Imagine you collect money
from people to invest it first and then distribute the returns. If
you would like to do this in the EU, you must deal with two types of
regulation:
- If you keep things simple, you will create a UCITS to receive and invest the funds. UCITS is a shortcut for “undertakings for collective investment in transferable securities”. A more cumbersome designation is probably difficult to imagine.
- If you want to make it more sophisticated, you will set up an AIF. AIF means ”alternative investment fund”. This term is pretty meaningless. We will come to this in a later post.
What is simple and what
is sophisticated? Let’s try to make it as easy as possible:
- Simple means collecting money from the general public, investing it in liquid financial securities, and allowing investors to withdraw it at any time.
- Sophisticated is everything which is not simple. This includes namely borrowing money in addition to the funds you collect (If you invest well, your return will be higher.) and collecting funds privately.
This post is only about
UCITS. We will look at three questions – Why does the EU regulate?
(Rationale), When does the respective regulation apply? (Scope of
Application), and What do you have to respect? (Regulation).
You can find a schematic
overview of the UCITS directive here.
Rationale
The
UCITS directive pursues four objectives:
- Protect investors, namely through the solvency of the management company
- Enhance free movement of capital
- Approximate conditions of competition among investment funds and secure a level playing field in the European market
- Safeguard the stability of the financial system
These objectives are
somewhat contradictory: For example, protecting investors usually
means imposing operating conditions on fund managers and this
restricts the free movement of capital.
Scope of application
Let’s define a UCITS
here. Cumulative conditions are
- Capital raised from the public (as opposed to private fund raising) in Europe
- Collective investment in liquid financial assets
- Application of the principle of risk spreading
- Fund units are redeemable at the request of holders. (This is called an open ended fund as opposed to a closed ended funds.)
Consequences
of application
Fund structure
The
EU directive allows three possible forms for UCITS structures:
- Common fund under contractual law
- Unit trust under trust law
- Investment company under corporate law
The
details are set by the national law of each member state.
A
UCITS fund can have different investment compartments. More
specifically, this means that investment strategies and returns can
differ among compartments.
Finally,
multiple UCITS funds can be set up as a master-feeder structure. This
simply means that one or more UCITS funds (the feeder funds) invest
at least 85 % of their assets in another UCITS fund (the master
fund). The EU directive also allows cross-border master-feeder
structures.
To
protect unit-holders in the feeder UCITS, feeder and master fund must
sign a binding agreement providing for exchange of information. In
addition, the marketing documentation of the UCITS must reflect the
master/feeder structure.
Management company
In
case of a common fund, the most common fund structure, a management
company administers the UCITS. How a management company looks like
and what it can do is closely regulated. For example, it must meet
minimum capital requirements and specific corporate governance and
risk management mechanisms.
If
your UCITS is organized as an investment company, it may or may not
designate a management company.
One
of the main features of the UCITS directive is the mutual recognition
of management companies’ authorizations. In short, once you are
authorized in a member state, you can operate and distribute your
funds’ units in any other member state. This obviously entails the
exchange of information among member states’ authorities which is
deepened by the UCITS regulation.
The
UCITS directive covers additional specific activities of a management
company such as
- a possible combination of collective and individual portfolio management activities if conflicts of interest are avoided;
- a possible outsourcing of specifics tasks and functions under the premiss that the management company remains ultimately liable.
Depositary
The
depositary issues, sells, repurchases, cancels, and values UCITS
units. A management company or investment company cannot be
depositary; the depositary functions must necessarily be exercised by
a third party established in an EU member state. The depositary acts
in the sole interest of the unit-holders.
Marketing of fund
units
As
outlined above, EU wide marketing of fund units is possible. The EU
directive contains two sets of regulation: First, you must provide a
document called “key investor information” to your
clients. Second, your additional marketing documentation must comply
with specific conditions.
Investments
Investments by UCITS
funds are limited. The stipulations of the EU directive are quite
complex and relate to the type of financial asset (debt, equity,
derivatives, bank deposits, other UCITS units etc.) as well as
concentration limits for each asset class.
Merger of UCITS
Cross-border mergers of
UCITS are possible. However, to protect investors, they are subject
to detailed material and procedural conditions such as drafting the
terms of merger and administrative clearance. For example, investors
are granted exit rights in case of a merger.
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