The reform of Ucits regulations should provide a great opportunity for Eastern European countries to develop their domestic savings markets and even steal a march on older EU states
Ucits III arrived with more of a whimper than a bang - yet there are elements of it that should cheer investors in both and old and new EU member states. Although less developed, the mutual fund industry in Eastern Europe has not suffered the same sort of asset outflow that was seen in Western Europe following the collapse of the technology bubble, and has generally continued to expand in recent years. The greater flexibility offered by Ucits III will surely help domestic savings markets to develop.
The first attempt at establishing a level playing field for financial services companies in the EU came in the form of Directive 85/611, conceived as part of the drive to create a single market for collective investments and mutual funds. Although a commendable effort in 1989, the scope of the directive was, of necessity, narrow.
The constraints meant that fund managers could not offer retail investors the more sophisticated options available to institutional investors and high net worth individuals. The upshot was that retail investors suffered more than they needed to when the technology bubble burst. And, if the spirit in which national regulators implemented the directive was one of general adherence, the practical consequence was that fund promoters still had to submit themselves to different legal and tax rules in each member state.
In subsequent years, the European Commission (EC) and member states tried to reach agreement on how to update the legislation. Finally, in 2002, the EC published two amending directives. One extends the powers of management companies, including the introduction of a 'passport' for managers to operate across borders within the EU. The other provides Ucits funds with greater flexibility in the types of investments they are able to make. Together, these two amending directives are known as Ucits III, and the new legislative regime took effect from 13 February 2004.
Broadening the scope
One of the most significant changes is a much wider definition of the type of fund which can be sold to retail investors. Allowing mutual funds to invest in derivatives subject to certain safeguards, and not just for efficient portfolio management, opens up a whole world of new investment opportunities. Although foreign funds have been distributed for some years in countries such as the Czech Republic and Estonia, until now they have been much more restrained in where they can invest, and how.
Now, retail investors can purchase domestically registered products with the ability to short the market, so potentially make money even when prices decline.
Another key change is the creation of a proper regulatory framework for investment firms offering various types of guaranteed and protected funds with the potential to deliver steady positive capital gains for investors and minimise the extent of any downside in the markets.
The badge 'Ucits III compliant' is creeping into use in financial advertising across Europe as a marketing tool. Investors should be careful here to make sure that funds labelled as Ucits III really are utilising the full flexibility of the new legislation. Too often, we have seen new absolute return bond funds launched described as taking advantage of the flexibility offered by Ucits III that do not invest in derivatives and which are capable of doing no more than preserving capital in a falling market rather than holding out the prospect of generating a positive return as more forward thinking products already do.
Not all of the new products available under the new regime will be suitable for every investor, and advisers will need to be especially careful in countries where this flexibility has not been historically available. Even so, the effect of the new regime has been to increase consumer choice and that has to be a good thing.
There is a downside with Ucits III, and it is simply that the regime does not go as far as it could have for investment firms looking to market funds across national boundaries. The old problem of trade protectionism is still with us in Europe. Just as with the original Ucits directive, the political desire to protect domestic industries has inspired many different ways to frustrate foreign competitors looking to gain market share overseas, even if the government has agreed to participate. The degree of co-ordination between national regulators is modest at best, and only the UK and Luxembourg were prepared to accept the 'passport' introduced with Ucits III by the initial deadline of 13 March last year.
In turn though, this provides the new member states with the opportunity to steal a march on some of the older states that are resisting change, and they have not been slow to take advantage of this. Many have also taken the chance to carry out a complete overhaul of existing regulations, making them flexible as well as Ucits III compliant.
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