number of steps to remove barriers to choice and flexibility in the 
appointment of fund custodians. In particular, the Commission will urge Member States to 
allow branches from banks authorised in another Member State to act as depositaries; and 
to  allow  depositaries  to  delegate  assets'  safekeeping  to  a  custodian  in  another  Member 
State.  In  the  longer-term,  Commission  services  will  continue  their  monitoring  of  the 
depositary  market  in  order  to  assess  the  necessity  for  greater  flexibility  and/or 
harmonisation. 

In these and other areas, the Commission urges Member States to review practices in respect 
of fund authorisation and supervision to identify ways where improvements can be introduced 
on a unilateral basis, having regard to 'best practices' elsewhere in the EU. While some of the 
impetus  for  a  successful  and  vibrant  fund  industry  will  come  from  EU-level  developments, 
there  are  many  steps  that  individual  Member  States  can  take  to  improve  their  domestic 
operating environment for investment funds. 

2. 

MAKING THE SINGLE FUND MARKET WORK FOR THE END-INVESTOR: 

Cost-savings  and  new  market  openings  for  the  industry  must  translate  into  tangible 
improvements for the end-investor – in the form of lower charges or higher returns but also in 
terms  of  access  to  continued  enhancements  in  product  performance.  For  this  to  happen, 
industry will need to be subject to strong demand-side discipline as well as stiff competition 
across  the  single  market.  Investors  will  need  understandable  and  reliable  disclosures  which 
allow  them  to  select  competitive  products  offering  the  most  attractive  risk-return 

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combinations.  They  will  need  to  be  able  to  count  on  the  quality  and  objectivity  of  services 
provided by financial advisors and intermediaries who sell investment funds to them. On both 
counts, progress is needed. 

2.1. 

Simplified Prospectus 

The  simplified  Prospectus  was  intended  to  provide  investors  and  intermediaries  with  basic 
information  about  the  possible  risks,  associated  charges,  and  expected  outcomes  of  the 
respective product. However, it has manifestly failed. In most cases, the document is too long 
and not understood by its intended readers. It has been the victim of divergent implementation 
and  'gold-plating':  the  relevant  Commission  Recommendation10  has  been  honoured  more  in 
the  breach  than  in  the  practice.  The  result  is  a  massive  paper-chase  of  limited  value  to 
investors and a considerable overhead for the fund industry.  

Despite  these  deficiencies,  there  is  strong  support  for  standardised  off-the-shelf  fund 
disclosures. Work is needed to re-centre the simplified Prospectus on delivering a short and 
understandable statement of charges, risks and expected performance which is meaningful to 
the end-investor. It should contain the same basic disclosures for all UCITS wherever they are 
domiciled in the EU. It will be necessary to change the provisions of the existing Directive so 
as  to  better  specify  its  rationale  and  core  principles;  and  to  allow  the  adoption  of 
implementing legislation to give uniform legally binding expression to those principles. This 
work could serve as a benchmark for effective off-the-shelf risk and cost disclosures for other 
investment products such as unit-linked life insurance. 

The shortcomings of the Simplified Prospectus are too significant to await amendment of the 
Directive.  Practical  steps  to  correct  the  failings  of  the  simplified  Prospectus  will  be  set  in 
motion  without  delay.  Recent  workshops  have  identified  the  areas  in  which  the  simplified 
Prospectus needs improvement. The Commission will seek to codify enhanced risk, cost and 
performance disclosures through a revision of its Recommendation on this subject. This work 
will  be  taken  forward  on  the  basis  of  contributions  from  CESR  and  national  authorities. 
Evolving work in this area will be tested with investors and intermediaries in order to ensure 
that  it  makes  a  useful  contribution  to  investment  selection.  Proper  consumer  and  market 
testing  will  take  time.  Nevertheless,  it  is  hoped  that  non-legislative  improvements  can  be 
brought  forward  by  mid-2008.  These  improvements  will  be  given  a  legally  binding  status 
following the entry into force of Directive amendments.  

A  two-level  approach  is  required.  The  Directive  itself  must  be  amended  to  clarify  the 
fundamental objectives and guiding principles of the simplified Prospectus. And also to 
allow  for  the  adoption  of  legally  binding  implementing  measures  to  give  effective  and 
uniform expression to those principles. Prior to entry into force of the amended Directive, 
the Commission will revisit its Recommendation to enhance risk, cost and performance 
disclosures. This work will be undertaken in close association with Member States, and 
be carefully tested with investors, distributors and industry. 

10 

Commission  Recommendation  2004/384/EC  of  27  April  2004  on  some  contents  of  the  simplified 
prospectus as provided for in Schedule C of Annex I to Council Directive 85/611/EEC 

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2.2. 

Distribution systems: putting investor interests first: 

Distribution  systems  which  match  investor  demand  with  fund  supply  must  work  efficiently. 
They must deliver products that meet the needs of individual investors on competitive terms. 
At  present,  fund  distribution  accounts  for  the  biggest  single  component  of  costs  in  the 
investment fund industry – ranging from 46% of total costs in France to 75% in Italy.  

The move from foreclosed distribution systems towards open or guided architecture - where 
intermediaries offer a range of third party products - is gathering pace. This change can be to 
the great advantage of the investor if third party funds are selected on the basis of objective 
considerations  such  as  cost  or  expected  performance.  Considerations,  such  as  the  level  of 
commissions paid by fund promoters to distributors, should not bias the selection of funds. At 
present,  fund  managers  will  pay  on  average  50%  of  their  management  fee  to  a  third  party 
distributor.  It  needs  to  be  examined  whether  such  commissions  constitute  payment  for 
services  rendered  such  as  pre/after-sales  service  to  clients.  Conflicts  of  interest  and 
inducements must be properly managed or disclosed: intermediaries must diligently undertake 
duties  of  care  to  the  retail  client.  MiFID  provides  the  tools  to  manage  these  concerns.  Its 
implementing  measures  stipulate  that  inducements  must  be  disclosed  and  can  only  be 
provided where they are in the interests of the client.  

More  generally,  MiFID  should  underpin  the  quality  of  client  support  that  advisors,  brokers 
and other intermediaries provide to clients contemplating investment in investment funds. It 
will  increase  the  onus  on  investment  firms  that  sell  funds  to  ensure  that  the  product  is 
appropriate for the individual client, and that the client is fully apprised of any risk warnings 
related to particular products.  

The Commission will carefully monitor the implementation of MiFID rules on "conduct 
of  business"  and  inducements  in  respect  of  intermediated  fund  sales.  The  Commission 
services will publish a 'vade-mecum' to consolidate the effective implementation of these 
provisions in order to ensure that investors can count on objective and professional fund 
intermediation. 

3. 

SINGLE MARKET SOLUTIONS FOR NON-HARMONISED RETAIL FUNDS? 

The UCITS framework no longer covers the range of investment funds that can be marketed 
to retail investors under fragmented national regimes. There are categories of investment fund 
which  are  not  UCITS  compatible  because  of  aspects  of  their  investment  policy  or  fund 
structuring. They may nevertheless be widely available to retail investors at national level – 
subject to differing forms of product or distribution regulation. The absence of a passport is a 
source of frustration for long-established retail products such as open-ended real estate funds 
(150  billion€  in  assets  under  management  [AuM]  in  EU)  which  see  potential  benefit  in 
serving  a  pan-European  investor  base.  There  is  broadening  investor  exposure,  subject  to 
varying  conditions  or  restrictions  and  via  different  distribution  methods,  to  non-harmonised 
funds.  

The  Commission  estimates  that  assets  under  management  by  the  retail-oriented  non-
harmonised  industry  amount  to  approximately  10%  of  total  assets  under  management.  This 
segment  of  the  investment  fund  industry  has  no  formal  framework  to  support  cross-border 

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retail  sales.  Should  one  be  put  in  place?  Before  responding  affirmatively  to  this  question, 
there is a need for greater clarity on the following issues: 

(1) 

Are the risk and performance characteristics of the funds in question such that they are 
broadly suitable for sale to the retail investor on an unadvised basis?  

(2)  Will the provision of passporting mechanism deliver real and material benefits for the 
sectors  concerned,  investors  and  the  wider  marketplace  taking  account  of  the 
additional  regulatory  costs  and  other  implications  of  putting  such  a  mechanism  in 
place?  These  reflections  should  also  establish  that  a  single  market  framework  is 
realistic and practical having regard to the variety of trading strategies, asset classes, 
financial  engineering  and  widely  varying  investment  cultures  across  the  Member 
States.  

(3) 

If  a  single  market  enabling  framework  is  needed,  how  can  it  be  realised  most 
effectively? 

(a) 

One  possible  legislative  route  is  to  enlarge  further  the  scope  of  the  current 
UCITS  framework.  However,  UCITS  provisions  on  fund  structuring  and 
investment policy might have to be extensively reshaped along more principle-
based  lines  to  accommodate  further  classes  of  non-harmonised  fund.  Such 
changes  cannot  be  undertaken  without  carefully  assessing  the  risk  of  diluting 
core  investor  safeguards  and  possible  impact  for  the  wider  UCITS  market. 
Would  the  re-scoping  and  reshaping  of  the  UCITS  Directive,  that  would  be 
necessary  to  accommodate  further  classes  of  non-harmonised  funds,  deliver 
substantial  net  benefits  and  at  the  same  time  sustain  high  levels  of  investor 
protection? 

(b)  Would  it  be  possible  to  introduce  product-specific  regimes  alongside  the 
UCITS  Directive?  This  risks  creating  a  regulatory  landscape  which  is 
fragmented  on  a  product  by-product  basis,  leading  to  market  distortions  and 
regulatory  arbitrage.  It  also  runs  the  risk  of  entailing  perpetual  adjustment  to 
the legal framework as new investment policies emerge.  

Given  uncertainty  on  the  likely  impacts  or  best  way  forward,  the  Commission  does  not 
believe that the time is ripe to table legislative initiatives to integrate markets for some non-
harmonised  funds  at  this  stage.  However  it  will  undertake  a  systematic  analysis  of  these 
issues,  including  consultations  with  practitioners  and  experts  in  the  relevant  areas,  giving 
priority to real estate funds, in respect of which it will establish an expert group, as the basis 
for a sound and empirically based decision in 2008. 

The Commission will study the likely costs, benefits and risks of providing an enabling single 
market framework for non-harmonised retail products and whether such products are suitable 
in the first place for marketing to investors on a cross border basis. Where extensive research 
and  input  from  industry,  investors  and  regulators  makes  a  persuasive  case  for  developing 
single market solutions for some non-harmonised products, the Commission will consider the 
options  available  and  the  nature  of  any  changes  to  the  UCITS  framework  that  would  be 
required.. The Commission will report to Council and Parliament on the conclusions of this 
assessment in 2008.  

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4. 

MARKETING AND SALE OF PRODUCTS TO "QUALIFIED INVESTORS": 

There  are  also  non-UCITS  funds  which  have  generally  been  regarded  as  more  suitable  for 
institutional  and  other  sophisticated  investors  who  are  capable  of  self-directed  investment 
decisions. Examples include private equity funds and much hedge fund investing. These are 
typically  investment  products  where  there  is  a  relatively  high  probability  of  very  adverse 
investment outcomes. They may also be products embodying new forms of risk (for instance, 
difficulties in asset valuation).  

There  is  no  common  European  approach  to  distinguish  products  which  are  suitable  for  the 
retail  public  from  products  which  should  remain  the  preserve  of  sophisticated  investors. 
National experience has shown that there is no fully satisfactory basis for making a cast-iron 
distinction. View as to what is a safe product for retail investment change over time, as new 
asset classes mature, risk features are better understood.  

MiFID  replaces  crude  restrictions  on  the  sale  of  certain  instruments  to  certain  categories  of 
investor with a system which places responsibility on the investment firm to ascertain, on a 
client–by-client,  basis  whether  a  particular  investment  is  suitable  or  appropriate.  For  many 
Member  States,  this  will  represent  a  new  approach  to  investor  protection.  Enforcement 
authorities  will  have  to  invest  heavily  in  order  to  ensure  that  investment  firms  understand 
what is expected of them. The implementation of this approach will be carefully monitored in 
order to ensure that investment firms across Europe rigorously implement these controls. The 
Commission  services,  working  closely  with  national  authorities,  will  examine  the  types  of 
marketing and sales restrictions that should be removed in the context of the shift to conduct 
of business rules at the level of the investment firm. In this process, particular attention will 
be  paid  to  the  marketing  and  sale  of  non-harmonised  funds,  which  entail  relatively  high 
probability of very adverse investment outcomes.  

to 

free  up  cross-border 

Alongside  this  process,  the  Commission  will  establish  an  inventory  of  national  rules  and 
restrictions  which  impede  the  'private  offer'  of  funds  and  other  financial  instruments  to 
institutional  investors  and  other  eligible  counterparties.  There  are  no  compelling  investor 
protection  reasons  for  national  regulators  to  interfere  in  financial  transactions  involving 
professional  investors  who  understand  the  risks  associated  with  an  investment.  The 
Commission  will  work 
transactions  between  designated 
counterparties,  as  long  as  they  remain  within  the  perimeters  of  a  common  'private 
placement'  regime.  MiFiD  and  the  Prospectus  Directive  put  in  place  some  of  the  key 
building-blocks  of  such  a  regime  –  by  providing  for  the  non-applicability  of  conduct  of 
business rules and selling restrictions to certain transactions. It will be necessary to complete 
the  picture  by  dealing  with  residual  obstacles  originating  from  national  rules  on  product 
approval.  The  Commission  believes  that  such  arrangements  can  make  an  important 
contribution to the deepening of European markets for institutional products such as private 
equity  investments.  Based  on  a  systematic  analysis  of  these  rules,  involving  CESR  and  the 
newly  created  European  Securities  Markets  Expert  Group  (ESME),  the  Commission  will 
report  to  the  Council  and  Parliament  on  the  most  effective  means  to  establish  a  common 
approach to private placement in autumn 2007. 

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The Commission services, working with CESR and national authorities will study the types of 
marketing  and  sales  restrictions  that  should  be  repealed  in  favour  of  reliance  on  the 
investment firms exercising responsibility for the sale of products on a client-by-client basis.  

As part of this process, the Commission and CESR will undertake a systematic inventory and 
analysis  of  national  barriers  to  'private  placement'  of  financial  instruments  with  institutional 
investors  and  other  eligible  counterparties.  The  Commission  will  report  to  Council  and 
Parliament on steps that need to be taken to give full effect to a common private placement 
regime in autumn 2007. 

5. 

CONCLUSIONS: 

Investment funds are a well-established and important pillar of the European financial system. 
Their importance is set to grow as European investors use them as one means to provide for a 
prosperous retirement. A sound and efficient regulatory environment is a precondition for the 
continued successful development of European investment fund markets.  

This  White  Paper  has  identified  a  package  of  measures  designed  to  simplify  the  operating 
environment  for  investment  funds  –  notably  by  overhauling  cumbersome  notification 
procedures  and  slimming  down  the  simplified  Prospectus.  These  steps  will  create  new 
opportunities  for  cross-border  operators  without  imposing  significant  additional  costs  for 
other industry participants. The White Paper also identifies the need to give investors better 
tools  to  make  informed  decisions,  and  to  ensure  that  they  receive  objective  and  impartial 
assistance  from  fund  distributors.  This  package  of  actions  represents  a  carefully  prepared 
agenda of immediate relevance to European fund industry and its investors. 

The  growing  importance  of  this  business  means  that  there  will  be  a  need  for  continued 
attention to modernisation and development of the EU legislative framework. The envisaged 
amendments  to  the  UCITS  Directive  may  not  be  the  final  word.  Recent  innovation  in 
investment techniques and products means that EU and national authorities will continue to 
face  hard  questions  about  the  scope  and  design  of  the  European  legislative  framework  for 
investment  funds.  Rather  than  leap  to  hasty  conclusions,  this  White  Paper  proposes  to 
examine these issues more carefully, in order to allow a more informed policy debate as these 
new products and asset classes mature. 

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–  Annex 1: List of actions pursuant to the White Paper: 

A. Proposal to modify Directive 85/611:  

The  Commission  will  propose  targeted  adjustments  and  additions  to:  1).  simplify  existing 
passporting  mechanisms  and  expand  the  freedoms  available  to  UCITS  funds  and  their 
managers;  2).  underpin  an  effective  and  relevant  simplified  Prospectus;  3).  enhance 
supervisory  cooperation.  Proposals  for  legislative  amendments  will  be  tabled  as  a  single 
package in autumn 2007. As part of its commitment to transparency, the Commission services 
will  undertake  open  consultation  on  envisaged  proposals  in  spring  2007.  This  consultation 
will also provide for scrutiny of the envisaged measure from a cost-effectiveness perspective. 
Amended or new provisions of the Directive will provide for the use of detailed implementing 
legislation to define the manner in which the rights or obligations should be exercised. This 
will  allow  for  greater  legal  certainty  and  uniformity  in  the  implementation  of  rights  and 
obligations  flowing  from  the  Directive  and  more  flexible  adaptation  to  changing  market 
circumstance and investor needs. Expected timing: The Commission will publish its proposal 
in autumn 2007. 

B. Non-legislative actions to support improvements in the UCITS framework: 

–  Communication, recalling relevant ECJ case-law, to clarify that national capital gains tax 
treatment of mergers of locally domiciled funds should be extended to mergers involving 
funds from another Member State. Expected timing: early 2008 

–  Revision  of  Commission  Recommendation  on  Simplified  Prospectus,  based  on  guidance 
from  CESR  and  consultation  and  consumer  testing.  This  work  will  be  undertaken  in 
parallel  to  modification  of  the  relevant  provisions  of  the  Directive.  Expected  timing  for 
launch of the work: early 2007: target completion date, mid-2008. 

–  Vade-mecum  of  Commission  services  on  application  on  relevant  provisions  of  MiFID  to 

collective investments/UCITS. Expected timing: summer 2007. 

–  Communication/Recommendation on delegation of custodial functions by depositaries and 

designation of EU bank branches as depositary: expected timing: early 2008. 

C. Non-harmonised investment funds: 

–  Review  of  national  rules  governing  placement  of  financial  instruments  including  certain 
funds  with  qualified  investors  and  first  assessment  of  options  for  building  a  common 
European private placement regime: Expected timing: autumn 2007. 

–  New  research  on  investment  policies  for  harmonised  and  non-harmonised  funds,  and 

related risk and performance: publication of results – end 2007; 

–  Creation  of  an  expert  group  on  open-ended  real  estate  funds:  publication  of  report  – 

autumn 2007; 

–  Report  of  Commission  to  Council  and  Parliament  assessing  the  need  for  and  possible 
options  for  developing  the  single  market  framework  for  certain  retail-oriented  non-
harmonised funds: mid-2008. 

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