Undertakings for Collective Investment in Transferable Securities Regulations 2011
(Limited Text - Ministerial Extracts only)
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Lord Sassoon
That the Grand Committee do report to the House that it has considered the Undertakings for Collective Investment in Transferable Securities Regulations 2011.
Relevant document: 24th Report from the Joint Committee on Statutory Instruments.
The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, these regulations transpose into UK law the updated fourth EU directive on Undertakings for Collective Investment in Transferable Securities—UCITS IV—and are supplemented by new FSA rules. I will give a little background on the UCITS framework before explaining why the Government are seeking to introduce the new regulations.
The UCITS directive sets out a common set of cross-EU rules for how eligible investment funds should be run. The rules emphasise transparency and consumer protection, which means that UCITS funds are designed particularly for retail investors. However, they are frequently used more widely, including by pension funds and insurance companies. UCITS funds account for roughly three-quarters of funds under management across Europe.
The UCITS framework is very important to the UK fund management industry and to investors. For investors, the directive ensures strong consumer protection—for example, through clarity in marketing—and integrates the EU market, which gives investors a wider and more diversified set of funds to select from. UCITS has been a key contributor to the growth of UK asset management firms. The directive brings down barriers, allowing them to market across the EU based on authorisation by the FSA. The UCITS brand is recognised worldwide and EU fund managers market it globally. There are now some £500 billion of UCITS assets under management in the UK. This is the third update to the UCITS directive since it was introduced in 1988. It is intended to ensure that the market can operate more efficiently, bringing further industry and consumer protection benefits.
UCITS IV addresses four widely recognised shortcomings. The first is the difficulty that fund management companies face in establishing UCITS funds in other member states. UCITS IV removes this barrier by streamlining the way UCITS funds are notified in other member states. Funds can access the market without delay once their fund manager has notified the domicile’s regulator.
The second shortcoming relates to investor disclosure. UCITS rightly emphasises clear and transparent disclosure to retail investors so that they can easily understand the information about the fund that they are considering investing in. In practice, the requirements have led to prospectuses that are too long and complex and do not allow investors to make effective comparisons between UCITS funds. UCITS IV improves investor disclosure, replacing the required prospectus required with key investor information that will be contained in a simple document and will give key facts to investors in a clear and understandable manner.
Thirdly, European funds are often not taking advantage of economies of scale and are generally smaller than their American counterparts. Again, this has led to increased costs for investors. The directive addresses this in two ways. For the first time, UCITS will allow master feeder structures to be marketed across Europe. For example, feeder funds in different domiciles across the EU will be able to invest in the same master fund located, for example, in the UK. This will allow a single portfolio of assets to be offered across jurisdictions and for different types of investor. The directive also introduces a framework to allow UCITS funds to merge across borders, again removing a barrier to the creation of larger funds.
The final criticism made of UCITS is that it prevents specialisation. All the most important activities associated with a fund’s management have to be located in one member state as only the fund can be passported. So, in practice, even though much of the investment management activity may be carried out in the UK, funds not based in the UK would have to establish extra fund management companies in the domiciles of each of their funds. That has pushed up the administrative costs that ultimately have to be borne by the investor, and prevents gains from scale and specialisation.
UCITS IV introduces an effective management company passport. This allows a management company to operate a fund in a different member state without the need to be established in the member state of the fund. To support this, UCITS IV requires improved co-operation between UCITS regulators, particularly when they are supervising a UCITS management company and fund established in different member states.
The new UCITS regime has been warmly welcomed by the UK industry, which considers it a further opportunity to grow, while serving investors better. The Government are taking all available means, within the current fiscal constraints, to maintain and build on the UK’s lead as a centre for asset management, and that includes capitalising on UCITS IV.
In particular, the Government want the UK to be a home for new master funds. To achieve that, we are working with industry to develop the most suitable vehicle to meet the real demand for a tax-transparent vehicle in Britain. This year’s Budget announced that the Government will legislate to introduce a tax transparent fund, from 2012. We are amending tax law to accommodate the conditions introduced by the management company passport, removing any risk that a foreign UCITS fund may become taxable in the UK as a result of having a manager resident in this country.
I hope that the Committee will support the making of these regulations today. I hope that this brief speech has reassured noble Lords that the regulations will bring considerable benefits to both the UK industry and consumers, and that they will therefore gain their support.
Lord Eatwell
My Lords, I do not like this legislation, because it is moving in exactly the wrong direction with respect to regulatory responsibility in a multijurisdictional context; namely, it is legislation that empowers the home regulator, not the host—and this when recent events, particularly in international banking, have shown beyond all reasonable doubt that power should be flowing in the opposite direction, towards the host regulator.
I understand that one of the ultimate objectives of the programme to create a single market in financial instruments in Europe is to make the home-host distinction irrelevant. That can be done only by the development of a regulatory regime in which the domain of the regulator is the domain of the market—that is, there is effectively a single regulator for the entire market space. However, that is not the case in the EU, or the EEA, and will not be in the foreseeable future; indeed, I rather suspect that the Government hope that it will not be the case. Therefore, the Government must face up to the fundamental weakness of home-based regulation—that it encourages regulatory arbitrage.
It may be argued that one of the purposes of these regulations is to encourage the adoption of common standards, to which the noble Lord referred, particularly in conduct of business regulation, and that that will tend to reduce the potential for arbitrage. We hope that that is true, but arbitrage will not be eliminated. For example, different enforcement standards can provide rich pickings for mobile and perhaps not entirely respectable firms. That is evident even in the much more coherent financial space that is the United States of America. It is far more likely in the somewhat less coherent European Union.
I was surprised that I could find nothing in the Treasury’s impact assessment that refers to the impact of regulatory arbitrage. Nor could I find any reference to the role of the new European Securities and Markets Authority, the successor to CESR, which might be seen as a medium-term solution to the single-regulator problem. What is the Treasury’s assessment of the impact of this legislation on regulatory arbitrage? Is the Treasury content that regulatory arbitrage is in the best interests of UK consumers? If not, what steps is the Treasury taking to discourage regulatory arbitrage, and more generally, what are the costs and benefits of such arbitrage for the UK, as will be encouraged by these regulations? What will be the role of ESMA in the definition of procedures to be followed in the UK both in the short and medium term?
A key element enhancing the likelihood of regulatory arbitrage is the simplified notification procedure to which the noble Lord referred. This removes the right of national regulators to vet funds before they are marketed. Is that not a regulatory weakness at a time when the need for the efficient and effective regulation of financial instruments has been clearly demonstrated? Why are we giving up our right to vet instruments marketed to UK consumers? The FSA or any successor organisation will now have a significantly diminished capacity to ensure that new fund managers seeking to enter the national market will conform to our standards.
This leads to the vexed question of consumer protection. The impact assessment, in considering the role of the Financial Ombudsman Service, states:
“We have also asked whether … FOS referral rights should be made available in: Scenario 3—a UK management company operating a UCITS authorised by a regulator in an EEA member State other than the UK, on a cross-border services basis”.
The assessment apparently asks the question, but unfortunately does not tell us the answer, so could the Minister tell us now? Will UK consumers have access to the FOS in such circumstances and, if so, what authority will the ombudsman have with respect to activities authorised in another jurisdiction? When answering these points, perhaps the Minister would like to consider whether his answer would be the same were the relevant authority to be, say, Romania or Malta. That is not a criticism of those states; rather, it is a reflection on their capacity to manage complex instruments. So the crucial question, as yet unanswered, is: what extra measures are Her Majesty’s Government taking to protect UK consumers once UCITS IV is agreed?
Finally, I turn to the question of the review of the impact of this legislation. The Explanatory Memorandum states that:
“The Treasury will review the operation and effect of the Regulations within five years”.
However, the European Commission plans to make further reforms regarding the roles and responsibilities of UCITS depositories and expects to publish proposals later this year. There are therefore no plans to have a post-implementation review until these further changes have been developed and proposed. Is that wise? Are we not likely to get into something of a muddle as to the impact of various changes layered upon one another over time? The changes about to be implemented have significant ramifications for the regulation of fund managers in national markets and on the options available to consumers. Would a review of the current changes not be in order sooner, regardless of other changes being proposed, to ensure that any problems are identified and addressed before they develop?
While this legislation will undoubtedly increase consumer choice by easing the market access of UCITS managers throughout the EEA, I cannot but feel, despite all the warm words on exchange of information between regulators and the introduction of the key investor information document, that it represents a significant diminution of consumer protection. That, to say the least, is unfortunate.
Lord Sassoon
My Lords, I thank the noble Lord, Lord Eatwell, for his contribution to the discussion, but I am sorry that he does not seem to see much of merit in what should be a sensible piece of tidying-up of a regime in Europe which has been in place since 1988. It has taken with it the interests of not only the industry but also the consumer groups as it has been developed successfully through three amendments—and now the fourth—to the directive. We have transposed the directive by way of copy-out without any gold-plating. It rather surprises me that the noble Lord takes this basic stance to a framework which has stood consumers across Europe very well for a considerable number of years and not to date raised any of the concerns that he suggests that this series of amendments might raise.
I shall go through those concerns. I hope that the noble Lord agrees that there is considerable work to be done to complete the single market, whether it is fund management, other parts of financial services or business services more generally. In areas of completing the single market, consumer protection has to be taken seriously but I would interpret that, as a starting position, as not wanting to help complete the single market. That is protectionist in its import if not in the intention, given how the noble Lord, Lord Eatwell, spells it out. That is an unfortunate starting point. We should be looking at ways to sensibly advance what is a well worked regime and to see how we can enable both consumers and the financial services industry to take advantage of sensible further development and the opening up of the single market.
On the noble Lord’s specific concerns, there are two aspects to the question of regulatory arbitrage. First, in the regime, the directive leaves little room for member states’ discretion. It is not that the UK will be transposing these rules in one way and other member states in a radically different way. I know that this is probably not the main thrust of the charge that the noble Lord made on this but it is important to be clear that it is not the rules themselves that will give any significant scope for regulatory arbitrage. Beyond that, it is of course important that we ensure in the UK that funds passported into the UK are suitably regulated. Broadly speaking, that is what has happened under UCITS to date. There are already a good number of funds passporting into the UK under the UCITS directive. The FSA has powers to regulate their marketing activities. This is not opening up some completely new avenue here.
Lord Eatwell
The noble Lord is quite wrong. It certainly is new. The whole point of the new regulation is that funds can be passported into the UK without the prior agreement of the FSA. That is entirely new.
Lord Sassoon
My Lords, it is completely possible—it is done widely now—to passport funds into the UK or other European member states. What is new is that, for example, there will not have to be a multiplicity of management companies set up, so that the passporting in will happen on a much more flexible basis. That is why in UCITS IV there is the introduction of enhanced supervisory co-operation measures between European regulators, precisely to take account of this point. The noble Lord may shake his head and tut-tut but this is what the directive introduces, precisely to address the sorts of concern that he has.
For example, if the FSA has concerns that an inwardly passporting fund is not being managed in accordance with the directive, it is laid out how it can raise the matter with the home state regulator, which must take appropriate action and inform the FSA of the outcome. While I accept that not all regulators will necessarily have the same capacity round Europe, the fact that the FSA or other host regulators will have those sorts of powers gives adequate protection given the sort of regime that we are talking about. We are not talking about bank capital or things that go to the heart of financial stability. Therefore, it is important that the proposed regime is proportionate. The points the noble Lord raises are very reasonable but they have been thought about and are accommodated in the regime.
Arrangements regarding access to the FOS and to compensation arrangements for foreign funds passported into the UK are covered by FSA rules. The FSA rules require that EEA UCITS management companies that passport into the UK in order to operate a UK-authorised UCITS fund will have to contribute to the FOS and FSCS levies so that they are treated equivalently to UK-authorised firms carrying on the same activity. If a claim arises against such an EEA firm under the FSCS rules, it will be met from the general levy on firms in the fund management subclass. We believe that that is appropriate and justifiable because of the need that the noble Lord properly identifies to protect eligible UK investors.
I hope that I have addressed the two main issues which the noble Lord raises on this regime. As I have said, the regulations will work alongside FSA rules to implement the fourth UCITS directive. If they are approved by this House, it is intended that they will come into force on 1 July 2011. The Government will in parallel continue to develop the tax and regulatory landscape to ensure that the industry is able to take full advantage of new opportunities provided by the directive, and to maintain—the noble Lord may not want to see this but the Government do—the UK’s position as a major centre of fund management activity in Europe.
Lord Eatwell
My Lords, I am very keen that the UK fund management industry should develop, grow and be successful; whether this piece of legislation will contribute to that only the future will tell. My main concern is consumer protection. I also asked when the regulations would be reviewed.
Lord Sassoon
The noble Lord is often one step ahead of me; I was coming to exactly that point. One of the best answers to the charges that the noble Lord puts is review. It should be good regulatory practice to review any regulation or directive of this kind. Indeed, the Commission is required to review the UCITS IV directive two years after its implementation. The Government will, of course, continue to monitor the UCITS framework and engage constructively with the European review. We do not anticipate the noble Lord’s worst fears being justified but if that is the case a review is indeed built into the structure to address anything that arises.
I hope that I have addressed the noble Lord’s concerns on the directive. Having heard that those concerns are already addressed in the directive, I hope that the Committee will support the making of these regulations.