European regulators will decide early this year whether UCITS funds should be reclassified as “complex” and “non-complex” products in order to improve transparency of information about investment strategies.
Under proposed changes to the Market in Financial Instruments Directive (Mifid II), fund managers must assess the buyer’s knowledge before selling so-called ‘complex’ UCITS funds to retail investors. Under current Mifid rules, all UCITS funds are considered as ‘non-complex’ products, meaning the buyer’s knowledge of financial products does not have to be assessed.
Complex funds are permitted to adopt more elaborate investment strategies than traditional UCITS funds and, says the European Commission, may therefore be difficult for investors to understand. Asset managers with ‘execution-only’ sales teams would be particularly affected by the change.
The Mifid II proposal raises questions over the direction of the global UCITS brand, which is marketed to retail investors as a single shell for simple funds. Total assets of UCITS funds stood at E5,425bn in November 2011, according to the latest available figures from the European Fund Asset Management Association (EFAMA).
Some supporters of the change believe it will bolster expansion into Asia, which wants to emulate the UCITS model with its own version. In November 2011, the Asia-Pacific Economic Co-operation forum (APEC) said it welcomed “further development work to help explore the establishment of a pilot Asia Region Funds Passport (ARFP)”.
Asia will be a key market for UCITS fund distribution in the year ahead and more than 5,000 UCITS funds are already being sold there. The region’s growth story is attractive to fund managers reaching out for new revenues as Western economies struggle with government deficits and the possibility of recession in the Eurozone. In response to the increased flow of money, Hong Kong and Singapore have imposed restrictions on alternative fund managers.
Separate labelling of UCITS funds may also help protect investors and manage expectations.
Under the new rules, ‘complex’ UCITS funds would require asset managers to vet potential customers and ensure that clients and funds are more appropriately matched and less chance of risk-adverse investors experiencing unexpected losses.
The so-called ‘non-complex UCITS would remain a trusted source for savers and investors seeking a core portfolio of low-risk investment vehicles.
But those against the Mifid II proposal are concerned that labelling UCITS funds along their investment policies goes against the principle under which they were created in 1985 – a uniform highly-regulated product which offers investors a high level of protection while simultaneously restricting investment policies which are more difficult to understand.
For example, the use of hedging techniques is allowed only to a limited extent.
The argument over whether some types of UCITS funds should be reclassified will intensify as regulators finalise their plans. Introducing a ‘complex’ classification for structured funds may help the UCITS product to expand into Asia at a time when a possible rival regime is planned there.
It would also gold-plate investor protection by ensuring fund managers match their products with appropriate investors. Conversely, such a split may create confusion among investors who understand and trust the UCITS brand as a single umbrella for lower-risk investment vehicles. Whatever happens, UCITS funds may no longer remain as straightforward as they were intended to be.