The European investment fund industry has become a powerful business in its own right. No longer the little brother of banking or insurance. No longer a back-water of the financial industry. Its development has been spectacular. A four-fold increase in the space of a dozen years.
An efficient investment fund industry can help Europe meet pressing structural challenges. Put household savings to work in the real economy. Strengthen financial stability by diversifying risk. Democratise European financial markets. Drive higher standards of corporate governance. Become the vehicle of choice for private retirement provisioning. They can also serve as a ready-made investment solution for occupational pension schemes. In the US 25% of the assets of retirement accounts are invested in mutual funds.
There is significant untapped potential for growth within Europe. Assets managed by EU funds amount to 45% GDP - compared to 70% in the US. Investors in new Member State markets are discovering investment funds for the first time. Finally, there is a burgeoning alternative investment industry – currently serving institutional and affluent investors across Europe subject to a patchwork of national placement regimes.
The European fund industry must not limit its ambitions to the local marketplace. Worldwide, the fund industry manages €12 trillion. European managers account for one third of this. European managed funds are recognised in Asia and South America. European fund managers can build on this success.
This is an industry with a lot to be confident about. However, European fund managers will need to be on their toes if they are to compete successfully against new products. Against tougher global competition. The industry cannot afford to be held back by fragmented markets or outdated regulation. Nor can it afford to be burdened with the costs of a raft of new legislation unless the realistically assessed benefits that flow from it demonstrably exceed the costs of implementing it. Our Green Paper is about providing a regulatory environment which allows this business to grow itself on a pan-European basis. So that it can play its full part in meeting the bigger challenges facing the European economy.
The short-term agenda – fixing the UCITS passport
The first task we have set ourselves is to finish the job that we set out to do in 1985 – a good year for the wine – maybe too good for UCITS drafters. What we want to do is create an environment in which UCITS funds can be passported effectively across the single market.
There is a long history of divergent implementation of UCITS provisions. Some of these divergences are hard-coded in national law. There is no magic wand that we can wave to make them disappear overnight. But now there is real reason to believe that we can start dismantling them. The Commission and CESR are working flat-out to deliver consistent implementation of UCITS law. We are working towards common enforcement practices; building confidence; and intensifying supervisory cooperation. All within the time-frames and allocation of responsibilities foreseen by the Directive.
Two projects deserve particular mention:
- First, on notification procedures: CESR is working to codify disciplines that host country authorities should respect when a UCITS is notified for marketing. These will bring greater transparency and certainty. They will curtail escalating demands for documentation. They will ensure the speedy and timely processing of notifications;
- Second, we are on track to issue legally binding clarifications of eligible assets in 2006. UCITS III widened the range of eligible assets and investment techniques available to funds. This triggered debate on the admissibility of some innovative financial instruments. The Commission and CESR are working to resolve these differences. This is not an attempt to claw back some of the new investment possibilities opened up by UCITS III. We are building a common understanding of how new financial instruments can be accommodated by UCITS law.
All of this work is informed by the desire to promote the smooth functioning of the single market. It is starting to bear fruit. There are good reasons to be optimistic that we are putting some of the implementation problems which have bedevilled the UCITS Directive behind us. We can turn our thoughts to building on this progress.
Rising to new challenges
UCITS has been the spring-board for integration of the European fund marketplace. 29’000 instances of funds notified for sale in another Member States. 5’000 funds on offer in 5 or more Member State markets. UCITS is a recognised regulatory template in Europe and beyond. There is an understandable preference for building on these foundations. But we cannot rest on our laurels. Making existing rules deliver is a must. But, it must not blind us to some big questions about the longer-term challenges. Financial markets have not stood still since 1985 or indeed 2001. Regulation needs to respond to these changes; to work with the grain of the markets. Otherwise, UCITS law risks becoming a strait-jacket rather than a facilitator. We need to start engaging with some of these issues if the European industry is to remain in the global vanguard. Let me outline a number of guiding principles which should inform our discussions today, and our future work in this area.
We must put investors back in the driving seat
New products are more complex. Often more costly than traditional investment funds. Distribution systems are evolving; blurring the respective responsibilities of promoters and distributors and making fee schedules more complex. Is the retail investor equipped to cope with these changes? If the EU fund industry is serious about being the investment vehicle of choice for the European retail investor, it will need to provide answers: it will need to help retail investors find the right product for their needs in a more diverse marketplace: to give them confidence that they are accessing these products under appropriate conditions. Even an educated investor needs reliable information to make informed choices – otherwise, he/she is just a frustrated expert. Therefore, fee disclosures and clear information on risks and investment policies are crucial. The Green Paper singles these areas out for particular attention: we will take this work forward as a matter of urgency.
We cannot turn back the tide of financial innovation
The era of the long-only fund is quickly disappearing in the rear-view mirror. Fund managers are capable of delivering superior investment products. There is a growing demand from European (retail) investors for capital protection and absolute returns.
Our work to clarify eligible assets has taken a distinctly liberal and pro-innovation approach. We are pushing the investment freedoms to the very limits of what is possible under the existing Directive. We must be careful not to undermine the pretensions of UCITS to be a retail investment product. This brand positioning has won the European industry success in Europe and further afield.
A brand is a storehouse of trust and we need to be careful to ensure that we achieve the right balance between maintaining that trust and providing the necessary degree of flexibility to maintain competitiveness.
We must help the fund industry to help itself
We have 29’000 UCITS funds; many of these are micro-funds generating heavy costs for their unit-holders. This fragmentation - and the associated overheads – weigh heavily on the competitiveness of the EU industry. The Green Paper has identified 5 possible avenues for enhancing the efficiency of the market: management company passport; cross-border fund mergers; asset pooling; cross-border choice depositary/custodian; fund order processing. Some of these look intuitively appealing. The potential benefits have yet to be quantified. We do not know whether they can be realised cost-effectively. Making them possible will almost certainly entail legislative rewiring, compliance costs and tax solutions. My services will work with industry to explore these issues. However, I reserve judgement on these issues until there are solid reasons to believe that there are significant gains to be made.
We don’t need to fix things that aren’t broken
The hedge fund and private equity sectors have enjoyed growth rates that are the envy of the traditional fund industry. Many of their insights and techniques are now entering the mainstream. These sectors have achieved all of this – without needing an overarching European regulatory framework. There is no need for a heavy-handed legislative intervention. I hope we can do more to remove unnecessary obstacles to the registration and offer of investments to institutional investors – without triggering new legislative procedures.
Investment funds do not exist in a competitive vacuum. We hear some concerns regarding competition from structured notes and certificates in particular. We would like to hear from industry and stakeholders on this issue. We have no intention of sheltering fund managers from competition. What we need to understand is whether there is a risk of mis-selling of some of these products, if so to what extent it is material and to what extent any anticipated Commission response would be proportionate and/or justified. .
We must open doors for fund managers
Pension funds, their managers and contributors should not be denied access to investment opportunities by outdated regulatory distinctions. Investment funds are a natural vehicle for accumulation of retirement savings. In particular, they may be a candidate for investments from defined contribution occupational schemes. The fund industry needs to look further at how investment funds can be packaged in a product which pays-out over the duration of retirement.
Where next?
Where will these reflections lead us? There is a growing consensus about the challenges facing the European fund industry. There is much less clarity about what needs to be done.
Some voices call for ambition; for decisive action. They accuse the Commission of timidity. I would rather be accused of being timid than rush to badly prepared legislation which generates unforeseen consequences. But let us not reduce this to a polarised debate about the form of possible action. This is putting the cart before the horse. First, we need to be clear about how the current framework needs to be improved. Which single market failures really hold back business and deprive investors of opportunities? Then, we need to be confident that we have tested the implications of pursuing those ideas. What are the options for tackling those barriers and their associated costs? We need to do our home-work. Otherwise, as the Chinese proverb warns us, we risk getting what we wished for! There is too much at stake to get this wrong.
Better regulation means being thorough, proportionate, and doing things properly. The next 12 months will be all about assessing the case for change: for exploring and eliminating options. In concrete terms, how do we intend to proceed?
- First, we will focus on making the existing framework work: we will deliver on the pledges of the Green Paper. With CESR, we are forging consensus on common enforcement practices. These will pave the way for smooth functioning of the UCITS passport and boost transparency in the marketplace.
- Second, your responses to the Green Paper will inform thinking on further steps to complement existing rules. It is crucial that stakeholders submit considered and comprehensive reactions. We will publish a comprehensive summary of responses early in the New Year.
- Third, we will shortly set up the two expert groups announced in the Green Paper – on alternative investments and rationalisation of the investment fund value-chain. We will shortly be asking all interested associations which can mobilise expertise in these fields to nominate possible participants. We hope that these groups will publish their final reports in June 2006.
- Fourth, new research to track developments in the European investment fund markets is about to get underway. This will help us to identify areas where competition or rationalisation of the fund architecture might deliver benefits.
- Fifth, we will work with Member States and industry to monitor changes in industry risk-features. Our work on eligible assets has already provided a clearer picture on the types of fund being brought to market. We will explore further ways of tracking the extent to which UCITS III funds make use of their enlarged investment powers. This will help us to map the retailisation of more complex products under the UCITS label.
These inputs will help us to build a clear and evidence-based view on useful steps to strengthen the single market framework for investment funds. We will draw these elements together in the form of a White Paper. This will be published around this time next year. It will sign-post the way towards cost-effective and sensible actions which will make a real difference to the operation of European fund markets.
Some of the challenges before us are significant. The existing Directive may not be equal to the task. But the bar for taking action is higher now. I will want to be convinced that there is a cast-iron case before launching far-reaching change to existing European law in this field. I will not kick-start the regulatory machine for marginal benefits. If industry or stakeholders believe that we need to change the existing framework, they will have to come up with compelling evidence: you will need to demonstrate how proposed actions will significantly enhance European welfare.
Your contributions and that of the rest of the European industry, other stakeholders and public authorities will determine the future direction of EU-level work in this area. We count on substantive responses from you to inform our thinking on the need for and form of any further work in this area.
Our discussions today will hopefully represent another step on the road towards a dynamic, world-beating, pan-European asset management industry.
