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Charles Muller assesses recent EU legislative developments aimed at enhancing consumer protection in asset management products

The recent crisis has encouraged lawmakers in Europe and elsewhere to review the regulatory framework relating to the financial sector in general. Although investment funds were not a cause of the crisis, they have been caught in the web of this overarching review.

A very good example is the upcoming AIFM Directive. First issued as an effort to regulate hedge funds and reduce systemic risk, it has evolved into a mix of investor protection and product harmonisation efforts. The AIF product with its passport could well become a new standard also outside Europe and a strong quality brand - just as UCITS has. In general, our industry should be more open to the lessons learnt from the financial crisis and to regulation that aims at better informing and protecting investors. Recent examples are outlined here.

Clearer information for investors
For investment funds subject to the harmonised European legislative framework, the UCITS IV Directive has introduced the key investor document (KID) to replace the simplified fund prospectus by 1 July 2012 at the latest. This document must include appropriate information about the essential characteristics of the UCITS fund. The KID will be concise and non-technical. It needs to be fair, clear and not misleading and, therefore, consistent with the relevant parts of the prospectus. Today we are in the process of implementing the KID. It is a lot of work; it is cumbersome and costly to get hundreds of thousands of KIDs ready in time. But our industry once again serves as a model of transparency when it comes to providing clients with comparable, easy-to-understand information.

ALFI's KID sub-committee meets twice a week to discuss questions on the production and use of the KID in distribution networks. The process is completed by specific contributions from other working groups, dedicated (for example) to the calculation of the synthetic risk and reward indicator. This initiative results in the publication of a Q&A document about KID implementation. Five issues have been published since September 2010. Moreover, last October, ALFI organised an event with representatives from the industry and the Luxembourg regulator to pave the way for a successful KID implementation.

Depositary framework for UCITS will be strengthened

The European Commission (EC) is in the midst of an ambitious and intensive programme of regulatory reform in the aftermath of the financial crisis. The creation of a new framework for UCITS depositaries - a cornerstone of UCITS investor protection policy - will increase consumers' confidence and strengthen the brand.

The regulation of depositaries as laid down in the UCITS Directive only sets out some basic principles, leaving nearly all the details to member states. This is why the duties and responsibilities of depositaries in the various member states often vary significantly, depending on the respective legal environment and on the legal structure of the investment fund.

In December 2010 the EC published a second public consultation, based on the feedback statement of a first public consultation and the proposed AIFMD depository provisions, in order to present a new legislative proposal, in 2011, to update the framework applicable to UCITS depositaries and to introduce new provisions on the remuneration of UCITS managers.

While 2002's UCITS III was a product directive and 2009's UCITS IV was a market directive, UCITS V will focus on investor protection. Its benchmark, the Commission says, is the AIFM Directive. Thus it is seeking to co-ordinate its work on UCITS depositaries with the provisions relating to the depositary function in the AIFMD, as adopted by the European Parliament last November. The requirements on the function of the depositary for UCITS and AIFs should be made consistent to the extent that they show operational similarities, but the review of the liability regime applicable to the UCITS depositary will take into consideration specificities linked to the UCITS investment environment and its suitability for retail investors.

At our second depositary bank forum breakfast seminar in February 2011, both the Luxembourg Bankers' Association (ABBL) and ALFI paid tribute to current consultations launched by ESMA and the EC. The AIFM Directive and the forthcoming new legislation on the UCITS depositary function will be an integral part of the future framework of European supervision. The new legislative proposals in this area will certainly be some of the most difficult to draft in order to achieve an enhanced investor protection while at the same time avoiding negative impacts on the UCITS product and the fund industry in general.

Towards more investor protection and product transparency
Important problems have been identified in the EU retail investment market. On 30 April 2009, the Commission's ‘Communication on Packaged Retail Investment Products' (PRIPs) announced that legislative changes were necessary at the European level in two areas: product transparency and sales rules.

Led by this, the Commission started a consultation in November 2010, whose aim is to address crucial issues of investor protection and the lack of level playing field in the distribution of retail financial products. Retail investment products can take a wide variety of legal forms and it is important that all products sold to retail customers as investments are subject to a precise, short and appropriate explanatory note. The benchmark fixed for such explanatory note would be the UCITS KID since the UCITS regime aims at addressing retail investors' need for pre-contractual information to improve decision-making.

At the international level: point of sale disclosure requirements
Recognising the importance of investment funds and their responsibilities to investors, the mission of the International Investment Funds Association (IIFA) is to promote investor protection, facilitate the growth of the investment fund industry internationally, advance understanding of the investment fund industry around the world, and encourage adherence to high ethical standards by all participants in the industry. IIFA has several working groups and I am chairing the one on global regulation: the International Organisation of Securities Commissions (IOSCO) committee.

IOSCO stated in its recently published report on principles of point of sale disclosure that retail financial services may be characterised by information asymmetries - where the supplier of the product has more information about the product than the buyer. Most jurisdictions already have in place some type of point of sale disclosure requirements for funds and other collective investment schemes (CISs), but the degree of prescription in disclosure requirements varies. Market authorities have to find the right way to ensure effective disclosure for retail investors. Regarding UCITS, the EU opted for the KID.
In February 2011, IOSCO published its final report, which includes six principles for disclosure of key information in regard to CISs prior to the point of sale (POS) - ie, prior to the moment at which a customer requests that a product be purchased. Those principles are designed to assist markets and market authorities when considering point of sale disclosure requirements.

Before setting out principles, IOSCO analysed the retail investor's needs when it comes to investment decisions. The latter should be based on solid information; to this end, retail investors should be able to understand a market intermediary's associated conflicts of interest and the layers of costs associated with purchasing those products, any guarantees being offered by the product, or the risks of investing in the product.

Timing and language are critical to ensuring that the disclosure is effective. Many, but not all jurisdictions require that information be disclosed before a transaction is completed. The European MIFID Directive includes disclosure requirements that focus specifically on the intermediary and the services it offers. Plain language can be described as communicating in a way that facilitates audience understanding - as being clear, succinct and comprehensible while avoiding unnecessary jargon and technical terms.
ALFI supports all these efforts towards a high level of adequate regulation as they will benefit the industry and lead to greater protection of investors. This is crucial to the evolution of the asset management industry.

Charles Muller is deputy director general of the Association of the Luxemburg Fund Industry (ALFI)


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