After studying law in Paris and London Charles MULLER became a Luxembourg barrister. In 1994 ne joined Banque Générale du Luxembourg, then, in 2003, the Association of the Luxembourg Fund Industry (ALFI) where he held the position of Deputy Director Gênerai. He was also a Board member of the world-wide federation of investment fund associations (IIFA) and a member of the Management Committee of the European Fund and Asset Management Association (EFAMA). Since December 2011, Charles Muller is a partner with KPMG Luxembourg, in charge of the Investment Management arm of the EMEA Financial Services Regulatory Centre of Excellence.
Alain RUTTIENS holds a master’s degree in Chemical Engineering (Faculté Polytechnique de Mons, Belgium). After about a 20-years experience in financial markets (mainly Indosuez bank), he started his own business as a partner of NEURON sàrl, providing services related to financial markets and products. He is professeur affilié at ESCP Europe (Paris), also teaching in several universities and institutions, a.o. HEC Paris, the Sorbonne University of Paris I, the Institut d’Etudes Politiques (Paris). He is also the author of several books, among others, Futures, swaps & options, Edipro (4th ed., spring 2012), and Mathematics ofthe financial markets, John Wiley & sons, March 2013.
UCITS funds today represent a major share of European funds. The European directives started with UCITS I in the mid 1980s, and have been amended up to UCITS IV in 2009, to be followed soon by a UCITS V package. In its first part, this book is summarizing the evolution and features of these successive sets of European regulations. Among others, it covers the UCITS eligible assets, the key parties involved in UCITS funds operations, their reporting and information requirements, taxation and many other useful related subjects, to give a short but useful understanding of the UCITS world.
Besides, the UCITS IV directive is entering into the risk management field, which is materialized by the issue of a key document entitled Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS (the famous ref. 10-788 Guidelines of the Committee of the European Securities Regulators “CESR”). These Guidelines require some technical skills: the second part of this book reproduces the CESR’s Guidelines, punctuated with comments and prerequisites of quantitative finance, to help for a better understanding of the content and significance of this UCITS IV objective.
George CHACKO, Anders SJoMAN, Hideto MoToHASHI, Vincent DESSAIN, Credit derivatives, Pearson Prentice Hall, 2006.
Moorad CHOUDHRY, An introduction to Credit Derivatives, Butterworth-Heinemann, 2nd ed., scheduled November 2012.
Moorad CHOUDHRY, An introduction to Value-at-Risk, John Wiley & Sons, 5th ed., 2012.
Frank FABOZZI, Fixed income mathematics, Mc Graw-Hill, 4th ed., 2005.
Richard R. FLAVELL, Swaps and other derivatives, John Wiley & Sons, 2nd ed., 2009.
John HULL, Options, Futures and Other Derivatives, Pearson, 8th ed., 2011.
Philippe JORION, Financial Risk Manager handbook, John Wiley & Sons, 6th ed., 2010.
Philippe JORION, Value at Risk: The Benchmark for Controlling Market Risk, McGraw-Hill, 3rd edition, 2007.
Raymond M. LEUTHOLD, Joan C. JUNKUS, Jean E. CORDIER, The theory and practice of futures markets, Stipes Publishing, 1999.
Alain RUTTIENS, Mathematics of the Financial Markets, John Wiley & Sons, 2013.
In French:
John HULL, Patrick ROGER, Options, futures et autres actifs dérivés, Pearson, 8e éd, 2011 (translated from Hull’s book above).
Alain RUTTIENS, Futures, Swaps, Options; Les produits financiers dérivés, EDIPRO, 4e éd., 2012.
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AIFMD: Alternative Investment Funds Managers Directive
AMl: Anti Money Laundering
AUM: Assets Under Management
CESR: Committee of European Securities Regulators
CSSF: Commission de Surveillance du Secteur Financier
EBA: European Banking Authority
EFAMA: European Fund and Asset Management Association
EIOPA: European Insurance and Occupational Pensions Authority
EPM: Efficient Portfolio Management
ESMA: European Securities and Markets Authority
ETF: Exchange Traded Funds
FATCA: Foreign Account Tax Compliance Act
FCP: Fonds Commun de Placement
FFI: Foreign Financial Institution
GAAP: Generally Accepted Accounting Principles
ICI: Investment Company Institute
ISAE: International Standards on Assurance Engagements
KIID: Key Investor Information Document
MiFID: Markets in Financial Instruments Directive
MMI: Money Market Instrument
NAV: Net Asset Value
OECD: Organisation for Economic Co-operation and Development
OTC: Over The Counter
REPO: Repurchase Agreement
SICAF: Societé d’Investissement à Capital Fixe
SICAV: Societé d’Investissement à Capital Variable
SIF: Specialized Investment Fund
SRRI: Synthetic Risk and Reward Indicator
TS: Transferable Security
UCI: Undertaking for Collective Investment
UCITS: Undertaking for Collective Investment in Transferable Securities
VAT: Value Added Tax
The fund industry general, and the UCITS world in particular, occupies a specific and often underestimated role in the fund industry. Asset managers and investment bankers consider it boring, full of rules limiting creativity and “real” money-making and full of administrative and legal constraints. Regulators see it as a receptacle of savings that needs to be particularly heavily regulated to protect retail customers from losing money.
In fact funds are vehicles that help connect people that have money with people that need money. On the contrary to banks and insurances, funds don’t operate their own balance sheets and don’t make profits. All the added value that is generated (minus cost of service providers) goes directly back to investors. On the contrary to direct investments, funds provide investors with certain safety measures, “airbags” that cost money but will reduce risk and increase certainty. The assertion that funds would in addition provide an increased return compared to corresponding direct investments has been questioned over the last years, even if it remains an important selling arguments for fund promoters.
The EU has enacted directives governing UCITS (Undertakings for Collective Investment in Transferable Securities) since 1985. Today, UCITS IV is implemented, with a further UCITS V already in preparation. It seems useful to us to take stock of this growing set of regulations, and present the salient facts of the UCITS funds, which today represent a major share of European funds. This constitutes the first part of the present book.
Besides, a significant feature of the UCITS IV directive relates to risk management, which has become a major concern for the funds industry, particularly in the wake of the credit crisis of 2007, since then having spread to a broader financial crisis. To that extent, the Committee of European Securities Regulators (“CESR”) has issued Guidelines on Risk Management that makes this concern concrete. Although clearly presented and exemplified, these Guidelines refer to several aspects of quantitative finance, which may not be sufficiently familiar to the average people confronted with UCITS IV. Hence the second part of this bookreproduces the CESR’s Guidelines, punctuated with comments and prerequisites of quantitative finance, to help for a better understanding of the content and significance of this UCITS IV objective.
The authors would like to thank the KPMG Centre of Excellence team for its support and contribution to the regulatory part of this publication and especially Dee Ruddy, Gabrielle Jaminon, Dorothea Mevissen, Thomas Ertl, Kian Navid and Ludivine Zanetti.
Charles Muller, Charles.muller@kpmg.lu
Alain Ruttiens, ruttiens@pt.lu
Commission Directive 2010/42/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards certain provisions concerning fund mergers, master-feeder structures and notification procedure
Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organizational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company
Commission Regulation (EU) No 583/2010 of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards key investor information and conditions to be met when providing key investor information or the prospectus in a durable medium other than paper or by means of a website
Commission Regulation (EU) No 584/2010 of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards the form and content of the standard notification letter and UCITS attestation, the use of electronic communication between competent authorities for the purpose of notification, and procedures for on-the-spot verifications and investigations and the exchange of information between competent authorities
Law of 17 December 2010
Law of 13 February 2007
CSSF Regulation 10-04
CSSF Regulation 10-05
CSSF Circular 2012/546
www.efama.org
EFAMA: Fact Book 2012 and 2011
EFAMA: Annual Report 2011
EFAMA: Asset Management in Europe – Facts and Figures (May 2012)
EFAMA: European Monthly Industry Fact Sheets
EFAMA: European Quarterly Statistical Release
EFAMA: International Quarterly Statistical Release
www.cssf.lu
CSSF: Annual Report 2011
CSSF: Newsletter (issued monthly)
www.alfi.lu
ALFI: Annual Report 2011-2012
ALFI: Luxembourg Regulated Investment Vehicles
ALFI: Luxembourg Investment Vehicles – An overview of the legal and regulatory requirements (March 2012)
ALFI: Investment management - Setting up an investment fund in Luxembourg
ALFI: UCITS VI – 10 reasons for a Luxembourg management company
ALFI Study: Trends in Cross Border Distribution (Sept 2012)
ALFI – Lipper – Thomson – Reuters: Symbiosis in the evolution of UCITS / 1988 – 2018: Three decades of funds industry transformation (March 2010, updated June 2012)
www.luxembourgforfinance.lu
Luxembourg for Finance: How to set up a UCITS fund (April 2012)
Luxembourg for Finance: How to set up a UCITS management company (April 2012)
www.ici.org
ICI: 2012 Investment Company Fact Book (May 2012)
Claude Kremer / Isabelle Lebbe: Collective Investment Schemes in Luxembourg – Law and Practice, Oxford University Press (2009)
Investment fund structures already existed in Europe at the end of the 19th century, but their development at a larger scale really only occurred after the second world war. At that time, investment funds were regulated according to largely differing national laws. The first attempt to regulate investment funds at the European level dates back to the mid 1980s, when Directive 1985/611/EEC was adopted and the “UCITS” (Undertaking for Collective Investment in Transferable Securities) label created.
The main focus of this first Directive, now referred to as UCITS I, was the establishment of a common set of rules to facilitate the distribution of UCITS across Member States while ensuring a consistent level of protection to investors. The aim was to allow a UCITS authorized in one Member State to be authorized for sale in other Member States without additional authorization requirements from national authorities. However, reality did not meet expectations. On the one hand, distribution was hampered by specific local marketing rules introduced by individual Member States and on the other hand, investment possibilities were considered too restrictive, providing only limited scope in terms of the range of products that could be offered. These difficulties called for a revision of the rules in the early ‘90s, and an amended version of the Directive under the name of “UCITS II” was put on the table. As the Council of Ministers of the European Union failed to find an agreement, the revision was finally abandoned.
It took almost 10 years before a new, amended version of UCITS was finally approved. Directives 2001/107/EC and 2001/108/EC represent what is commonly known as “UCITS III”, a package of new rules that were respectively focused on Management Companies and simplified prospectuses on one hand, and investments of UCITS on the other hand, all aiming at wider consumer choice and improved investor protection.
Directive 2001/107/EC sought to provide Management Companies with an European Passport to operate throughout the European Union, with a tightening of the risk management framework and substance requirements. The Directive also introduced the “simplified” prospectus in order to ease public comprehension of financial information, using a simplified format that, it was hoped, would be understandable across different European jurisdictions.
Directive 2001/108/EC expanded the type and range of investments a UCITS may hold to money market instruments, deposits, other UCITS and derivatives under certain conditions. The evolution of the UCITS framework under UCITS III however fell short in tackling industry consolidation and efficiency constraints. In addition, the hope of a fully functioning Management Company Passport did not materialize. Having recognized these shortcomings, the European Commission initiated a new wave of amendments - the “UCITS IV package” that was adopted in 2009 (Directive 2009/65/EC).
The main amendments to the legal regime introduced by UCITS IV relate to:
Though the implementation of UCITS IV is recent and all the opportunities offered by the new framework have not yet been exploited, the European Commission is already discussing future changes to the UCITS rules.
A “UCITS V” draft directive from the European Commission is currently being discussed at the level of the EU Parliament and Council of Ministers. It focuses on harmonizing the role and liability of the UCITS depositaries, introduces remuneration policies for UCITS managers and a catalogue of sanctions that national competent authorities must apply in the event of a breach of the UCITS regulation. It could be adopted in the course of 2013.
The European Commission also issued a consultation paper in July 2012 seeking the views of the market on, among other things, the definition of additional rules concerning risk management within UCITS, the scope of eligible assets and the depositary passport. These changes to the UCITS framework might materialize in a new set of rules already commonly referred to as “UCITS VI”.
Statistics are fluctuating animals. Assets under management and market shares can vary depending on what you consider a fund (regulated, unregulated), a mutual fund (UCITS, non-UCITS…), and depending if you can eliminate double counting in fund of funds.
The following international figures are based on reports from the ICI in the US and EFAMA in Europe, collecting data on regulated funds from 45 jurisdictions. This means that funds domiciled in non-reporting jurisdictions (mostly alternative funds in offshore locations) are not included.
At a global level UCITS funds are considered as a major investment product. While the US still lead the way with almost 50% of total assets in worldwide mutual funds, Europe has a market share of roughly 30%.
Source: EFAMA Factbook 2012
However, the average size of a European fund is still much smaller than in the US, a fact that has drawn the attention of EU regulators who have tried to encourage cross-border fund mergers in Europe.
Source: ICI/EFAMA (31/03/2012)
UCITS is a pure European “invention” that dates from the middle of the 1980s, and its evolution can undoubtedly be considered as an unparalleled success story, as statistics show. Today UCITS funds have become the standard in Europe, since over 70% of all assets in regulated European funds are invested in UCITS products. Between 2000 and 2012 net assets in UCITS funds increased from 3.5 to more than 6 billion EUR.
Source: EFAMA Fact Sheet December 2012
The six top investment fund domiciles in Europe in terms of assets have historically been Luxembourg, France, Germany, Ireland, United Kingdom and Switzerland; amongst the EU markets, Luxembourg, Ireland and the United Kingdom have always been benefiting from a higher equity exposure of fund assets compared to France and Germany, and this has contributed to the rapid post-crisis growth of those markets in the past few years.
Market share of European Fund Domiciles as at 31/12/2012
Source: EFAMA Quarterly Statistical Release Q4/2012
European markets tend to differ based on the assets preferred by local investors.
Equities tend to be the most popular kind of assets in Europe, due to the higher return they can provide, especially in times of low interest rate; but equities also potentially embed higher risks compared to other kinds of securities, and this is reflected in the tendency that markets have to divest from equities during a financial crisis.
Bonds represent a relatively stable type of assets. They are considered as one of the safest investments, as they grant a return of capital plus interest at the end of a fixed period.
Asset allocation by UCITS type (%) as at 31/12/2012
Source: EFAMA Factbook 2012 & Quarterly Statistical Release Q4/2012
Investment funds should therefore been considered as tools to help finance the “real” economy: governments, local public entities and enterprises. The source of money is diverse but mostly comes from retail customers and long-term saving, pension and insurance vehicles.
Investment Fund Asset Ownership (%) as at 31/12/2012
Source: EFAMA Factbook 2011 & 2012
Even excluding insurance and banking products, the retail segments represents, directly and indirectly through pension funds, roughly 40% of total savings in funds.
Main financial Assets of Households (%) as at 31/12/2012
Source: EFAMA Factbook 2012
The evolution of assets under management in Luxembourg domiciled funds derives from the widening of the Single European Market (growth in the number of EU countries), the increase in promoters and funds, the developments on financial markets and, last but not least, the distribution of UCITS funds outside the EU. The beginnings were rather slow: it took the fund industry from the late 1980s to 1999 to reach 500 billion Euros in assets under management. AUM then doubled between 1999 and 2004, and doubled again within 3 years (benefiting from the various enhancements of the UCITS regulation) to reach the 2 trillion threshold in May 2007. Due to the crisis, AUM fell back to 1.5 trillion in March 2009 and it took the industry until the beginning of 2010 to reach pre-crisis levels.
In Luxembourg, the main categories of funds are UCITS (i.e. Part I funds), other UCI (i.e. Part II funds) and SIF (i.e. specialized investment funds). Whereas UCITS and other UCI are regulated in the Law of 17 December 2010 on undertakings for collective investment, SIF are regulated in a separate Law of 13 February 2007 on specialized investment funds.
Fund promoters in Luxembourg by Country of origin (as at 31/12/2011)
Source: CSSF Annual Report 2011 & Newsletter 02/2013
Net assets in Luxembourg funds (in bn EUR)
Source: CSSF Annual Report 2011 & Newsletter 02/2013
Except for the crisis year 2008, net sales in Luxembourg have remained positive and the number of funds has continued to increase (3,867 funds representing 13,407 sub-funds at the end of June 2012). While less than half of the funds are UCITS, they represent almost 80% of assets under management.
Breakdown of funds by legal form and net assets
Source: CSSF Monthly Statistics as at 31/01/2013
Luxembourg law recognizes three different legal forms to the funds: Fonds Commun de Placement (FCP), Societé d’Investissement à Capital Variable (SICAV) and Societé d’Investissement à Capital Fixe (SICAF). The FCP is the most common legal form used for funds in Luxembourg, followed by the SICAV. The SICAF, a fixed capital structure, is less popular and its use has been decreasing to 33 units only as at the end of 2011. The preference for FCP in Luxembourg is confirmed by the figures provided by the market at the end of 2011:
Number of UCIs according to their legal form
Source: CSSF Annual Report 2011
The most popular types of assets traded by the above mentioned funds are represented in the chart below; the figures are split between UCITS – Part I, UCI – Part II and SIF, as these are the three main categories of funds we can find on the market of Luxembourg:
Investments of Luxembourg funds per asset type (in bn EUR)
Source: CSSF Annual Report 2011
Not included in the figures for UCI – Part II are those UCITS excluded from Part I of the Law of 17 December 2010 closed for redemptions, not promoted in the EU or only sold to individuals in countries outside the EU, as well as UCITS excluded from Part I of the 2010 Law under one of the categories laid down by CSSF Circular 03/88 owing to their investment and loan policy.
The principles governing UCITS funds are laid down in an European Directive that was first adopted in 1985 with the objective of creating a retail collective investment fund that could be freely sold across the EU, subject to common rules on authorization, supervision, structure, portfolio and the information to be provided to investors. In the intervening years the UCITS Directive has undergone multiple amendments (see history of UCITS above) to modernize the regime and the latest changes were formally adopted in 2009 (Directive 2009/65/EC). In July 2012 in line with their investor protection agenda the Commission issued a new proposal (UCITS V) to amend the UCITS framework which is expected to be voted before the end of 2012.
In the same month the Commission launched a wide-ranging consultation (UCITS VI) covering new areas where the framework could be further enhanced.
This section will give you an overview of EU regulation with, as a special focus and case study, the regulation in Luxembourg as the leading European fund domicile.
At EU level, only the European Commission has currently the right of initiative (right to propose new pieces of regulation) and the Commission generally proposes “Directives” or “Regulations”. UCITS takes the form of a directive and accordingly must be implemented by EU Member States, which may require new national legislation or amendments to existing legislative provisions. The implementation process is called “transposition”, and Member States are normally required to comply within a specific deadline that is set in the Directive. In contrast, “regulations” are directly binding as soon as they are passed and do not need further legislation at a national level.
As part of its preparatory work prior to drafting a legislative proposal, the Commission normally launches a consultation seeking feedback from the various stakeholders, although this phase is not compulsory. After the consultation phase the Commission adopts a draft legislative proposal which is submitted to the European Parliament and Council for evaluation, comments and amendments, and then for approval or rejection.