Our quick guide to UCITS IV

Rachel Hanger, partner in KPMG’s investment management & funds practice, explains the new UCITS IV legislation.

The European Union (EU) continues to strive to create a single efficient European market for investors and the latest step in this process is the introduction of the Undertakings for Collective Investments in Transferable Securities (UCITS IV) Directive.

UCITS are funds that adhere to specific regulatory requirements e.g. asset diversification. UCITS IV is designed to enhance the existing UCITS framework which allows for EU wide distribution of UCITS. UCITS IV should enable investors to benefit from clearer information which should help in reaching more informed investment decisions. 

In addition, the innovative provisions of UCITS have the potential of reducing costs via economies of scale which if passed onto the investor could improve investment returns.

UCITS IV contains three optional “enabling” features: a pan-European management company passport; the facilitation of cross-border mergers; and a framework for cross-border master-feeder structures. UCITS IV also contains three mandatory features: the introduction of a key investor document (KID) to replace the simplified prospectus; a new notification procedure for the cross-border marketing of UCITS in the EU and supervision measures that are aimed at improving cooperation mechanisms between national supervisors.

EU member states will need to transpose UCITS IV into national law by 1 July 2011. In particular, simplified prospectuses of existing UCITS must be replaced with a KID within 12 months of national implementation.

Company passport

The first enabling feature of UCITS IV is an EU-wide management company passport, which allows management companies established in one member state to manage funds in other member state. Currently UCITS are required to have management companies established in the same jurisdiction in which the funds are located. 

This provision is more likely to be of interest to fund managers rather than the investors themselves, as it will allow the promoter to rationalise the amount of management companies within their structure if desired and use an existing company when entering new markets.

However, use of the management company passport has the potential of influencing the tax residence of a UCITS fund in some jurisdictions which could lead to unexpected and unwanted tax burdens.   Where this is the case fund managers are unlikely to make full use of the passport.  We have recently seen Ireland make it clear that management company operations located in Ireland will not influence the tax status of the UCITS funds they manage. 

Similar changes may be forthcoming from other jurisdictions where this is a potential problem.  In the absence of tax certainty fund managers will need to balance their desire to create management company efficiencies with the need to ensure that this is not at the expense of the tax positions of fund investors.

Fund merger

The second enabling feature of UCITS IV is that it provides for cross-border fund mergers. The idea is that by creating a larger fund, return expense ratios will be improved, thus improving the returns for investors and making the EU industry more competitive.

However, tax continues to frustrate managers who wish to merge funds.  From an investor’s perspective a merger of funds should be tax neutral as the investors are not realising their investment and they could be paying tax on an investment that may ultimately be disposed of at a loss. However, in many jurisdictions cross-border mergers create a tax exposure for the fund investors.

If a merger of funds is a tax event for investors, it is unlikely to happen despite the efficiencies and costs saving that could be derived. A recent report issued by the European Fund and Asset Management Association and KPMG recommended an EU wide solution in the form of a UCITS tax directive to deal with this problem.

The third enabling feature of UCITS IV is the creation of cross-border master-feeder UCITS structures which will allow feeder funds to invest at least 85% of their assets into another UCITS fund i.e. the Master Fund. Although not as cost effective as having a single fund platform distributed cross-border, a master-feeder structure enables groups to focus investment management in one location which will lead to some cost savings. Managers may choose to convert existing UCITS into feeders or to establish new feeders when entering new markets.

There are a number of tax considerations to take into account when establishing a master-feeder structure.  Charges could arise on conversion of existing structures and the ongoing tax treatment of investing via a master Fund could be less efficient than investing directly into the underlying assets.  The UK has recently announced the introduction of a tax transparent vehicle which could be used as Master vehicle and should preserve the tax treatment between the investor’s home country (in which the feeder would be located) and the country in which the master fund’s assets are located.

Key investor document

The key investor document (KID) is being introduced to replace the simplified prospectus. The KID takes the form of a short document (two pages) containing key facts, strategy and objectives, risk/reward and performance. This is in response to the widely held view that the simplified prospectus was at times indigestible for the investor.

It is therefore hoped that a less “technical” KID will result in investors being better informed. The condensed nature of the KID is also likely to lead to some level of standardisation, which will also make comparing UCITS easier for the investor.

Supervision measures

Supervision measures that are aimed at improving cooperation mechanisms between national supervisors and are also designed to minimise or remove obstacles and delays will be implemented.

If the enhancements available under UCITS IV are fully embraced by the fund management industry and the tax barriers can be overcome then this should be good news for investors in the form of more choice and increased returns. Whether or not UCITS IV will enable Europe to achieve the consolidation and cost efficiencies underpinning the US mutual funds market remains to be seen.