HM Treasury's review of implementation of UCITS IV in the UK

Summary

HM Treasury has published the results of its post-implementation review (PIR) of the Undertakings for Collective Investment in Transferable Securities Regulations 2011 (the Regulations) which implemented UCITS IV into UK law.

Taking evidence from various sources, including relevant trade associations, the FCA and the European Commission, the PIR’s findings are that, in general, the UK approach to implementation (ie copy-out) neither imposed undue "gold plating" above that required in the Directive nor led to any unintended consequences.

The improvements to the UCITS framework which the PIR identified are largely changes to the underlying UCITS IV Directive itself (now amended by UCITS V), rather than being necessary as a result of UK implementation. The review notes that, in light of this, HM Government will "consider how best to feed the findings of this review into future EU-wide reviews or consultations regarding the UCITS framework".

Introduction

On 30 June 2016, HMT published the findings of its post implementation review (PIR), in which it assesses the extent to which the Undertakings for Collective Investment in Transferable Securities Regulations 2011 (the Regulations) achieved their objectives.

The Regulations contained amendments to both primary and secondary legislation - these were necessary to transpose the changes introduced by the UCITS IV Directive into UK law by July 2011.

Article 17 of the Regulations required HM Treasury (HMT) to undertake a review of the Regulations and publish its conclusions within five years of the Regulations coming into force (ie by 30 June 2016).

What does the PIR cover?

In its review, HMT was required to:

• set out the objectives intended to be achieved by the regulatory system which the Regulations established
• assess the extent to which those objectives have been achieved, and
• assess whether those objectives remain appropriate and, if so, the extent to which they could be achieved with a system that imposes less regulation.

To address these issues, HMT sought feedback, through questionnaires, from the main UK trade associations whose members have a direct interest in UCITS legislation. HMT also received information from the FCA and (on implementation of UCITS IV in other Member States) from the European Commission.

What were the objectives?

The PIR identifies the following six objectives of the UCITS IV Directive:

• the removal of administrative barriers to the cross-border marketing of UCITS so UCITS could access the market without delay once the regulator of the fund has notified the regulator in the EEA Member State where the management company wants to sell its product
• the introduction of a management company passport so that a management company can operate a fund in a different Member State without the need to be established in the fund’s Member State
• improved investor disclosure with the key investor information document (KIID) replacing the Simplified Prospectus
• a framework for mergers between UCITS funds
• provision for UCITS to establish "master-feeder" structures, and
• improved supervisory co-operation, particularly in relation to supervising a UCITS management company and fund when they are established in different Member States.

What did the PIR find?

• Removal of administrative barriers:
  • It was felt that, although there were relatively few barriers for those trying to market non-UK UCITS into the UK, implementation of UCITS IV may have introduced some benefits in terms of efficiency gains for firms wishing to passport their funds out of the UK.
  • Although the simplified notification procedure under UCITS IV gives regulators a maximum of ten working days in which to review a notification file and transmit it to the host Member State, experiences of industry indicated that, in practice, this process can take longer (and “up to six weeks in certain Member States”).
  • Registration fees for UCITS funds were found to vary dramatically between Member States - the UK’s registration fee imposed on UCITS passporting into the jurisdiction was thought to be reasonable and proportionate.
  • Although some Member States require the UCITS to have a physical presence in the Member State (typically referred to as the facilities agent or paying agent) this requirement was felt to have proven costly - in the UK, COLL 9.4 specifies that the operator of a recognised scheme must maintain facilities in the UK to satisfy the requirements of the Directive, but does not place restrictions on what form these facilities must take.
• Introduction of a management company passport:
  • According to the FCA, relatively few UK firms have taken advantage of the passport.
• Improved investor disclosure:
  • It was generally felt that the KIID fulfilled its objectives - it both improved the comparability of products and was an improvement over the Simplified Prospectus
  • Suggestions were made as to how investor disclosure requirements could be improved further:
    • institutional investors are likely to prefer more detailed information provided by prospectuses, so providing a KIID for all UCITS can entail the replication of unnecessary data
    • a future UCITS Directive could consider the possibility of providing the Key Investor Information digitally.
  • The PIR notes that the KIID will be replaced by the Key Information Document (KID) under PRIPS from December 2019 - this is modelled on the UCITS KIID but aims to improve consumer protection by increasing transparency on transaction costs.
• Framework for mergers between UCITS funds:
  • Feedback from industry associations suggested that the framework for mergers between UCITS funds, whilst successfully implemented into UK law, had not delivered the benefits which the European Commission had intended.
    • The need to provide notice a merger in writing to all unit holders of the receiving UCITS, even where this is extremely small, can lead to prohibitive costs.
    • Tax, too, was regarded as a significant barrier to cross-border fund mergers.
    • Major changes to the Mergers Directive would be required if the economies of scale that UCITS IV was intended to deliver were to be achieved.
  • Article 46 of the UCITS Directive, on costs and entry into effect, was also seen to contribute to making the cost of merging funds prohibitive. Article 46 requires ManCos to pay any legal, advisory or administrative costs associated with the preparation and completion of mergers. The way in which some Member States interpret this provision is regarded as hampering fund mergers in those jurisdictions - as some regulators go beyond the UCITS IV requirement by adding the words ‘and any other costs‘, the implication is that ManCos must also pay for any rebalancing of portfolios that might take place prior to the merger, thereby imposing an additional cost.
  • The UK’s implementation of Article 46 (through COLL 7.7.20) also refers to ‘any other costs’, since, as HMT states in the PIR, this “was thought to be the intention of the Directive, and was intended as a clarification of purpose rather than an attempt to enlarge the scope of costs covered”. However, the FCA has called for a review of Article 46 to determine whether a more flexible approach could be taken to merger cost charging which might encourage more fund managers to take up the merger option.
• "Master-feeder" structures:
  • As with the issue of fund mergers, industry’s response to the PIR indicated that it was not felt that the Directive would deliver the intended benefits.
  • Article 58 of UCITS prevents a UCITS from being the master UCITS in a master-feeder structure, which hinders the uptake of such structures. This, in turn, is problematic given the popularity of the fund of funds model as a vehicle.
  • HMT has recommended, as part of its response to the European Commission’s Call for Evidence on the EU regulatory framework for financial services, that Article 58 be reviewed and that UCITS fund of funds should be able to operate as master funds in a master-feeder structure.
  • Industry’s recommendations relate to improvements to the underlying Directive, rather than to its implementation in the UK. As a result, such improvements would need to be addressed at a European level and could not simply be delivered through action on the part of the UK alone.
• Improved supervisory co-operation:
  • Industry responses agreed that the UK’s implementation delivered its objective and met the Directive’s requirements.
  • The FCA has not yet needed to make use of the supervisory co-operation provisions in UCITS IV which set out formal procedures for addressing difficulties between Member States.

The costs of implementing UCITS IV

HM Government’s UCITS IV Impact Assessment estimated that implementing the Directive would cost industry £50m in transitional costs, with ongoing annual costs of £10m - ie, £90m over a five year period.

Although trade associations agreed with the Impact Assessement that the introduction of the KIID was likely to have been the major cost, they were unable to confirm whether or not the costs estimates had been accurate.

What happens next?

Since the improvements to the UCITS framework set out above relate to changes to the UCITS Directive itself, and do not arise as a result of the UK’s implementation of it, HM Government will now “consider how best to feed the findings of this review into future EU-wide reviews or consultations regarding the UCITS framework” - though clearly, the recent vote by the UK to leave the EU may have some impact on how the government decides to proceed.