Jean Devambez, suggests 3 ways that these challenges could be eased.
UCITS IV made enormous strides in removing a number of barriers that had been introduced by EU member states which impeded cross-border UCITS distribution. Introduced in 2011, UCITS IV sought to allow centralised management of funds across Europe and improved the fund passport mechanism, streamlined the regulatory notification process for managers, eased requirements around fund mergers and master-feeder structures, and discouraged member states from initiating barriers to UCITS distribution.
Despite the stated intentions of UCITS IV to reduce barriers and standardise cross-border distribution of UCITS, impediments do remain due to the introduction of new pan-EU regulations and varying interpretations of those regulations across EU member states. This has led to some fragmentation in funds distribution markets.
3 drivers of the fragmentation
Unstandardized reporting requirements are creating challenges for fund managers who face different requirements under: UCITS, AIFMD and Money Market Funds. The filing that Fund managers must supply to regulators to comply with AIFMD, differs from the regulatory filings submitted by UCITS, for example.
There may be certain aspects of MiFID II that will apply to UCITS. It may require firms to report details of their transactions. This would include over-the-counter (OTC) derivatives that are traded on any EU trading venue - such as an organised trading facility (OTF) or multilateral trading facility (MTF). MiFID II makes reference that structured UCITS will be deemed complex and market participants have expressed concern about fragmentation within UCITS as a consequence. There is uncertainty as to how structured or complex UCITS will market themselves going forward.
The ban on inducements across some EU countries is causing confusion. The ban on inducements has been translated differently across the EU which has led to regulatory divergences. For example, the inducement ban in The Netherlands differs somewhat to the UK’s Retail Distribution Review (RDR) provisions. This is something that in the future could be harmonised.
3 ways to ease distribution (in this fragmented environment)
Market participants have routinely called for harmonisation of regulatory reporting obligations instead of requiring firms to report at different frequencies and formats. Standardisation would reduce costs for fund managers whose investment vehicles are caught out by all of these regulations. One way to ease the distribution challenges could be to allow fund managers to supply a more uniform regulatory report to each of the national competent authorities.
Another mechanism advocated by industry participants to ease UCITS distribution would be to centralise the notification process with ESMA instead of requiring firms to file reports or register with each individual EU member state where they are marketing into. EU jurisdictions have varying regulatory reporting and registration requirements which can complicate distribution. It has been argued that a centralised notification system would save UCITS fund managers significant amounts of money. The incremental costs of registering a fund in each EU country and appointing local representatives such as lawyers and auditors to manage the specific requirements can be a significant workload. Having a single point of notification would take away this burden and streamline the entire process. Some regulators though may be reluctant to allow reporting to be centralised with ESMA since they see their primary role as protecting local investors.
Many believe that discussions around the Capital Markets Union (CMU) - a pan-EU initiative designed to bring about further harmonisation in the European single market - could provide a boost to cross-border UCITS by removing national barriers. The CMU is still in its nascent stages. However, an Action Plan was issued by the European Commission in September 2015 and proposals to enact some of CMU’s objectives including streamlining the rules on issuing simple, transparent and standardised securitisations are in train. Finalising agreement on CMU, given its scope, across member states will be challenging, and should not be underestimated. CMU is generating some excitement among managers as it intends to review is UCITS and AIFM distribution rules. However, UCITS and AIFMs are encouraging regulators to create a unified, cross-border distribution framework as it would certainly help bring about capital inflows and reduce costs at a time when regulatory and operational costs are rising and returns are hard to come by.
Whilst CMU harmonisation would help fund managers once it is implemented, It is essential that fund managers have a detailed knowledge and understanding of each market and the distribution methods in those markets when distributing cross-border funds.