Documents considered by the Committee on 2 May 2018 Contents

3Asset management: cross-border distribution of funds within the Single Market

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Treasury Committee

Document details

(a) Proposal for a Directive amending Directive 2009/65/EC of the European Parliament and of the Council and Directive 2011/61/EU of the European Parliament and of the Council with regard to cross-border distribution of collective investment funds; (b) Proposal for a Regulation on facilitating cross-border distribution of collective investment funds and amending Regulations (EU) No 345/2013 and (EU) No 346/2013

Legal base

(a) Article 53 (1) TFEU; Ordinary Legislative procedure; QMV; (b) Article 114 TFEU; ordinary legislative procedure; QMV



Document Numbers

(a) (39548), 6988/18 + ADDs 1–2, COM(18) 92; (b) (39549), 6987/18 + ADDs 1–2, COM(18) 110

Summary and Committee’s conclusions

3.1As part of its effort to create a Single Market for collective investment funds, the EU has legislated to create a number of types of funds and regulate fund managers, including ‘undertakings for collective investment in transferable securities’ (UCITS),10 funds, aimed at small investors like households, and various types of Alternative Investment Funds (AIFs) such as hedge funds and European Venture Capital Funds. EU legislation for investments funds contains the so-called ‘passport’, allowing funds domiciled in one Member State to be marketed to investors, including individual savers, across the entire Union.

3.2However, use of the ‘passport’ for both UCITS and AIFs is subject to a number of regulatory requirements, for example relating to supervisory fees or restrictions on marketing materials. These rules are often imposed at the discretion of each individual EU Member State, and therefore vary from country to country. Partially11 as a result of these divergent regulatory practices, and despite the existence of the EU-level regulatory frameworks for UCITS and AIFs, funds remain largely constrained to national markets rather than the Single Market as a whole. EU investment funds representing 70 per cent of the total assets under management (AuM) are registered for sale only in their own Member State.

3.3In 2015 the European Commission announced that—as part of its Capital Markets Union (CMU) programme to increase the supply of capital to businesses (particularly from sources other than banks)—it would seek to address regulatory barriers that prevent funds from effectively using their ‘passport’ under EU law to grow, compete in different national markets, and maximise economies of scale to reduce the cost of investing. It tabled a legislative initiative to that effect in March 2018, seeking to address five identified regulatory barriers by setting EU-wide harmonised standards:

3.4To reduce the disparity between the way in which Member States regulate in these areas (and therefore make it easier for investment funds to ‘passport’ into new national markets), the Commission proposal would impose new restrictions on the leeway national regulators would have to set their own rules.12 The new horizontal requirements would affect marketing communications, so-called ‘pre-marketing’ activities, supervisory fees, and notification requirements. It would also ban Member States from requiring UCITS managers to maintain a physical presence if they ‘passport’ a fund into their territory. We have summarised the substance of the proposal in more detail in “Background” below.

3.5Although the proposals have no direct link to the UK’s withdrawal from the EU, the Commission has noted that Brexit “will have an impact on the EU investment fund market”, as many fund managers are located in the UK and it also has a large investor base.

3.6The Economic Secretary to the Treasury (John Glen) submitted an Explanatory Memorandum on the proposals to make cross-border distribution of UCITS and AIFMD funds easier on 23 April 2018.13 In it, he expresses the Government’s support for measures that “[remove] barriers for fund managers marketing funds across borders and provides greater consumer choice of fund products”. However, the Minister adds that any legislative change should “genuinely facilitate market access and […] not impose additional and unnecessary burden on firms across the EU, which could run contrary to the overall objectives. Similarly, the introduction of new elements to the EU legislative framework for investment funds should not inadvertently result in limitations on the distribution of funds and should accommodate the diverse range of fund structures and distribution models that exist within the EU”.

3.7The UK is a global asset management centre. Any changes to the EU’s regulatory framework for investment funds (given the size of its market) are therefore likely to be of importance to the industry, irrespective of the UK’s membership of the Union. As such, we consider the proposed changes to the marketing requirements for UCITS and alternative investment funds within the Single Market to be politically important. In any event, there is still considerable uncertainty about the legal and regulatory impact of Brexit on the financial services sector, and the extent to which the British asset management industry can continue to service EU-based clients when the UK leaves the Single Market.

3.8Under the transitional arrangement sought by the Government for the immediate post-Brexit period, the UK would effectively stay in the Single Market until the end of 2020. If changes to the UCITS and AIF frameworks to facilitate their cross-border distribution take effect before the end of the transition, the Government and the Financial Conduct Authority would be required to transpose them into UK law, and UK-based funds would (temporarily) benefit from any changes that make their marketing within the EU easier.

3.9The situation for UK funds or fund managers seeking to service the EU market after the UK leaves the Single Market depends on the outcome of the Brexit negotiations. The exit from the Single Market means that UK-registered UCITS and AIFs will automatically become non-EU alternative investment funds when marketed within the EU.

3.10The impact on UCITS funds of this change may be mitigated relatively easily, as they can be redomiciled to an EU country while their effective management can be retained in the UK (as EU law already permits the portfolio management of UCITS to take place either in or outside the Union). Many UCITS funds are already domiciled in Ireland and Luxembourg but have appointed managers in the UK. However, the British Bankers Association (now UK Finance) has noted this will not necessarily be as straightforward after Brexit because marketing of portfolio management services within the EU by third country firms is restricted under MiFID.14 Moreover, delegation of UCITS operations to a UK entity will become subject to additional regulatory requirements that do not apply while the UK is still in the Single Market.15

3.11For UK-based AIFs (and UCITS funds that are not redomiciled to an EU country after Brexit, and therefore automatically become a non-EU AIF for the purposes of EU law) aimed at EU investors the situation will be more complicated. AIFs, unlike UCITS, are regulated at the manager rather than fund level by EU law. As a result, even if a British AIF was redomiciled to an EU country after Brexit, it would not enjoy a ‘passport’ to service the entire Single Market unless the manager also relocated to the EU. Instead, UK-based funds could only be marketed in an EU country where it has a “national private placement scheme” in place for non-EU AIFs.16 While the AIFM Directive contains an equivalence regime which can extend the ‘passport’ to AIFs and AIF managers in non-EU countries where the latter apply regulation that effectively mirrors the Directive, this has not to date been activated.17 To overcome these issues, UK AIFs or AIMFs could redomicile to the EU to keep their ‘passport’ (allowing them to access the entire EU investor base) and then delegate some of their functions back to the UK. However, as is the case for UCITS funds, this will become subject to restrictions that do not apply when delegation is made to EU-based entities.

3.12Given the absence of operational ‘third country’ regimes for both UCITS and AIFs, in practice the UK asset management industry is likely to rely largely on delegation to continue servicing the EU’s investor base after withdrawal from the Single Market. While this will already require some additional regulatory hurdles to be passed once the UK leaves the EU’s common legal framework, the Committee notes with concern that the UK’s decision to withdraw from the EU has led to calls for further restrictions on the use of delegation by EU-based investment funds. The European Commission and the European Securities & Markets Authority (ESMA) have repeatedly expressed concern about the extent to which asset management activity would take place outside the EU if the current levels of delegation to the UK persist after Brexit.18

3.13While the recent proposals on cross-border distribution of funds do not alter the ability of non-EU entities to carry out investment management activities for EU-based funds, the Commission has already proposed separately to use Brexit as a reason to increase EU-level oversight of the overall use of delegation.19 Any further restrictions on delegation of asset management by EU funds overseas investment services providers, whether through new legislation or supervisory practice, would have a detrimental impact on the EU’s access to asset management expertise. This is an area of concern the Committee will keep under review as the negotiations on the new European System of Financial Supervision progress.

3.14The UK Government is aware of the vulnerability of relying on delegation and equivalence for future trade flows of financial services with the EU, as these frameworks for market access can be altered by the Union unilaterally and therefore do not offer the same guarantee of continuity as the Single Market. It is seeking a post-Brexit financial services trade agreement that preserves preferential market access based on intensive (but non-binding) regulatory cooperation to ensure similar supervisory outcomes. However, the Treasury has not published a draft legal text on the workings of this system in practice. Moreover, the 27 remaining Member States20 and the EU’s Chief Negotiator21 have not accepted the basic premise of the Government’s offer, instead insisting that UK services providers will have to access the EU market based on “host state” rules. For asset management that will mean delegating functions back to the UK where permitted by EU law or using the NPPR scheme for marketing of non-EU AIFs on a country-by-country basis (both subject to an additional layer of supervision by the competent authority of an EU Member State).

3.15In view of the possibility that the UCITS and AIFM Directives (as amended by the recent Commission proposals) will have to be applied in the UK under the post-Brexit transitional arrangement, and given the continued uncertainty about the extent of regulatory alignment under any future UK-EU financial services agreement (for example if the UK sought an ‘equivalence’ arrangement under the AIFMD), we retain the proposals under scrutiny and draw them to the attention of the Treasury Committee. We also repeat our call to the Treasury for publication of its detailed proposals for how its proposed UK-EU financial services agreement would be operationalised in legal terms, including the functioning of its dispute resolution body, so that we can assess the potential impact the envisaged arrangement would have on the UK’s regulatory autonomy after Brexit.

Full details of the documents

(a) Proposal for a Directive amending Directive 2009/65/EC of the European Parliament and of the Council and Directive 2011/61/EU of the European Parliament and of the Council with regard to cross-border distribution of collective investment funds: (39548), 6988/18 + ADDs 1–2, COM(18) 92; (b) Proposal for a Regulation on facilitating cross-border distribution of collective investment funds and amending Regulations (EU) No 345/2013 and (EU) No 346/2013: (39549), 6987/18 + ADDs 1–2, COM(18) 110.


3.16Investment funds are investment products created with the sole purpose of gathering investors’ capital, and investing that capital collectively through a portfolio of financial instruments such as stocks, bonds and other securities. Funds play a crucial role in facilitating the accumulation of personal savings, whether for major investments or for retirement. They are also important because they make institutional and personal savings available as loans to companies and projects which contribute to growth and jobs.

3.17As part of its effort to create a barrier-free Single Market for collective investment funds, the EU has legislated to create a number of types of funds and regulate fund managers, namely:

3.18Investment fund ownership in the EU is heavily concentrated within institutional investors such as insurance companies, pension funds, and monetary financial institutions. By the end of 2016 they collectively held two-thirds of the investments in investment funds. Households accounted for a quarter of all investments in funds, making them the second largest holder of investment funds. Total assets under management (AuM) in UCITS grew from €3,403 billion at the end of 2001 to €8,704 billion by June 2017. Assets managed in AIFs grew from €4,075 billion at the end of 2014 to €5,606 billion by June 2017.

3.19The UK asset management industry is estimated to represent approximately 1 per cent of GDP. In 2016, UK asset managers generated fees amounting to £7.3 billion in gross exports (£6.2 billion in net terms, once UK asset management service imports are subtracted). UK authorised asset managers will often establish (or domicile) their international investment fund ranges in specialised international hubs to serve their non-UK clients. Figures included by the European Commission in the impact assessment for its proposal indicate there are approximately 2,000 UCITS funds and 700 AIFs domiciled in the UK. However, it is unclear for how many UCITS domiciled elsewhere in the EU the portfolio management is effectively carried out from the UK.

Capital Markets Union and barriers to cross-border investment

3.20Increasing the ability of both retail and institutional investors to access funds based in other EU countries is one of the key objectives of the Commission’s 2015 Capital Markets Union (CMU) Action Plan. The CMU consists of numerous EU-level policy measures intended to increase the supply of capital to businesses (particularly from sources other than banks) and unlock more yield for savers by addressing fragmentation in the capital markets and removing regulatory barriers to the efficient financing of the EU’s economy.

3.21As part of the analysis underpinning the original 2015 CMU work programme, the Commission noted that EU legislation—while allowing asset managers of both UCITS and AIFs to ‘passport’ their investment funds across the EU based on their home state authorisation—still face barriers when doing so. It therefore announced further work to encourage greater cross-border distribution of funds, enabling asset managers to compete within the EU’s various national markets. This would then, in turn, to allow funds to grow and allocate capital more efficiently across the EU.

3.22The European Commission carried out a public consultation on cross-border distribution of funds in 2016, and in June 2017 announced its findings.23 It concluded that variations between Member States’ regulatory approach to investment funds—in particular with respect to marketing requirements, regulatory fees, and disclosure requirements—represented “a significant barrier to efficient cross-border fund distribution”. It found that differences in taxation24 and market structures (e.g. domestic markets being dominated by banks and insurers offering ‘in-house’ funds)25 also posed obstacles to a more integrated single market for investment funds.

3.23As a result of this fragmentation along national lines investments funds in the EU mostly do not take advantage of the ‘passport’ to grow in multiple Member State markets:

Regulatory barriers identified by the Commission

3.24To create a more efficient EU-wide internal market for investment funds, the Commission said it would seek to address the regulatory barriers identified as part of its analysis and consultation exercise. By October 2017, the Commission had decided that any meaningful reduction in the regulatory barriers to the cross-border distribution of funds would require legislative action at EU-level. It announced a proposal would be presented in the first quarter of 2018. The specific barriers the initiative would seek to address were:

3.25The Commission also said the problems related to taxation of investment funds and market structures were considered “out of scope” of this particular policy initiative, as they would respectively require a different legal basis (matters of tax being subject to a unanimity requirement among all Member States, compared to the qualified majority for Single Market issues) or because work is already underway at EU-level to make the market structures for distribution and intermediation channels for investment funds more efficient.27

The Commission proposal

3.26In March 2018 the Commission adopted its proposals on facilitating cross-border distribution of collective investment funds. The specific aim of the proposed legislation is twofold:

3.27The Commission has also noted that the UK’s withdrawal from the EU “will have an impact on the EU investment fund market”, as many fund managers are located in the UK and it also has a large investor base. Consequently, the UK’s exit will make the Single Market for investment funds smaller (even allowing for some restructuring and relocation of fund managers to remain within the EU), which “accentuate[s] the need to ensure that the Single Market for funds operates as effectively and efficiently as possible”.28

3.28The initiative consists of two linked29 legislative texts: a Regulation with the new harmonised rules for cross-border distribution of investment funds in the EU, and consequential amendments to the EuVECA and EuSEF regulations;30 and a Directive to make consequential changes to the UCITS and the AIFM Directives.31

Details of the proposals

3.29The proposed Regulation on cross-border distribution of funds contains new horizontal requirements on marketing communications, ‘pre-marketing’, supervisory fees and transparency for all investment fund activity regulated by EU law. These new requirements can, broadly, be summarised as follows:

Marketing and pre-marketing

Supervisory fees

Transparency of national rules

Physical presence of the investment fund manager

Notification requirements

Overview of the AIFMD passport for non-EU investment firms

3.30The Single Market treatment of UK-based AIFs (including UCITS) after Brexit under the AIFM Directive, in the absence of any overriding UK-EU trade agreement, is shown in the table below. As can be seen, until the UK is granted equivalence, funds or fund managers domiciled there would have to rely on the national rules for private placement of each EU country where they wish to operate.

EU-based AIF

Non-EU based AIF in ‘equivalent’ country

Non-EU based AIF in other countries

EU manager

Passport. Fund can be marketed throughout the EU

Passport. Fund can be marketed throughout the EU1

No passport; reliance on NPPR

Non-EU manager in ‘equivalent’ country

Passport. Fund can be marketed throughout the EU39

Passport. Fund can be marketed throughout the EU39

No passport; reliance on NPPR

Non-EU manager in other countries

No passport; reliance on NPPR

No passport; reliance on NPPR

No passport; reliance on NPPR

Previous Committee Reports

None. These are new proposals for legislation.39

10 UCITS stands for ‘undertakings for collective investment in transferable securities’.

11 The European Commission notes that other barriers to cross-border distribution of funds relate to how each EU country taxes asset management activity, and existing market structures (which can favour incumbent providers and inhibit market entry by competitors based elsewhere in the EU). See paragraph 3.26 for more information.

12 See paragraph 3.27 for more information on the Commission’s use of both a Regulation and a Directive as part of this initiative.

13 Explanatory Memorandum submitted by HM Treasury (23 April 2018). The Memorandum was submitted with a significant delay, given that the legislative proposals were published in March. We understand this was due to an administrative error within the Department.

14 British Bankers Association, “UK exit from the EU: an orderly transition for banking” (August 2016). For more information on third country access to the EU market for investment services under MiFID, please see our Report of 28 February 2018 on prudential requirements for investment firms (in particular paras. 8.64 to 8.85).

15 The EU-based management company cannot become a ‘letter-box entity’; delegation must be notified to the domestic regulator where the fund is domiciled in advance; disclosures must be made to investors; the entity to which functions are delegated must be authorised for the purpose of asset management and subject to prudential supervision; and there must be a cooperation agreement in place between the UK’s competent authority (the FCA) and the home regulator of the fund.

16 Different EEA countries have implemented the AIFMD private placement rules differently, and in some countries it is not permitted at all or restricted to professional investors only. It is also intended that in due course, the private placement regime will be closed entirely. Using private placement to market a non-EU AIF to EU-based investors also requires a cooperation agreement to be in place between the regulator of the AIF’s home country and those of each Member State where it wants to operate.

17 The extension of the ‘passport’ to non-EU AIF managers is contained in the Directive, but the entry into force of its provisions depends on the adoption of a Delegated Act by the Commission.

19 The increased EU oversight of delegation was proposed by the Commission as part of its reforms of the European System of Financial Supervision. See for more information our Reports of 13 December 2017 and 21 February 2018.

20 On 23 March 2018, the European Council at 27 noted that the future UK-EU trade agreement would contain a section on services “with the aim of allowing market access to provide services under host state rules, including as regards right of establishment for providers, to an extent consistent with the fact that the UK will become a third country and the Union and the UK will no longer share a common regulatory, supervisory, enforcement and judiciary framework”.

21 On 23 April 2018, Michel Barnier said in a speech that the UK’s decision to leave the Single Market meant that, under a future UK-EU trade agreement “companies from the other party have the right of establishment and market access to provide services under host state rules”.

22 The first UCITS Directive, adopted in 1985, introduced the concept of the ‘passport’ for financial services in the EU. Once a UCITS fund had been authorised by the competent authorities of its home country, it could be marketed all over the EU subject to notifying its intention to the competent authorities of the host Member State. The current, fifth, UCITS Directive was adopted in 2014.

24 For example, investment funds often have restricted coverage under double tax treaties, “due to their tax status in the territory where they are domiciled or because they cannot demonstrate that their investors meet particular residence or nationality requirements”. Other tax issues identified by the Commission were diverging national tax reporting requirements—in particular reporting on investor income tax—and tax discrimination of non-domestic investment funds, which discourages (retail) investors from investing cross-border.

25 The Commission noted that “the closed architecture of distribution and intermediation channels” can also pose a significant barrier for cross-border distribution. In many EU countries, banks and insurance companies are the biggest distributors of retail investment funds, offering in some cases predominantly in-house funds. Consequently, financial advice might be biased when financial advisors also act as sellers of financial products. Such advisors are also unlikely to consider cross-border funds from other distributors (on an equal footing).

26 Updates to the fund’s regulatory documentation are necessary for example when there are changes to fund rules, the investment prospectus, periodic reports or key investor information documents. See e.g. article 17(8) of Directive 2009/65/EC.

28 See Commission Impact Assessment, p. 32.

29 The initiative is split into two separate legal proposals because it is aimed, in part, at amemding existing EU legislation which is laid down in both Directives and Regulations, which are typically amended by a similar instrument.

30 See Commission document COM(2018) 110.

31 See Commission document COM(2018) 92.

32 This new provision is broadly based on Article 77 of the UCITS Directive, and effectively extends the scope of application to the AIFM Directive.

33 The new requirements with respect to marketing communications aimed at retail investors would only apply to AIFs where a Member State has allowed such funds to market units or shares to retail investors in their territories.

34 At present, Belgium, Italy, France, Greece, Bulgaria, Finland, and Spain carry out ‘ex-ante’ checks on marketing materials.

35 The Commission argues that pre-marketing “should be limited to professional investors in order not to endanger retail investor protection”. See Commission Impact Assessment SWD(2018) 54, p. 36.

36 If a professional investor ultimately invests in an AIF managed by the AIF manager that under the pre-marketing, this will be legally considered the result of marketing.

37 For an overview of the regulatory fees charged by Member State for ‘passported’ investment funds, see page 139 of the European Commission’s impact assessment (SWD(2018) 54).

38 A few Member States also require these local facilities to perform additional tasks, like handling complaints or serving as a local distributor or being the legal representative (including dealing with the national competent authority).

39 The ‘passport’ for non-EU AIFs or AIFMs is not yet available as the European Commission has yet to propose a Delegated Act to that effect.

Published: 8 May 2018