Wednesday, April 24, 2013

EU UCITS Directive – Rationale, Scope of Application, and Regulation

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.


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.


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 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.