European Union

Author: | Published: 3 Oct 1999
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The fund management industry is increasingly sensitive to international developments and initiatives. Gone are the days when largely domestic banks, insurance companies and independent fund managers could ignore overseas developments confident that their home market was secure.

These changes are driven in part by the internationalization of business generally and in particular by mergers bringing about large international financial services companies selling products globally. One of the drivers in all of this is the internet and e-commerce generally which, at the same time as making the development of truly international businesses a reality, are throwing up completely new challenges to financial services companies and regulators alike.

To some extent EU and other de-regulatory initiatives (particularly in the US and the emerging markets) are also driving this process. By removing barriers and increasing competition, prices are being driven down and firms are finding it necessary to cut costs and/or increase funds under management/administration to maintain profit margins. The same forces are partly responsible for the current trend towards de-mutualization and mergers of exchanges and clearing houses. In turn, regulators are finding it necessary to develop means of regulating such international operations, so wider international coordination is, through necessity, fast becoming a reality. So what are the specific international developments which the fund management industry needs to be aware of and influence?

EU developments

The number of EU proposals now being considered is quite breathtaking. A list of those likely to have an impact on the fund management industry is set out in the box on page opposite.

All of these will directly or indirectly effect the fund management industry. Thus, the proposed amendments to the Listing, Public Offers and Accounting Directives are each likely to broaden Europe's capital markets by making it easier to market and list securities throughout Europe and to better compare the financial position and performance of all European companies. Others will result in changes to rules and regulations which will more directly affect European fund managers and those in related service operations. The following is a brief summary of some of those proposals.

Distance selling directive

This Directive is anticipated to be adopted this year, with member states likely to have to adopt it by means of local laws by June 2001. The Directive will have a significant effect on the sale of international financial services and products. It will apply whenever sales of products or services are conducted long distance (ie by means of mail, telephone, e-mail, internet etc) as opposed to face to face and will therefore cover most retail products. The following are the key features of the Directive:

  • suppliers of financial services will be able to market their products and services to consumers throughout the single market subject to compliance with (harmonized) local rules on distance selling;

  • consumers means natural persons not acting in a business capacity — ie the Directive does not apply to marketing of financial services to companies or other bodies as opposed to individual consumers;

  • financial services includes typical banking (eg acceptance of deposits, mortgage and other lending and foreign exchange services), investment services (eg transactions in securities, derivatives and units in funds) and insurance (eg life, non-life, permanent health and pensions products);

  • Consumers must receive a comprehensive set of information concerning the products and services before conclusion of the contract;

  • a cooling off period will apply providing a general right to withdraw without giving any reason within 14 and 30 days in relation to most services (but not foreign exchange, securities or fund transactions, certain short-term loans and certain property loans);

  • unsolicited communications may be prohibited entirely, or at each state's discretion, the subsequent supply of services only permitted where the consumer has not objected to the unsolicited approach made;

  • the burden of proof will lie solely with the supplier; and

  • consumers can be required to pay for services rendered prior to the end of the cooling off period but must be informed in advance of what those costs will be.

The Directive will have a significant effect on the compliance obligations of suppliers of financial services and products. Moreover, the onus of proof of compliance is firmly on the supplier (who will therefore need to be able to evidence compliance). Failure to comply will result in contracts being void and consumers being able to obtain redress for costs incurred and damages suffered. If anyone is uncertain as to the possible impact of these rules, consider the costs and reputational issues following the recent UK pension mis-selling scandal.

It will be appreciated that while the Directive will prevent member states from prohibiting distance sales it does not address the question of compliance with local marketing, advertising or conduct of business rules. This will be dealt with by other proposals.

Some other points worth noting are:

  • the Directive only applies to the initial sale of a product or service — subsequent consequential acts concerning the relationship established are not covered. Thus, once a bank account is established or a sale of fund units concluded, subsequent dealings concerning additional deposits or subscriptions for units are not covered. On the other hand, the promotion of new products (eg credit cards or a new class of fund units) would be covered;

  • if there is any face to face communication (even though combined with long distance communications) the Directive will not apply; and

  • since the requirements of the Directive are compulsory, it will be necessary for each state to review its current cold calling, cooling off and other provisions and amend them as appropriate to comply with the Directive.

E-Commerce Directive

The proposal for an e-commerce directive is in many ways an essential supplement to the Distance Selling Directive in that it deals specifically, among other things, with distance selling of financial services over the internet.

  • advertising rules and restrictions which frequently deem internet sites to constitute advertisements even though not specifically directed at the local marketplace;

  • uncertainty as to whether contracts can be concluded electronically (eg requirements that matters be dealt with in writing, requirements for original copies or that matters be published or authenticated or lodged with a third party); and when a contract is so concluded — when you hit OK or only when the message arrives on the counterparty's screen/server?

  • whose copyright laws apply?

  • liability of intermediaries (eg service providers) for the content on websites.

The Directive will provide that, generally, member states may not preclude residents from establishing an information society service — ie services provided by electronic means at a distance without prior authorization. Such service providers are therefore not going to be subject to specific licensing or regulatory regimes — although they may still be covered by other financial services rules and regulations depending on their activities see below.

Member states will in future have to have laws:

  • permitting contracts to be concluded electronically (subject to certain excepted areas);
  • requiring service providers to set out the manner of formation of contracts and whether contracts will be archived;
  • in default of other arrangements, contracts are to be deemed concluded only on receipt of an acknowledgement of receipt of acceptance from the counterparty via the service provider and the recipient in turn acknowledges receipt of the acknowledgement;
  • acknowledgements of receipt are only deemed received when the parties can actually access them; and
  • generally intermediaries will not be liable for information they merely pass on, or store in the absence of knowledge of illegal activity and will not be under a duty to monitor information passing through them.

Notwithstanding the above, member states will be allowed derogations on the grounds of, among other things, public policy and consumer protection.


UCITS II contains some of the long-awaited changes to the current UCITS Directive which has as its objective the freedom for qualifying funds to be established and marketed to the retail public throughout the EU subject to compliance with certain notification and filing obligations in the host state and compliance with host state advertising and marketing rules.

The current UCITS Directive is very prescriptive in terms of the types of investments which are permitted — basically listed debt, equity and warrants — and the structure of such funds — no fund of funds or feeder funds for example. UCITS II will make three fundamental changes to the current Directive:

  • widen the types of investments which will be permitted to include certain types of derivative funds (but probably using on-exchange instruments only), money market funds and fund of funds — feeder funds will still not be allowed;
  • remove an anomaly in the Investment Services Directive by allowing managers of UCITS funds to market their services throughout the EU and to establish branches in other EU states. Such managers would no longer be restricted to managing UCITS funds only, as at present; and
  • allow the use of a short form prospectus for marketing purposes and require the distribution of a full prospectus only if the investor requests this.

While it is still not certain that UCITS II will become law as drafted, the general feeling is that it will be approved in the above form this time and if so it might become a Directive by the end of this year but would be unlikely to be implemented by member states until 2000 or even 2001.

So, if UCITS II becomes law, will it radically affect the fund management industry? Probably not. While many of the changes can be said to be a step in the right direction they are really rather conservative. For example, derivative funds will not be allowed to gear up and must have cover for all derivatives contracts held in the form of securities, cash or other derivatives contracts. Likewise the proposals whereby the manager will have an ISD type passport seems unlikely to make any significant difference in terms of the ability to market funds and investment management services across borders. Although it is obviously to be welcomed that managers of UCITS funds can also undertake pension fund and portfolio management, they can clearly do so already through separate subsidiaries and so this is really a provision which will remove unnecessary duplication rather than attack fundamental problems.

What then would make a real difference? A number of broader changes have been put forward over the last five years and it is to be hoped that some of the following will ultimately be adopted:

  • Feeder Funds – one of the main obstacles to the development of a truly European fund management business at present is the lack of a means to genuinely pool all assets of a particular type in a single fund. Although this is possible in principle, in practice local tax and other obstacles mean that UCITS funds are rarely sold across the whole of Europe. Instead, separate funds are usually set up for local investors in each country or for distribution in a limited number of countries — eg Luxembourg funds launched by French and German promoters for marketing back into France and Germany. While cloning and other means have been developed to try to allow managers to manage the underlying assets as if they were in one fund, these mechanisms are not proving popular and a number are felt to have their own tax and regulatory complications. As a result there is an appetite for feeder funds which would allow funds set up to be marketed in one country and designed to take account of local requirements which could then invest in a single master fund through which all of the assets of any number of local funds could effectively be pooled.
  • Sandwich companies — there has been some controversy over the interpretation by some countries (notably Luxembourg and Ireland) of the efficient portfolio management provisions to allow UCITS funds to invest via special purpose subsidiaries — eg to take advantage of double tax treaties not available to the fund but available to the subsidiary formed in another jurisdiction. Perhaps surprisingly UCITS II intends to outlaw this whereas it would have been more attractive to fund managers to legitimise the practice subject to appropriate safeguards. Otherwise UCITS will become inefficient as compared to other offshore funds which can use such mechanisms.
  • State by state filing — at present each fund has to register in each other state in which it is to be marketed. It would make life a lot easier if the fund could simply notify its own local regulator and they informed all other states where the fund was to be marketed — as happens with cross-border marketing under the ISD and is proposed for the manager of UCITS in this very proposal.

Pensions Directive

A number of efforts have been made to introduce an element of harmonization of European pensions or at least to end local requirements, which restrict investment freedom unnecessarily. Although EU pensions remain uncoordinated at this time, it seems increasingly likely that further efforts will be made to bring in some form of harmonization in the not too distant future, at least if member states do not make significant changes to their rules in the meantime. Why? Not only has the EU stated publicly in its October 1998 Framework for Action document that they intend to deal with various anomalies in this area but:

  • the euro will make nonsense of some existing rules and bring about a fundamental shift in asset allocation. So current requirements in some member states that 80 to 100% of assets are held in the same currency as liabilities, will in future mean 80 to 100% of investments can be euro denominated and represent investments spread across the whole of the EU rather than held in the local currency and held in domestic shares and bonds only; and
  • the under-funding of state schemes in a significant part of the EU will force restructuring of both state and private pension provision. This has already begun.

What kinds of changes can we expect to see? Previous EU initiatives have focused on:

  • removing or watering down local requirements that local pension schemes invest significant amounts in domestic bonds (as opposed to equities); and
  • restrictions on the appointment of foreign fund managers.

In addition, we are already seeing new forms of private and government sponsored schemes. Increasingly the emphasis is on private individuals to make provision for their own retirement and governments are therefore sponsoring new forms of savings schemes, not all of which are structured as traditional pensions — eg Investment Savings Accounts in the UK, which are tax advantaged savings schemes.

The other area where we would expect to see significant changes is in relation to pan-European arrangements for large corporate pension schemes. At present the concept of a European pension scheme does not exist. Large groups have to either group employees together in a single scheme established in one location (frequently that of the ultimate holding company) or have a proliferation of local schemes. The latter is administratively burdensome and fails to deliver the sort of economies of scale which a single fund would provide. On the other hand, it is frequently not tax efficient for individuals to make investment into and/or receive benefits from overseas schemes and it is often difficulty to structure schemes so that different groups of pensioners receive different benefits dependant only on their geographical location. We would therefore expect to see continued pressure from larger corporations for a degree of harmonization of EU pension requirements and taxation of benefits — indeed the Safir case has already gone some way to achieving this in the tax area and we therefore expect to see the EU moving to acknowledge the situation through legislation.


The harmonization of tax rules across the EU has proved to be the most difficult area for the Commission. Although progress has been made and a degree of harmonization exists (eg VAT), one only has to look at the current proposal for an EU-wide withholding tax to see the problems. The EU has nevertheless repeated in the Framework for Action document that it intends to legislate where existing rules restrict cross-border business and one can therefore expect the EU to continue to press for changes and to look for innovative ways to bring about its objectives.

Other International Initiatives

We are familiar with the efforts of the Basle Committee in relation to banking matters and whose proposals are frequently adopted not only by banking regulators but also, in suitably amended form, by securities regulators also.

The globalization of the securities industry is forcing international cooperation between domestic regulators in order to swap information and agree initiatives which should be pursued at a domestic level. We have seen the effect in pressure being applied on offshore financial centres to adopt money laundering rules and to regulate those carrying on banking, securities and fund management businesses and we can expect to see more and more by way of international cooperation of this kind.

Although there has been discussion of a global or super regulator we seem to be a long way away from any such body in practice. But, with the advent of the internet and e-commerce we are certain to see more and more pressure on domestic regulators to fall into line with the international consensus. Unwillingness to do so will result in lack of mutual recognition of establishment and marketing or other rights. The EU has been more than willing to throw its new found weight around, even harassing the US to change its position on occasion. Where the US and the EU act in concert, one can expect other nations to fall into line unless there are very good domestic reasons to do otherwise.


The dismantling of exchange controls and trade barriers by eastern Europe and much of the rest of the world over the last decade has unleashed large challenges and opportunities for fund managers and regulators alike. Deregulation on a macro scale has been accompanied by increased regulation at the micro level. The price of dismantling fundamental barriers is to regulate the detailed operations of those who are suddenly free to market their wares in places where they previously could not do so. One sees the same process within the EU — in return for removing obstacles to cross-border establishment and marketing, rules are brought in regulating the licensing and conduct of financial services businesses.

The next stage in the global process is to identify those domestic regulations which are inhibiting the overall regulatory movement and to seek to remove these. Within the EU we have a zealous pursuer of these restrictions in the shape of the EU Commission. The US has, of course, always been a leading advocate of free trade and together with the EU and other regulators is increasingly bringing about the dismantling of trade barriers wherever they exist – witness the consistent pressure brought to bear on Japan and which, after years of trade wars, seems to be bearing fruit. We can expect more and more initiatives in this direction.

Contact Details:

Martin Cornish

Tel: +44 171 212 1540