This Note examines the proposals put forward by the European Commission to change a number of the rules governing the cross-border distribution of undertakings for collective investment in transferable securities (UCITS).
The European Commission has published proposals to change a number of the rules governing the cross-border distribution of undertakings for collective investment in transferable securities and alternative investment funds.
On 12 March 2018, the European Commission (Commission) published proposals to change a number of the rules governing the cross-border distribution of undertakings for collective investment in transferable securities (UCITS) and alternative investment funds (AIFs). The changes are an attempt to bring greater clarity and harmonisation to cross-border marketing (a) between the UCITS and Alternative Investment Fund Managers Directive (‘AIFMD’) regimes and (b) between practices adopted by Member States. They also show again the increasing role of ESMA in policing the regulatory behaviours not just of asset managers but also of the national competent authorities (NCAs) themselves.
This Note examines the proposals put forward by the Commission to amend certain marketing provisions in the UCITS Directive. See our separate note which examines the changes through the perspective, primarily, of the AIFMD.
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As a result of its work on seeking to build an efficient capital markets union in the EU, the Commission notes that a number of barriers exist to the efficient cross-border marketing of investment funds throughout the EU. It has, therefore, now proposed a number of changes to the UCITS Directive and AIFMD, aimed at ensuring that various marketing provisions in these directives are aligned, regardless of the type of fund being marketed.
The changes are contained in two proposed texts, one in the form of a Directive (which must be implemented into the laws of Member States), the other a Regulation (having direct effect). The proposals are aimed primarily at UCITS management companies (ManCo) and AIFMs.
From the point of view of a UCITS ManCo, whilst the proposals are generally to be welcomed, they do represent something of a mixed bag. On the one hand, the removal of the ability of Member States to require that local facilities are provided through a physical presence is to be welcomed, on the other hand the proposals have attracted some criticism for "opening up" the UCITS regime to a new legislative process, thereby introducing potential uncertainty. Equally, although the proposals seek to bring about greater clarity by, for example, introducing a central database of fees and charges across the EU, certain aspects of the proposals introduce elements of increased bureaucracy, such as in the areas of de-registration or cessation of marketing.
The transposition of a number of provisions from the UCITS Directive to the draft Regulation is intended to bring about greater clarity and harmonisation of cross-border marketing rules - a Regulation has direct effect so cannot be changed or nuanced on implementation in the way that a Directive can, so removing - or, at least, significantly reducing, the ability of Member States to interpret the provisions differently (although they can always “gold plate” the requirements).
The Directive puts forward changes to the UCITS Directive which include:
- the deletion of existing Article 77 (on the content requirements for marketing communications) and Article 91(3) (on the publication of national rules on marketing) of the UCITS Directive. These provisions would be replaced by similar ones in the proposed Regulation - see below
- a modification to the existing requirements on the provision of local facilities, to allow these to be provided on line and preventing Member States from requiring a UCITS ManCo to provide such facilities through a physical presence. These provisions will now (based on the draft proposals) also be extended to apply for the first time to AIFs marketed to retail investors
- the introduction of procedures that a UCITS ManCo should take when it wishes to discontinue marketing a UCITS in a Member State other than the ManCo’s home Member State - similar provisions would apply in respect of AIFMD, and
- alignment of procedures for a UCITS ManCo to notify its home NCA of changes to the information provided in a prior notification of its intention either (a) to establish a branch or (b) to market a UCITS in a Member State other than its own - again, essentially the same provisions would be included in AIFMD.
The Regulation would require:
- the introduction of provisions on the content of marketing communications to investors, based largely on the existing provisions in Article 77 of the UCITS Directive but to be applicable also in respect of AIFs, whether those communications are aimed at retail or professional investors
- the alignment of the rules that apply if, under the law of a particular Member State, a UCITS ManCo is required to pre-notify its NCA of any marketing materials which the ManCo intends to use, so the NCA can verify that such materials comply with local marketing regulations. These provisions would apply equally in relation to an AIFM marketing an AIF to retail investors
- the online publication by NCAs (and in a central database maintained by ESMA) of all applicable national laws, regulations and administrative provisions governing marketing rules for UCITS and AIFs - a modification and extension of the current Article 91(3) of the UCITS Directive, and
- the online publication by NCAs (and in a central database maintained by ESMA) of all applicable regulatory fees and charges - or the relevant means of calculating these - levied by such authorities under the UCITS Directive or AIFMD.
Since the Commission proposes a two year period from publication of the final text until the rules become effective, it is highly unlikely that these changes would be in force before the UK is expected to leave the EU (and they may well only be applicable in the final few months before the end of any transitional period, if one is agreed). At that stage, in the absence of an agreement to the contrary, UK ManCos will be third country entities and current UK UCITS will no longer be able to be marketed as such in the EU.
Background to the proposals
On 12 March 2018, the Commission formally adopted (ie, published proposed draft texts of) a Directive and a separate Regulation. These look to change a number of the rules governing the cross-border distribution of UCITS schemes and AIFs set out in the UCITS Directive and AIFMD respectively.
The Commission has long been aware that differing marketing requirements, regulatory fees, and notification requirements between EU Member States represent a significant barrier to efficient cross-border fund distribution.
To illustrate this point, the Commission notes that:
- EU investment funds representing 70% of the total AuM are registered for sale only in their own domestic market
- only 37% of UCITS are registered to be marketed in more than three Member States, and
- although the EU market is smaller than that of the US in terms of AuM, there are almost four times (58,125 as against 15,415) more EU funds - ie, the average EU fund is significantly smaller than its US counterpart, with a consequentially negative impact when it comes to making economies of scale and minimising fees paid by investors.
Following a review, (taken forward through its Green Paper on Building a Capital Markets Union, Communication on building a Capital Markets Union, Call for Evidence on the EU Regulatory Framework for Financial Services and public consultation on barriers to cross-border distribution of investment funds), the Commission has now put forward a series of proposals - in the form of the Directive and a separate Regulation.
These proposals are intended (a) to “unlock capital” by making it easier for investors, fund managers and invested undertakings to benefit from the single market and (b) to refine certain provisions in the UCITS Directive and AIFMD which were identified as being burdensome or insufficiently clear (allowing for unhelpful interpretations and variations when being transposed into the national law of the different Member States).
Looking at the proposals in more detail:
Proposals in the Directive
Changes in relation to local facilities for UCITS and AIFs sold to retail investors
Article 92 of the UCITS Directive requires UCITS ManCos to ensure that there are facilities available in each host Member State in which the UCITS is registered for sale, for making payments to investors, repurchasing and redeeming units and providing the necessary information to investors. Most (but not all) Member States have interpreted this to require physical facilities to be made available in their jurisdiction.
The requirement is regarded by many as an anachronism and there was pressure from industry to remove the largely redundant role of the facilities agent in cross-border marketing. The Commission itself regards these requirements as "costly" and notes that they fail to take into account the fact that investors now make far greater use of digital technology for such interactions. In a welcome move, that the Commission has proposed to prevent Member States from requiring that local facilities be provided though a physical presence.
Accordingly, the proposed amended Article 92 would still require that facilities be made available in each Member State where marketing of the UCITS takes place, albeit it would now allow UCITS ManCos to use electronic or other distance communications means to comply.
The usefulness or otherwise of this latter provision will depend largely on the extent to which Member States decide to gold plate the requirements.
(It is interesting that the Commission considered a Directive to be the more appropriate means of introducing these provisions even though, in its Explanatory Memorandum justifying the use of a Regulation for the proposals contained therein, it states that:
“[a] regulation will [..] eliminate the problem that even relatively minor divergences between national laws require managers of investment funds interested in raising capital across borders to compare national rules in order to ensure that they have fully understood and comply with the relevant laws”.
Why a Regulation is the proper instrument to prevent divergence between Member States as far as, say, the procedure around verification of marketing materials is concerned but not when it comes to local facilities is not made clear.)
The requirement to ensure facilities are available, whilst already in place in respect of UCITS ManCos, is also to be extended to cover both an EU and a non-EU AIFM who is marketing an AIF (again, irrespective of whether it is an EU or a non-EU AIF) to retail investors.
Discontinuing marketing an EU AIF in a Member State other than the AIFM’s home Member State
The proposal would insert a new Article 93a into the UCITS Directive, permitting a UCITS ManCo to discontinue the marketing in a Member State other than its home Member State of a UCITS if there are less than ten investors in that host Member State, holding less than 1% of the fund’s total AuM.
[It is not clear if these are the only circumstances in which a UCITS ManCo may be permitted to cease marketing in a host Member State] but in these circumstances, the ManCo would be required to:
- make a blanket offer to repurchase “free of charges and deductions” all shares or units held by investors in the Member State in which marketing is to be discontinued. The offer would be public and made for at least 30 working days, and
- publicise its intention to stop marketing in the given Member State, by a “medium customary for marketing” a UCITS and “suitable for a typical” UCITS investor.
In such a case, the ManCo would notify its home NCA. Within 20 working days of receipt, the home NCA would transmit the notification to the NCA of the Member State in which marketing is to be discontinued and to ESMA and would inform the ManCo of such transmission. After this time, the UCITS must not be marketed in that Member State although all obligations to provide information to investors who remain invested would continue.
Essentially identical provisions would be inserted into AIFMD in respect of an EU AIFM which wished to discontinue marketing an EU AIF in a Member State other than its home Member State.
Although the proposals themselves seem largely uncontroversial, they introduce an additional element of bureaucracy where one is not, perhaps, required.
Aligning national procedures on certain notifications
Articles 17 and 93 of the UCITS Directive would be amended.
By Article 17, a UCITS ManCo wishing to establish a branch in a Member State other than its own must notify its home NCA of its intention.
It must also notify the NCA of its home Member State and that of the host Member State if there is subsequently any material change to the information previously provided. It must do so at least one month ahead of implementing the change.
Under the provisions of the proposed Directive:
- if the notified change would mean that the UCITS will no longer comply with its obligations under the UCITS Directive, the relevant NCA must inform the ManCo within 10 working days that it is not to implement the change, or
- if the notified change does not affect the UCITS’ compliance with the UCITS Directive, the NCA of the ManCo’s home Member State must inform the NCA of the host Member State of the changes within 10 working days.
By Article 93, a ManCo wishing to market a UCITS in a Member State other than its own must notify its home NCA of that intention.
It must also notify the NCA of the host Member State if there is subsequently any change to the information provided before implementing the change. Under the proposed Directive, It must do so at least one month ahead of implementing the change (or immediately after an unplanned change).
The Commission’s proposals would require the relevant NCA to inform the ManCo within 10 working days that it is not to implement the change or, where the changes would not affect the ManCo’s compliance with the UCITS Directive, the NCA of its home Member State must inform the NCA of the host Member State of the changes “without undue delay”.
Marketing communications to investors
The requirements currently set out in Article 77 of the UCITS Directive would be deleted and slightly extended wording included in the Regulation (see below).
Publication of national marketing requirements
Similarly, Article 91(3) of the UCITS Directive, concerning the publication of national marketing rules, is proposed to be deleted and very similar requirements included in the Regulation (see below).
Proposals in the Regulation
Contents of marketing communications
As mentioned above, the provisions currently set out in Article 77 of the UCITS Directive would be deleted and moved, instead, into the Regulation.
Accordingly, the proposed Regulation would require that marketing communications (a) are identifiable as such, (b) are fair, clear and not misleading and (c) make no statement that contradicts or diminishes the significance of the information contained in the prospectus and the key investor information document.
It would, however, introduce an additional provision, not in the UCITS Directive, requiring ManCos, for the first time, to ensure that any marketing communication presents the risks and rewards of purchasing shares or units of a UCITS in an equally prominent manner.
UCITS ManCos must ensure that all marketing communications indicate that a prospectus exists, that the key investor information document (KIID) is available and where, how and in what language these documents can be obtained.
ESMA would be mandated to issue guidelines regarding the application of these criteria, taking into account on-line aspects of marketing communications. It would seem reasonable to assume that ESMA’s starting point would be Article 44 of the MiFID2 Delegated Regulation, which sets out a detailed statement of such a standard in the context of MiFID business.
Essentially similar provisions would also apply to AIFMs and it would appear that the Commission’s intention is that the requirements would not differ whether the investor to whom the AIF is marketed is a retail or a professional investor.
Transparency around national marketing rules
Article 91(3) of the UCITS Directive would, as mentioned above, also be deleted and the provisions it contained would form part of the Regulation, with the addition of enhanced powers for ESMA.
As a result, the Regulation requires the NCA of each Member State:
- to publish and maintain on its website a central database which contains “all applicable national laws, regulations and administrative provisions governing marketing rules for AIFs and UCITS, and the summaries thereof, at least in a language customary in the sphere of international finance”
- to notify these laws, regulations and provisions to ESMA (in a format and following procedures to be developed by ESMA), along with hyperlinks to the website where such information is published, and
- to notify ESMA without delay in the event of any change in the information provided.
ESMA would, within three years of the Regulation coming into effect, be required to maintain on its own website a central database which contains the laws, regulations and provisions notified to it.
Again, identical provisions would apply in respect of AIFMD.
Verification of marketing communications
Where a NCA requires a UCITS ManCo, to notify it of any marketing communications which the manager intends to use in its dealings with investors, in order for the NCA to verify that such communications comply with relevant national marketing requirements, the NCA would have to:
- inform the manager of any request to amend its marketing communications within 10 working days of receiving its notification
- publish on its website the internal rules and procedures for such notification, and
- report annually to ESMA on decisions taken in the previous 12 months where it has either rejected or sought adaptation of any such marketing communication.
The proposals do not attempt to prevent Member States from requiring the vetting of marketing materials. Instead, they attempt to harmonise the process, to introduce some transparency and to require accountability of the NCA to ESMA. They also make it clear that Member States may not require prior verification of marketing materials as a pre-condition of marketing units in the UCITS.
These provisions would apply equally to an AIFM marketing an AIF to retail investors.
Fees and charges
Under the Commission’s proposals, fees and charges levied by a NCA would have to be proportionate to its expenditure in exercising its powers of authorisation, registration, supervision and investigation.
Each NCA would be required to notify ESMA of its levels of fees and charges and, where applicable, the methodology for calculating these. It would also inform ESMA where any previously provided information had changed.
In turn, ESMA would publish on its website:
- an interactive database listing the fees, charges and calculation methodologies notified to it by the NCAs and, as part of this database, and
- an interactive tool for managers to make on-line calculations of the costs involved in a given Member State.
Within 30 months of the final Regulation entering into force, ESMA would be required to publish on its website, and maintain, a publicly accessible central database listing (based on notifications from the NCAs of home Member States):
- all UCITS ManCos and AIFMs
- all UCITS and AIFs which those managers manage and market, and
- the Member States in which those funds are marketed.
Although some managers (in particular, non-EU AIFMs) have expressed concern in the past at the idea of information regarding the AIFs which they market being publicly accessible, it should be noted that, in the UK, the FCA already maintains a public, online database (the FCA Register) of all authorised AIFMs and UCITS ManCos, as well as all authorised and passported funds.
What happens next?
The Commission has transmitted the proposed Directive and proposed Regulation to the Council of the EU (which comprises representatives of each of the 28 Member States’ governments) and to the European Parliament.
These will, separately, consider what amendments they would wish to see made to the Commission’s original proposals before they and the Commission meet together in trilogue meetings. In time, these negotiations will lead to an agreed final version of each text. The published Directive and Regulation could, therefore, differ greatly (or very little) from the original Commission proposals summarised above.
Once formally adopted and endorsed by the Parliament and Council, the texts will be published in the Official Journal. The Directive will "enter into force" the day following publication, the Regulation on the twentieth day following publication. Entry into force is a procedural step and does not mean that the legislation is yet in effect.
The Commission is, in this case, proposing a two year period following entry into force for Member States to transpose the Directive into national law. The Regulation, when implemented, would have direct effect in Member States without the need for transposition.
It seems inevitable that the final rules will not be applicable until after 29 March 2019, the date on which the notice expires of the UK’s intention to leave the EU. It is possible even that the rules will not be in force even before any transitional period which might be agreed has ended. The specific impact that these rules will have as far as UK ManCos and AIFMs will depend, to a large degree, on the final form of any agreement reached on Brexit. In any event, though, UK firms should take heed of the proposed changes as they may, in time, set a standard for third country managers seeking to market into the EU.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.