European Commissioner for Internal Market and
Services
Fulfilling the Promise of Europe’s Asset
Management
Industry
Institute of European Affairs
Dublin, 24 November
2006
Good morning Ladies and Gentlemen, Excellencies,
I am delighted to be back here again to talk about another topical issue on the EU financial services agenda. But before turning to the specific topic that we have under discussion today, I would like to make brief reference to two developments that have taken place since we last met here about six months ago. On that occasion we were talking about better regulation: The ink was just drying on the final implementing measures of the Markets in Financial Instruments Directive which Member States are now transposing into national law. The overall purpose of that measure was and is to broaden and deepen competition in the field of investment services, to stimulate competition between stock exchanges and alternative trading platforms across Europe and to enhance the overall efficiency of the pan-European investment services industry. Already we are beginning to see positive impacts: Last week Project Turquoise was announced – a project initiated by seven global investment banks to establish a new trading platform for equities to compete with the established European exchanges. It is expected to be up and running in 2008- shortly after the MIFID takes full legal effect. This is good news for competition and will I hope bring down the cost of trading.
Since we last met also, a Code of Conduct has been agreed among providers of clearing and settlement services for equity trading. I decided on the Code of Conduct route as a better alternative to regulation and I expect that this too, once implemented on the phased basis as planned, will further reduce the cost of equity trading across borders, boost trading volumes and liquidity, and reduce the cost of capital.
In the context of the challenges posed by globalization and the specific demographic challenges faced by Europe, this is important – and not least for our asset management industry, which we are going to talk about today, and on whose success and efficiency we rely for our future pensions.
The first point I want to make about the Asset Management White Paper is that the steps we are proposing to take will be largely of a facilitative rather than of a restrictive nature – steps designed to enhance the efficiency of the industry by facilitating fund mergers, asset pooling, and the passporting of different parts of the fund value chain across borders.
The regulatory framework around the funds industry – principally the UCITS Directive- was devised 20 years ago. While it has provided a good basic template for the development of the European industry, the dynamism and diversity of modern fund markets has been such that the directive has found it difficult to keep pace.
The challenges we face in seeking to help the industry move forward are many.
The first thing we need to tackle is the bureaucracy and complexity that has frustrated the objective of the UCITS Directive. As I meet with the industry around Europe I get the same message all the time: Notification procedures take too long. They cost too much. They are subject to too much supervisory interference. In the White Paper we are proposing to replace the current snail's pace, costly, and bureaucratic notification procedure by a streamlined information exchange between regulators.
Second, we need to take a knife to the simplified prospectus. It is anything but simple. It was meant to provide investors and intermediaries with concise and understandable information about the risks, associated charges, and expected outcomes. However, it has been sabotaged by national gold-plating and divergent implementation. We will try to salvage it through better specification of the rationale and core principles of the Simplified Prospectus and by bringing forward detailed implementing legislation to give uniform concrete expression to these principles.
The third thing I want to do is to help the industry to consolidate funds to generate scale efficiencies. In the absence of clear enabling provisions, cross-border fund mergers are complex, time consuming and expensive – if at all possible. So I want to create the appropriate legal and regulatory conditions for mergers to take place. These should, in particular, ensure that the interests of investors in the funds concerned are adequately protected. But secondly we need to enable fund domiciles to compete on equal terms to attract merged funds and pooling vehicles. However, we cannot wait for the full legislative process to be completed to make progress. Given the scale of the competition challenge facing the industry – from other products and from other parts of the world – short-term solutions are needed to enable cross-border fund mergers. Fund domiciles should look at how they can use powers available to them at national level. They should avoid defensive, short-termist reflexes. Those domiciles that allow fund mergers into and out of their market will emerge stronger in the long run. But it is in everyone's interests that all the main fund domiciles play the game. I call on the relevant authorities to explore all options for facilitating the merger of funds into and out of their jurisdictions.
Another issue I want to tackle is the management company passport. Since the original UCITS Directive, technological innovation has advanced rapidly and opened up greater opportunities for management companies to manage funds on a remote basis. However, UCITS prevents the industry from reaping full advantage of functional and geographic specialisation. The Directive requires concentration of all value chain activities in one Member State: Management groups must establish a fully functional management company in each fund domicile. This adds unnecessary cost and fragments management expertise. These restrictions weigh heavily as industry actors begin to specialise along the value-chain. And to warehouse core functions in different financial centres. So we need to create an effective management company passport. That’s why I will be proposing amendments to the Directive to allow managers to manage corporate and contractual funds in other Member States. There are of course still some open questions about the scope of the management company passport and about the conditions needed to ensure effective supervision of such structures and about their tax-efficiency. These will have to be addressed.
Clearly, new freedoms for the fund industry should not come at the expense of effective fund supervision and oversight. We will therefore strengthen provisions for supervisory cooperation and ensure effective supervision of cross-border operations and fund structures.
I realise that the fund industry is coming under pressure from other types of investment product – such as structured notes and certificates. The answer does not lie in imposing prescriptive regulation on the issuance and construction of these products. The way ahead is through simplification of the UCITS regime.
The reforms we propose to improve economic efficiency of the fund business will be developed as quickly as possible. Legislative amendments are needed to get rid of administrative burdens and requirements that destroy value for investors and industry alike, to expand the possibilities for fund managers to take full advantage of the benefits of a continent-wide fund market and to improve the way in which the costs, risks and likely rewards of investing in a particular fund are disclosed to investors.
In terms of our legislative proposals our solutions must deliver real added value. And regulatory overheads must be kept to a minimum. That is why we will be continuing with the open consultative process that has served us so well thus far. An exposure draft will be presented for public consultation in February or early March next year. Depending on reaction to this exposure draft, we would hope to issue the Commission’s formal proposal in autumn 2007.
Alongside our legislative proposals, we foresee some complementary non-legislative measures. We will in particular be looking at how we can build on existing laws to drive down distribution costs and ensure that intermediaries put investor interests first. Fund distribution is a major-cost-centre. In many EU Member States distribution costs account for over half of total costs of fund investing. Our research suggests that the potential cost savings in distribution far exceed those in other parts of the value chain. We will try to tackle bottlenecks in fund distribution by building on existing legislation – rather than proposing new measures.
Looking beyond the current framework:
Looking beyond the current framework, the non-harmonised segments of the fund industry have also grown spectacularly – particularly alternative investments, hedge funds, fund of funds, real estates funds. Some of these asset classes are becoming mainstream investments – available to a wide investor base. Our back of the envelope calculations suggest that the non-harmonised retail sector – including listed real estate funds and some fund of hedge funds - manages assets equivalent to 10% of those managed by UCITS. I know that the absence of a single market passport is a particular source of frustration for some providers of long-established retail products. Such as open-ended real estate funds.
This leads some stakeholders to call for a fundamental revision of the scope and architecture of the UCITS Directive. However, our impact assessment reveals insufficient grounds to undertake such fundamental reform. The risks are vastly under-estimated.
That is not to say that we dismiss all of the issues out of hand. Constant innovation in investment techniques and products means that we will continue to hear arguments for doing more. But instead of leaping to hasty conclusions and seeing regulation as the answer, these issues need to be assessed very carefully, in order to allow a more informed policy debate as these new products and asset classes mature.
The issues are not straightforward. Are all these really retail products in terms of risk and performance? Would they really benefit from a single-market passport? What are the options for and costs of creating a single market framework? The different legislative solutions could entail unintended consequences. Which might outweigh any expected benefits.
Consequently, I do not believe that the time is ripe to legislate on non-harmonised retail funds. We need a deeper understanding of the potential up-side and down-side. The Commission will therefore undertake a detailed assessment of whether such funds should be available to retail investors on a cross-border basis. We will report on our findings in mid-2008. In this context, we will devote particular attention to open-ended real-estate funds and will have an expert group looking at this particular segment.
Marketing and sale of products to "qualified investors"
As to non-harmonised funds which have more complex structures, such as private equity, and which are generally regarded as suitable only for professional investors, we propose to free up cross-border transactions between suitably qualified investors. As long as two street-wise professionals operate within the boundaries of a 'private placement' regime, there is no need for national regulators to interfere in bilateral trades.
MiFiD and the Prospectus Directive put in place some of the key building-blocks of such a regime. They de-activate conduct of business rules and disclosures for such transactions. However, we need to complete the picture by identifying any remaining obstacles – and assessing how they can be removed most cost-effectively. By either legislative or non-legislative methods. I believe that such arrangements can contribute to the deepening of European markets for institutional products such as private equity. In autumn 2007, I will report on steps needed to give full effect to a common private placement regime.
Now I know that there are many people jumping up and down about the need as they see it to regulate hedge funds. Let me make a few things clear: First, it is a myth that European hedge funds are not regulated. In the European Union, hedge fund managers, administrators and products are subject to wide-ranging national regulatory requirements. There is ongoing monitoring by banking supervisors of bank exposures to hedge funds. There are enhanced market disciplines enforced by hedge fund counterparties such as prime brokers which are EU regulated banks. European rules on market abuse and insider trading apply fully to hedge fund managers intervening on a European financial market.
In this respect, the situation is very different from the US where there has been limited regulatory action on hedge funds to date. Our analysis suggests that there are currently no regulatory gaps which call for EU-level intervention to regulate hedge funds above and beyond those measures that are already in place at national and European level. Before taking any action in this area, there would also need to be confidence that any such intervention would actually achieve some useful outcomes. There is a particular danger that hedge fund regulation could stifle the further development of a sector that has thrived on flexibility and a capacity to innovate.
However, we are not turning a blind eye to this asset class. The Commission and other EU and national authorities are carefully monitoring the ways in which growth of the hedge fund industry can impact the EU financial system.
The Commission recognises that hedge funds, private equity funds and other "activist" investors are increasingly challenging and influencing incumbent management's decision-making and the strategic direction within the portfolio companies in which they invest. Some argue that this investment may occur at the expense of the interests of longer-term shareholders and employees. However, it should be recalled that these investors are doing no more than exercising the rights that they have earned by taking a stake in a publicly listed company. Regulatory safeguards exist at European level to ensure that all investors – including hedge funds and private equity firms – publicly disclose their acquisitions and refrain from any abusive behaviour or insider trading.
The Commission has looked at whether hedge funds and other institutional investors should be subject to greater transparency of shareholdings or be obliged to disclose their voting policies. These questions were extensively debated during the Commission consultation on its Action Plan on Company Law and Corporate Governance. The Commission's view is that effective initiatives have been undertaken at international level (for example the International Corporate Governance Network), and that such mechanisms not only function satisfactorily but also cater for the flexibility that market participants need.
Against this background and seeing the downsides of rigid regulation we do not intend to take further action at EU level at this time but I do want all supervisors to take their responsibilities seriously in this area.
Ladies and Gentlemen, Excellencies, to conclude: Nobody could claim that the path to the adoption of EU financial services legislation has always been smooth. Nor should we downplay the scale of the implementation and compliance challenge. The time for grand designs however is now over. The broad framework is in place for integrated capital markets, for free movement of capital across borders, for a more integrated financial market infrastructure, and for a level playing field for the marketing of investment services across Europe.
The asset management white paper should be seen in the same light: It is, in the main, a paper that responds to the requests of the industry for measures that will enable them to enhance their efficiency through less cumbersome notification procedures, through fund mergers and pooling and through greater specialization along the value chain. The measures will provide a framework – not a straight jacket – to facilitate future innovation and where the industry signals – and is clear - that it wants further harmonization across the Member States to facilitate easier pan-European placement we will be attentive to those requests.
What is important as we put the finishing touches to the financial services framework in Europe is that we leave a lasting legacy in the form of a dynamic, highly integrated and sophisticated financial system able to hold its own against all comers.
Thank you very much.
