When is a Ucits fund no longer a Ucits fund? That is the question currently facing the European fund industry, as regulators attempt – as outlined in this week’s FTfm – to reconcile the increasing complexity of ‘Newcits’ funds with the rules outlined in the Markets in Financial Instruments Directive (Mifid).
It’s not hard to see the regulators’ problem. The Ucits framework was originally designed for the retail market under the general principle that funds marketed at unsophisticated investors should be simple to understand. But with the introduction of Ucits III – which allows fund managers to use a much wider range of investment instruments – that broad principle was more or less jettisoned, with many groups launching funds that are, to all intents and purposes, hedge funds.
In many ways this outcome was wholly predictable. In a single stroke Ucits III handed to investment professionals – not, on the whole, people inclined to look gift horses in the mouth – an extremely well-stocked, shiny new tool box: was there ever any doubt they would delve deeper than the spanners and the monkey wrench? Funds today often use most if not all of the broad powers at their disposal – not least because the volatility of some asset classes, like emerging markets, actively encourage it – and they do so in a number of increasingly complex ways. Indeed, it now seems even the most sophisticated hedge fund strategies can be substantially replicated under the Ucits III framework.
Should, then, this newer breed of funds be treated differently under Mifid? While the ‘yes’ case is, on the face of it, persuasive, it is difficult to envisage its proponents getting their way. Practically, there would be major hurdles to overcome – not least that a change in approach could place a considerable burden on advisers – while fund associations (if the response from Germany’s BVI, as quoted in FTfm, is a guide) – would be deeply unenthusiastic. And there is also, of course, the (some may say moot) question of: are retail investors buying ‘Newcits’ funds anyway? Hedge funds are not marketed to retail investors and neither, generally are their Ucits equivalents, with high minimum investments often elevating them well beyond the reach of the financially diminutive. That is not true of every single Ucits absolute return fund – some have industry standard minimums and could theoretically be bought by the man on the street – but few groups seem to be actively seeking to attract money from retail investors. That might not be a good argument for maintaining the status quo, but it remains a point worth making.
Ucits III was unquestionably a huge leap forward for the industry, enabling investors of all types to access hedge fund strategies within a liquid, regulated format. Whether or not they will eventually be sold to retail investors with tighter controls under Mifid is currently being investigated by the Committee of European Securities Regulators, which is to submit its recommendations to the European Commission in the not-too-distant future. The industry will await its verdict with interest.