Cicero Policy Briefer

Issue 22, March 2008

UCITS reforms must not come off the rails

By Mark Twigg

With the UCITS Directive still keenly awaited, it seems that last minute manoeuvring may see important elements fall by the wayside. The problem at hand concerns the introduction of the management company passport (MCP). The ability to passport was first introduced in 2001 through the branch or freedom of service provisions. However, the MCP failed to materialise due to ambiguities in the Directive and concerns over split supervision. Seven years on, these problems have yet to be resolved!

It was argued that establishing the management company in the fund’s domicile, rather than allowing it to passport, would enable better supervision by national authorities. The prospect of passporting created concerns over the creation of so-called ‘letterbox’ entities, which could jeopardise effective supervision if the fund is just a ‘virtual’ construction emptied of any substance. To be sure, these concerns were shared by some within the industry. As Claude Kremer, chairman of Alfi, the Luxembourg fund association, reiterated recently in the Financial Times: "If you don't have some serious administrative substance in the fund domicile, the fund will be an empty box and can't be properly supervised.” Whenever people argue against the free market, they are usually derided for displaying protectionist instincts. Luxembourg is, of course, the major domicile for UCITS funds. It has an interest in keeping fund domicile and administration in the same place.

However, we should not make light of the Commission’s concerns. It is, of course, crucial that regulators are able to discharge their supervisory requirements both in the pursuit of investor protection, but also to ensure the long-term health of the market as a whole. We all want effective cross-border regulation. However, by denying freedom of service, it is clear that you cannot simply create a single European fund market—not while you insist that fund managers source administrative services locally. It doesn’t stack up.

That is why the Commission came up with the idea of a ‘partial passport’. Fund centres such as Luxembourg and Dublin have favoured a more limited partial passport that would allow some, but not all, of a management company's functions to be carried out across EU borders. Possible amendments to the UCITS Directive covered such functions as the verification of valuation and pricing, as well as the maintenance where applicable of unit holder/shareholder register. However, the partial passport has its own problems. Not least, it reduces the cost benefits of the full passport—outlined below—as it would still require some duplication of activities. In effect, we would be replacing one set of obstacles to the creation of a free market with a new set of obstacles. Hardly a long-term solution; more of a short-term fix.

It is now understood that the European Commission may be minded to drop the management company passport proposals from the draft directive altogether. While the Commission may well have gone cold on the partial passport—perhaps for good reasons—this would not be the end of the matter. The ability to passport services is a critical cornerstone of single market legislation, and doing nothing is not an option. Let us consider the cost of inaction. The European Commission has estimated that as a result of fund promoters having to establish a fully fledged management company in each member state where their funds are located, the costs generated range from €500,000 to €1,000,000 per management company per year. The impact assessment which accompanied the White Paper on investment funds suggests that operational savings worth between €381-762 million could be generated across the industry as a result of allowing asset management groups to operate from one country. That is why the prospect of ditching the management company passport must only be a temporary stopgap.

With such benefits at stake, it is not a question of whether the EU can achieve a full passport, but when the full passport can be achieved. Surely regulators could afford to move faster? Many EU Member States with significant asset management interests—including France, Germany, the UK and the Netherlands—would all like to see progress towards a full passport now, sharing the view expressed by the UK's Financial Services Authority that if the full passport does not materialise, it could be a lost opportunity for improvements on the single market front. Of course, the Commission has not yet made any final decisions on the content of the Directive. But if it drops the passport, it must kick start an immediate debate on how best to seek a long-term solution.

Mark Twigg can be contacted on +44 (0)20 7665 9537 or click here to email.