Investment funds and particularly UCITS funds represent an increasing proportion of the investments of European retail and institutional investors in Europe and UCITS funds are widely exported outside Europe eg in Asia or Latin America. Investment funds amount now to more than 7500 Bio € of assets under management, which have nearly doubled over the last 5 years. The proportion of cross-border transactions is also strongly increasing representing more than 20% of total volumes.
Despite this obvious success, the EU investment funds industry is currently facing two main challenges that need to be addressed in the near future to ensure the development and profitability of the EU funds industry.
First an efficiency challenge. Scale economies are insufficient in the EU due particularly to the large number of existing funds (over 31,000) and the product passport does not function correctly resulting in delays and high costs. The costs of cross-border transactions are also very high with more than 50% of deals still handled manually. This results in several hundred million Euros of extra-costs that the EU industry, increasingly confronted with the competition of more commoditized products such as index-tracking funds and global competition facilitated by open architecture solutions, will no longer be able to absorb in the future.
Improving efficiency of the funds industry has been the priority of the proposals of the Commission so far and the current review of the UCITS Directive (UCITS IV) has put forward many solutions to these issues. But two major questions have so far been left out:- The Management Company Passport: this controversial topic opposing asset managers and administrative agents has recently gathered pace with the advice asked by the Commission to CESR. Work conducted earlier on this year by Eurofi, the European thinktank dedicated to financial services in Europe with a representative group of industry players shows that implementing a Management Company Passport is a feasible and attractive objective for the EU funds industry but should be implemented with a staged approach. Significantly reducing the administrative and prudential obligations set for asset management companies outside of their home country, without increasing risks is possible in the short term with a clear framework of responsibilities for market players and supervisors and an appropriate interface in the fund domicile – Management Companies should no longer be required to maintain a capitalized legal entity in the fund domicile -. These simplifications that should be included in the current review of the Directive could generate 30 to 50% – representing 250 to 300 million euros – of the total savings expected from a European passport for management companies, which would require a greater convergence of the regulatory frameworks governing administrative activities for UCITS in Europe. This convergence should be initiated during the current review of the Directive.
- Optimizing cross-border fund transaction and distributor commission processing: The lack of common standards and insufficiently automated processes are holding back cross-border exchanges of investment funds, generating additional costs, estimated at several hundred million euros per year, as well as growing operational risks. Many proposals are on the table in this industry-driven area for improving the situation, but progress is slow due in particular to a strong fragmentation of the market. Eurofi has drawn up a proposed roadmap that should enable around 80% of cross-border exchanges to be automated within four years. Eurofi also suggests that a European governance body be created for this market, regrouping all the players concerned - asset managers, fund distributors, depositaries and fund agents, solution providers – with the support of the existing associations, to make the decisions required for a timely implementation of common standards and improved processes.
Secondly an innovation challenge: Innovation is a major growth driver of the EU investment funds industry, enabling asset managers to create differentiation and to answer evolving investor demand. It needs to be adequately supported by the EU regulatory framework. UCITS funds that represent the bulk of the investment funds market (79% of volumes) are at present limited in their evolution by eligible assets and investment limit constraints and are increasingly challenged by substitute products such as notes and certificates. This is a threat for fund industry players but also creates potential risks for investors that are not easily mitigated by MiFID. MiFID rules indeed impose safeguards for retail investors at the point of sale but are no substitute for a product regulation defining consistent rules across the EU for information disclosure and investment rules in particular.
Many assessments and debates are underway involving industry representatives and EU authorities with a view to propose consensual solutions.
Two main issues appear as major priorities in the coming months:- The EU regulatory framework for investment funds needs to be renovated to allow for more flexibility and consistency, while ensuring sufficient protection to non-professional investors. Despite regular updates of the UCITS Directive, many asset classes and investment techniques indeed remain outside of the list of eligible assets such as eg real estate, private equity, funds of hedge funds… which can provide attractive returns to investors while contributing to finance EU economies and retirement needs. In addition many products structured under local frameworks are not passportable at present (eg open-ended real estate funds) and some do not offer consistent investor protection levels across Europe. Creating a new framework for assets not covered by the present UCITS framework with specifically tailored rules seems a preferable option to overloading UCITS with new asset classes which are not always specifically targeted to retail investors. In addition this could be an opportunity to progressively include Lamfalussy principles into the EU funds framework to facilitate its evolution over time and would facilitate the export of these products outside Europe by creating a new UCITS-type label.
- Favouring further convergence in the regulatory frameworks of substitute products targeting similar investment needs is also a major priority for the EU financial industry and for investor protection. Investment funds indeed compete with other investment products - particularly structured products such as notes and certificates - that operate under different regulatory frameworks and can be presented to investors as similar products. The further development of investment funds structured under harmonized frameworks at an EU level as suggested above should not be jeopardized by a possibly unfair competition with products subject to less strict rules.
Finally, developing a common EU private placement regime for institutional investors would be an additional way to foster innovation in the investment funds market and improve market liquidity, provided it is combined with adequate EU product frameworks to ensure that sufficient safeguards are put in place for retail investors and avoid over-complex products from being passed on to them.
Implementing these different reforms is of primary importance for the EU investment funds industry to remain competitive in the coming years. This is also a priority for EU investors for whom investment funds are one of the most attractive investment vehicles in a medium and long term perspective.
