EU asset management regulation UCITS and AIFMD

1. EU asset management regulationUCITS and AIFMD

2. What is asset management? • The practice of an investment firm making investment decisions on behalf of a client. • Asset management can take two main forms: • Individual asset management (i.e. the management of a client’s portfolio) • Collective asset management (i.e. the management of a fund of pooled assets, in accordance with specific and agreed risk levels and parameters)

3. What is an investment fund? • From a legal point of view it is a specially constituted investment vehicle, created with the purpose of • gathering assets from investors, and • investing those assets in a diversified portfolio of financial instruments.

4. What is an investment fund • It is a supply of capital belonging to numerous investors that is used to collectively purchase securities while each investor retains ownership and control of his or her own units. • In principle, an investment fund provides: • a broader selection of investment opportunities • management expertise and • lower investment fees than investors might be able to obtain on their own.

5. What is an investment fund • Types of investment funds include: • mutual funds, • exchange traded funds (ETF), • money market funds and • hedge funds. • Individual investorsdo not make decisions about how a fund's assets are invested. They simply choose which fund to invest in based on its goals, risk, fees and other factors. • Fund managers oversee the fund and decide investment policies.

6. What is the advantage for investors? • Investors buy units issued by the fund against the portfolio of underlying assets, and the value of those units fluctuates with the value of the portfolio. • In this way • small investors can buy exposure to a professionally managed and diversified basket of financial instruments. • costs are spread over the pool of investors, reducing average cost for the investor.

7. Investment funds: main actors • Management Company • Depositary • National regulator(s) (and… ESMA)

8. Management company • Responsible for the day-to-day management of the fund. This usually involves: • the management of the assets • but also a number of associated administrative functions such as record keeping, • regulatory compliance monitoring...

9. Depositary • The depositary carries out two main functions: • the safe-keeping of the assets; and • the oversight of the operation of the fund. • It has therefore a crucial role in the protection of investors' interests.

10. National regulator • National regulators are the authorities responsible for: • the authorisation; and • the supervision of the fund/management company.

11. EU regulation of collective investment - overview • European law currently covers four types of harmonized investment funds: • UCITS, specifically designed for retailers; • AIFM (Alternative Investment Fund Managers), covering managers of alternative investment schemes that are addressed to professional investors; • EuVECA(European Venture Capital Funds), a subcategory of alternative investment schemes that focus on start-up companies; • EuSEF (European Social Entrepreneurship Funds), an investment scheme that focuses on all kinds of enterprises that achieve proven social impacts.

12. What does UCITS mean? • UCITS (Undertakings for Collective Investment in Transferable Securities) are investment funds that have been established in accordance with UCITS Directive (adopted in 1985) • Once registered in one EU MS, a UCITS fund can be freely marketed across the EU. • UCITS are also sold to investors outside the EU

13. What is a UCITS investment fund? • A “UCITS” fund is a European regulated product that is marketable throughout EU Member States. • It is open to all investors, including retail investors, and is the most common investment fund type in Europe. • The UCITS brand is also recognised internationally • many UCITS funds are registered in non-European countries such as Switzerland, Hong Kong, Singapore, Taiwan, Bahrain, Chile and Peru.

14. What is a UCITS investment fund? • The aim of EU regulated investment funds is to “provide retail investors with access to professionally managed and diversified investments on affordable terms”.

15. What is a UCITS investment fund? • Since their inception in the 1985 UCITS Directive, UCITS have tried to achieve that objective. • Traditionally, UCITS have been regarded as plain vanilla retail investment funds which make use of conventional investment strategies, such as bonds and quoted equities, to achieve a return for their investors (N. Moloney)

16. EU legal framework • The current EU legislation (UCITS V) for investment funds is the basis for the cross-border offer of collective investment funds: • Directive 2009/65/EC (Recast of the Directive 85/611/EEC) (UCITS IV) • Directive 2014/91/EU (amending Directive 2009/65/EC) (UCITS V) - entered into force on 17 September 2014. • There are ongoing discussions on UCITS VI, although the EC has yet to issue a formal proposal

17. UCITS: rationale and history • The first UCITS Directive (Directive 85/611/EC) was adopted on 20 December 1985 and preceded by a long legislative process. • Aim: to facilitate cross-border offerings of investment funds to retail investors.

18. UCITS: rationale and history • The 1985 Directive allowed any fund authorised as “UCITS” in its home country to market its units in other EU Member States by simply notifying the host Member State of the intention to market the fund’s units or shares on its territory, without having to go through a process of prior registration in each country of sale.

19. Evolution: UCITS II? • An amended proposed revision to the Directive was tabled in July 1994, but considering … • the reticence of certain Member States with regard to the inclusion of cash funds • the legal concerns shared by many industry players with regard to the liberalization of the depositary regime • no common position could be reached by the Council of Ministers of the EU.

20. Evolution: UCITS II? • In early 1995, a compromise was found on limiting the extension of the Directive’s scope to fund of funds and master-feeder structures. • But then no further progress could be made and the European Commission decided to simply abandon the “UCITS II” project.

21. Evolution: UCITS III • On 17 July 1998, two new Commission proposals for a modification of the UCITS Directive were published, the so called “UCITS III” package. • Although the industry favoured the adoption of a single Directive, two new Directives were finally adopted on 21 January 2002

22. Evolution: UCITS III • Directive 2001/108/EC widened the investment possibilities of UCITS to include new instruments (money market instruments, units of other UCIs, bank deposits and financial derivatives), and eased investment restrictions for index tracker funds. • Directive 2001/107/EC detailed minimum standards which a UCITS management company should comply with in terms of capital and risk control, rules of conduct and conditions relating to technical and human resources.

23. UCITS IV • Further amendments to the UCITS legislation were made by Directive 2009/65/EC. • “UCITS IV” • introduced a passport … allowing • a UCITS to be managed by a management company authorised and supervised in a Member State other than its home Member State.

24. UCITS IV • UCITS IV also offered new opportunities for market consolidation and rationalisation of UCITS structures through the possibility of merging UCITS both on a domestic and cross-border basis. • Another feature enabled the pooling of fund assets via master-feeder structures, where one or more feeder funds invest the cash received from its own investors in a master fund.

25. UCITS IV • The simplified prospectus was replaced by a key investor information document (KIID), which is designed to provide the investor with important information about the fund in a non-technical language. • Last but not least, the notification procedure for the marketing of fund units or shares in another country was simplified by introducing a regulator-to-regulator approach.

26. What sort of undertaking does the Directive apply to? • UCITS include undertakings: • with the sole object of collective investment in transferable securities or in other liquid financial assets, capital raised from the public and which operate on the principle of risk-spreading; • the units of which are repurchased or redeemed out of these undertakings’ assets.

27. UCITS Directives do not apply to • collective investment undertakings of the closed-ended type; • collective investment undertakings which raise capital without promoting the sale of their units to the public in the European Union; • collective investment undertakings the units of which may be sold only to the public in third countries.

28. UCITS III vs UCITS IV • Waiting for the UCITS V to be transposed, it is useful to analyze the main differences between UCITS IV and the previous UCITS III package. The main issues relate to: • Authorization/Notification Procedure • Key Investor Information • Fund Mergers • Management Company Passport • Pooling • Regulator to Regulator Cooperation

29. Authorization: national authorities • A UCITS must be authorised by the competent authorities of its home Member State in order to be able to pursue activities. • The competent authorities may not authorise a UCITS under the following circumstances: • if the investment company does not comply with the preconditions; • if the management company is not authorised for the management of UCITS in its home Member State.

30. Other competent bodies • ESMA • can elaborate technical regulatory standards in order to specify the information to be provided to the competent authorities as part of a request for approval. • publishes the list of approved management companies on its website. • The European Commission has a delegation of power concerning the elaboration of draft technical standards.

31. Notification procedure • Under UCITS, a fund domiciled in an EU MS only needs to go through a simplified registration process with the national regulator of another EU country (so‐called notification procedure) to obtain the right to distribute units of the funds there. • The money collected can then be invested in securities based on the fund’s specific investment strategy.

32. KIID • UCITS III: “simplified prospectus” • Article 28 §3: “It shall be structured and written in a way that it can be easily understood by the average investor.” • UCITS IV (Article 78-82). Article 78 §5: • “KIID shall be written in a brief manner and in non technical language. It shall be drawn up in a common format, allowing for comparison, and shall be presented in a way that is likely to be understood by retail investors.”

33. KIID • “…includes appropriate product information about the essential characteristics about the UCITS concerned” • Essential elements: • Identification of the UCITS • A short description of its investment objectives and investment policy • Past performance presentation / performance scenarios • Costs and associated charges • Risk/reward profile of the investment

34. KIID: update and delivery obligation • Update: • UCITS III: whenever full prospectus is updated, at least once a year • UCITS IV “The essential elements of KII shall be kept up-to-date.” • Delivery: • UCITS III: No general obligation to deliver • UCITS IV: mandatory pre-contractual information

35. KIID: approval • UCITS III: • Home and host Member State authorities • UCITS IV: • Home Member State authority only

36. Fund mergers • Under UCITS III the merging of funds on a cross-border basis was not foreseen • UCITS IV (Article 37-48) • Authorisation: merging fund’s regulator: • Shall within at the latest 20 days of the submission of a complete file decide if authorisation of the merger is granted • Will transmit the authorisation to the receiving fund's regulator • Shall inform the receiving fund’s regulator of its decision

37. Type of mergers • Three types of mergers possible: • Merger by way of absorption • Merger by formation of a new fund • Merger by amalgamation • (i.e. delayed winding-up of the merging funds till their liabilities are discharged)

38. Fund mergers and unitholders’ rights • Information to unitholders • The unitholders of the merging and receiving UCITS must be provided at least 30 days before the last date for requesting repurchase or conversion without additional charges several information (background, possible impact of the proposed merger, procedural aspects and proposed effective date of the merger etc) • Right to redeem (or to convert) • (conversion into UCITS with similar investment policies, managed by the same managing company or by a company linked with the latter). Right to redeem is without charges for the investor of both the receiving and merging UCITS

39. Management Company Passport • Under UCITS III managing company and UCITS had to be domiciled in the same country • despite passporting possibilities foreseen, such possibility was not accepted by EU supervisory authorities • UCITS IV: • ManCo may provide the services in the Home Member State of the UCITS through • establishment of a branch, or • the use of freedom of services.

40. Management Company Passport • Authorisation procedure: based on the exchange of information between UCITS’ MS authority and ManCo MS authority • UCITS authority: • fund rules, choice of the ManCo and the depository • ManCo authority: • ManCo to be approved by its national authority. This latter authority to inform the UCITS authority

41. Pooling / Master-Feeder structures • Under UCITS III • pooling techniques have neither been forbidden nor specifically allowed; • Master-Feeder structures were specifically excluded due to fund diversification rules

42. Pooling / Master-Feeder structures • UCITS IV takes into account: • Master-Feeder funds • A Feeder UCITS is a UCITS or an investment compartment thereof that invests at least 85% of its assets in one other UCITS. The UCITS that hosts the investment is called the Master UCITS. Both, Master and Feeder may be established in the same or in different Member States • Virtual Pooling • A technique based on sophisticated IT solutions (accounting systems) to commingle the assets of two or more funds (or sub-funds) in a (virtual) investment pool

43. Regulator to Regulator Cooperation • Under UCITS III exchange of information between authorities was already regulated • UCITS IV lays down specific rules and methods to exercise supervisory and investigatory powers • Directly • In collaboration with other authorities • Through delegation • Through the judiciary

44. Regulator to Regulator Cooperation • Article 98.2 (powers and rights competent authorities may have recourse to) • Infringements • Member States lay down the rules on measures and penalities applicable to infringements of the national provisions and make public any measure or sanction that will be imposed for such infringements • On-the-spot verification • By the national competent authority • By the foreign competent authority (i.e. authority of ManCo verifying custodian in Fund domicile) • By auditors or experts

45. New rules … • UCITS V: 17 September 2014 • Member states have 18 months to transpose UCITS V into national law (new rules to apply by 18 March 2016) • management companies must appoint a depositary that complies with the UCITS V eligibility requirements by March 2018, if their existing depositary does not meet the eligibility requirements in March 2016.

46. What is the purpose of UCITS V? • UCITS V focuses on three areas: • depositary: • clarification of UCITS depositary eligibility criteria, oversight, cash monitoring and safekeeping duties, delegation and liability provisions; • remuneration: • introduction of rules on remuneration policies for staff whose professional activities have a material impact on the risk profiles of the UCITS they manage; and • sanctions: • harmonisation of the minimum administrative sanctions available to MS competent authorities for violations of the main investor protection safeguards.

47. Appointment of a single depositary • Like AIFMD, UCITS V requires the appointment of a single depositary for each fund, • to have general oversight over UCITS assets; and • to provide fund managers and investors with a single point of reference in the event of problems in relation to the safekeeping of assets or the performance of oversight functions. • Currently, under UCITS IV there is no requirement for a single depositary to hold the assets of the UCITS

48. Appointment of a single depositary/2 • Transition from multiple to single depositary structures • increased competition in the industry • (where there are currently multiple depositaries for a UCITS, each depositary will be keen to ensure that they are appointed as the single depositary).

49. Depositary eligibility criteria • stricter eligibility criteria for depositaries, in the areas of prudential regulation, capital requirements and effective supervision. • eligible UCITS depositaries will comprise • national central banks, • EU authorised credit institutions and, providing certain minimum requirements are met, • “another legal entity” authorised under the laws of member states to perform depositary activities for UCITS (i.e. requir. similar to CRD IV).

50. Depositary eligibility criteria /2 • Existing UCITS depositaries that fail to meet the new criteria can continue to act as depositaries for UCITS that have already appointed them for a further period of 42 months from the date on which UCITS V comes into force. • … grace period?