The European Union introduced its first Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive in 1985 and has since augmented and amended it with other directives. In this article we take a panoramic view of the laws known collectively as the UCITS regime.

When it first appeared, the UCITS regime created an investment vehicle that could (and can still) be established and licensed by regulators in a state in the European Economic Area (which consists of 28 EU countries plus Iceland, Liechtenstein and Norway) and sold in any other EEA country without the need for any additional authorisation. As such, UCITS funds have a “UCITS passport” that enables their units or shares to be marketed and sold to all types of investors in the other EEA states without having to establish a separate fund in each jurisdiction.

The initial objective of the UCITS regime was to create a standardised scheme for retail investors, but UCITS funds have evolved and now appeal to institutional clients such as insurers, banks and pension funds as well as investors outside the EEA who are attracted by the highly regulated nature of these structures. According to the European Fund and Asset Management Association, the net assets of UCITS funds were €9,284 billion (US$10,371 billion) at the end of 2018 (with net inflows to UCITS funds totalling €117 billion in 2018).

The UCITS passport

In July 2011, Directive 2009/65/EC (the so-called UCITS IV Directive) introduced the notification procedure, a more efficient passporting regime that removed various cumbersome administrative obstacles to the marketing of UCITS funds. Under this regime, a UCITS can apply to its home regulator for permission to market its units or shares in another EEA country. The notification procedure comprises an electronic regulator-to-regulator communication and includes:

• a standard-format notification letter (there must be a letter for each host EEA member state);
• instruments of incorporation;
• a prospectus;
• the latest annual report and any subsequent half-yearly report; and
• a key investor information document (KIID).

All the aforementioned documents should be in a “language customary in the sphere of international finance” unless the two countries agree that these documents can be provided in an official language of both. The KIID is the only document that needs to be translated into one of the official languages of the host member state or into a language approved by the competent authorities of that member state.

Once the home regulator has received the notification, it has 10 working days to notify the host regulator. The host regulator has 5 working days to confirm receipt of the application and supporting documents. The home regulator must immediately notify the UCITS after transmission and the UCITS may access the market of the host state as from the date of that notification.

The Manco passport

Prior to the UCITS IV Directive, the management company of a UCITS was required to be domiciled in the same member-state as the UCITS which it managed. UCITS IV removed this requirement and a 'manco' located in one country in the EEA is now permitted to manage UCITS established in other EEA member states.

Below, we have outlined some important elements that an investment manager should consider when picking jurisdictions in which to market some funds.

Processes for registering funds

Although the notification procedure seems straightforward, certain EEA jurisdictions impose additional local regulatory, legal or fiscal requirements on the process. In view of the diversity of the rules of different nations (many of which apply to retail investors), it is important for the investment manager to consider each jurisdiction on a case-by-case basis before commencing the passporting process. It can roughly categorise the complexity of countries' rules as high, medium and low and could, for example, award Holland a prize for 'low complexity' because its regulator only insists on the KIID being translated into Dutch.

1. Private placement

Investment managers should be aware that certain jurisdictions allow the private placement of securities without requiring the UCITS in question to register there.

For example, Belgium does not require a UCITS to obtain a passport in Belgium if the offer is directed solely to the investors below and there is no public advertising of the sub-fund. The conditions are that all investors should be professional investors, or that there should be fewer than 150 natural or legal persons who are not professional investors and/or with a minimum amount of €250,000 per investment.

Additionally, the UK allows marketing to "investment professionals" (e.g. banks, investment firms, insurance companies, pension funds) and high-net-worth entities without requiring the UCITS to obtain a passport.

2. Costs

Investment managers should note that costs vary greatly from jurisdiction to jurisdiction. The following factors are in play.

• Certain regulators charge fees at the sub-fund level, others at the fund level.
• Initial and annual costs differ.
• Certain regulators require that all fund documents, including the financial reports, must be translated into their language(s).
• Additional costs exist for country-specific submissions of tax returns.
• Various ad hoc costs are also associated with notifiable document updates.

3. Tax

Tax rules vary throughout the EU's markets and investment managers should be cognisant of this. Generally speaking, tax is a concern for the investor. Some countries' tax authorities impose (sometimes relatively expensive) reporting obligations on funds or require the appointment of local agents to ensure that those funds fulfil their obligations to withholding tax regimes. 'Tax reporting' [the reporting of various payments to allow tax authorities to evaluate a situation – the UK’s tax-reporting regime is known as ‘reporting fund status’] is not always obligatory, but a failure to submit reports can sometimes make investments by residents of this-or-that country prohibitively expensive.

4. National requirements

Certain regulators impose additional requirements on investment managers that are necessitated by the UCITS regime. At the moment, for example, Germany seems to be imposing restrictions on UCTIS funds that have performance fees that do not meet the German regulator’s requirements (regardless whether they have been approved by the home regulator).

Some jurisdictions may also have specific requirements for service providers, such as a local representative and a paying agent. For example, German law requires that each fund must appoint an information agent in Germany from whom investors may obtain information and documents. Italy requires the appointment of a paying agent and an intermediary situated in Italy if a retail licence is required, but not if the licence covers professional investors only. In addition, there must be a placing agent between the distribution network and the paying agent.

The requirements for marketing UCITS funds outside the EEA vary from country to country. Although UCITS funds are a global phenomenon, national regulation always applies.

For example, Switzerland represents one of the largest markets in the world for investment managers. In terms of the distribution of UCITS funds in Switzerland, there is a distinction between distribution to retail investors and distribution to qualified investors. If a UCITS wants to market to retail investors in Switzerland, it needs the prior approval of the Swiss financial markets regulator, FINMA. UCITS funds marketed to qualified investors in Switzerland do not have to be approved by FINMA but each one must appoint a Swiss representative and paying agent.

5. Industry-specific requirements

To add yet another layer of complexity to the situation, there are industry-specific requirements in certain countries e.g. reporting for insurance companies in accordance with the German Versicherungsaufsichtsgesetz or Insurance Supervision Act.

The regime set up by the EU's Markets in Financial Instruments Directive does not apply to UCTIS funds directly. It is important to note that in the event that shares or units are sold to certain categories of investors or intermediaries, the fund in question will be required to provide MIFID-related information and satisfy the requirements of the PRIIPs (packaged retail investment and insurance products) Directive (as locally interpreted).

Distribution opportunities

1. Target market. Investment managers are advised to concentrate hard when choosing their target markets. Investors in certain jurisdictions favour certain strategies and investment managers should research each nation's appetite for their strategies most thoroughly before embarking on the process of passporting.

2. Access to the target market. There are many different outlets for selling UCITS funds and investment managers should understand how best to use online and direct-distribution options across borders. There has been a massive increase in the use of online platforms to distribute funds, but some of these platforms can only work with larger investment managers, in which case a fund can distribute itself more widely if it is part of an umbrella structure. Furthermore, it can be time-consuming and costly to meet or otherwise communicate with local distributors while also drafting and negotiating numerous distribution agreements.

3. Changes to the target market. Investment managers ought to keep a close eye on the things that are happening in each market into which they distributing funds. They ought to do, or take account of, the following things if they want to keep up-to-date with changes in the regulatory landscape.

4. Marketing restrictions. A UCITS’ marketing materials must be clear, fair, accurate and not misleading and further national rules may apply. Regulators can always scrutinise marketing materials and funds should pay careful attention to national requirements, especially when they are marketed to retail investors.

5. The EU's proposal for a regulation and directive to do with the cross-border distribution of UCITS funds. On 12 March 2018, the European Commission published a proposal for a directive that it wanted to amend the UCITS Directive and the Alternative Investment Fund Managers' Directive. It wants this directive, if it becomes EU law, to remove some of the above barriers to the cross-border distribution of funds. These barriers relate to, among other things, pre-marketing and the discontinuation of marketing. The main proposals for reform include:

• the streamlining of certain rules that govern marketing and pre-marketing;
• the alignment of procedures with conditions for the de-notification of funds from national markets; and
• more information about national marketing requirements and fees to be made publicly available.

As is evident from this article, a simplified cross-border distribution regime would be most welcome.

* Cyril Delamare and Sinead O’Dwyer can be reached at info@montlakefunds.com