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Letter from Brussels: Enforcement problems

Enhancement to the EU’s successful UCITS legislation for cross-border collective investments is now underway. But there are nagging concerns that whatever the outcome for UCITS V, the good work could be undone by member states and their judicial systems failing to enforce common rules.

UCITS legislation allows collective investment schemes to operate freely throughout the EU on the basis of a single authorisation of one state. With some €6trn in assets they are, as the European Commission states, “highly valued due to the high level of investor protection they embody”.

The UCITS IV Directive came into force in July 2011, and the EC adopted proposed amendments in July 2012 covering depositary functions and remuneration policies.

The Commission’s proposal for UCITS V also includes investor protection safeguards and sanctions for failure to comply. But should providers of UCITS funds raise a cheer?

The problem is not the rules from Brussels, but that a single member state can cause the whole legislative paraphernalia to sag. Stéphane Janin, head of international affairs at the French asset management association, AFG, put the case that, while, in principle “administrative sanctions” should be applied by all EU national regulators, there were dangers of failure.

For instance, he continued, a minority of member states were currently pointing to provisions in MiFID which allow administrative sanctions, administered by national bodies, to be optional. If the sanctions were optional in MiFID, why not in UCITS too, they argue?
Lax enforcement, said Janin, would lead to the “polarisation” of rules across the EU. This would result in a clear gap between legislative intention and reality. Ultimately, the financial services industry could suffer from regulatory arbitrage among states.

Furthermore, Janin is clearly worried about jurisdictions implementing Brussels rules correctly, but not providing adequate court systems. He refers to LuxAlpha, an alleged “feeder fund” to Bernard Madoff’s firm, where aggrieved investors are still waiting for a decision from a Luxembourg court case initiated in 2008.

Janin also cites problems involving ‘third country’ jurisdictions outside the EU, that are deemed approved for the Alternative Investment Fund (AIF) passport rules. This would place the spotlight on foreign court systems, which would have to enforce the legislation. This in turn could endanger funds, including those of European retirees, warns Janin.

Another problem lies in confusion between the regulatory approach of the UCITS Directive and that of the Alternative Investment Fund Managers Directive (AIFMD). While scope of funds and their rules are strongly defined in UCITS, interpretation will be partly left to local authorities for so called AIFs within the AIFMD.

The AIFMD is supposed to be transposed by July 2013 – or 2015 for third countries – but Brussels is being held back by certain key concepts that are still to be defined by the European Securities and Markets Authority.

One EC official, Tilman Lueder, says the Commissioner’s intentions for the UCITS V upgrade were to set up a system of compulsory administrative sanctions. The same applied to regulations concerning depositories.

Brussels is also succeeding in stiffening enforcement with the European Parliament’s approval  of the Market Abuse Directive. This will require states’ approval to enact legislation with the possibility of custodial sentences for white-collar crime, including insider trading and market manipulation.

A July 2012 consultation document from the Commission looks at harmonisation of a range of aspects of different packages of financial legislation. It asks for opinions on the inclusion of eligible assets, such as derivatives in UCITS, and on long-term investing. On money market funds, it questions valuation methodologies and the relevant criteria to define “stressed market conditions”.

The Commission plans to bring out its report on the consultation early this year.

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