In theory, the advent of the Ucits IV Directive should lead to standardised documentation for structured products across the EU. In practice, structurers must still work with diverging national regulatory frameworks.

On July 1, 2011, the Ucits IV (Undertakings for Collective Investment in Transferable Securities) regulations came into force across the EU, giving retail investors a standardised set of documentation designed to enable them to compare products, and analyse fees, payoffs and risks.

The European Commission put the Ucits IV Directive in place in June 2009, and national regulators were given two years to implement it. The new rules apply to structured funds (funds with an embedded derivative) and to exchange traded funds (ETFs), which are generally structured to meet Ucits regulations, making them easier to market to retail investors even though most are bought by institutions.

Standardising the pitch

Product providers have been busy meeting the deadline, since all new products launched from July 1 onwards need to be accompanied by a two- or three-page Key Investor Information Document (KIID) alongside the full prospectus. Advisors are required to get a signature from the investor to show they have read and understood it.

"The KIID is replacing the simplified prospectus for Ucits funds, and must be only three pages in length for structured funds and two pages for other Ucits, such as ETFs," says Ian Rogers, partner at Simmons & Simmons law firm in Paris. "Over time, retail investors will get to know the document, and each of the obligatory headings and sections, and should be better able to compare products from different issuers."

However, under the Ucits passporting rules, the issuer can write the prospectus in their own language, and only need to translate the KIID into the local language in each market.

"This could raise liability issues with investors, who might claim they didn't fully understand the product they were buying because they only had access to a two- or three-page document," says Mr Rogers.

The structured products market realised early on that what happened with Ucits would affect disclosure documents for structured products more widely in a few years' time

David Rouch

Directive congestion

In addition to Ucits IV, a range of other initiatives are also proceeding that are altering the investment landscape. Alternative investments such as hedge funds, private equity funds and real-estate funds are being brought within new EU regulations via the Alternative Investment Fund Manager (AIFM) directive. The European Securities and Markets Authority (ESMA) is in the midst of consulting its individual members, the national securities regulators, on the technical aspects of putting the new AIFM regime in place at national level by 2013.

The Markets in Financial Instruments Directive (MiFID) is also being reviewed. And ETFs, which already usually fall within Ucits, are coming under scrutiny from the Financial Stability Board (FSB), which was established to co-ordinate at international level the work of national financial authorities.

On April 12, the FSB published a note on potential financial stability issues arising from recent trends in ETFs. It noted that though most funds remain plain vanilla, there has been an increase in product variety and in some cases complexity, which may necessitate closer surveillance. Meanwhile, structured products are facing their own new set of planned rules.

"The structured products market engaged with the Ucits KIID process, realising early on that what happened with Ucits would affect disclosure documents for structured products more widely in a few years’ time, via the Packaged Retail Investment Products [Prips] initiative," says David Rouch, partner at law firm Freshfields in London.

The Prips consultation process will probably lead to new rules from 2013 or 2014, but in the intervening period countries are introducing their own documents similar to the KIID, adds Mr Rouch. Prips is moving towards standardisation on distribution rules and documentation for, broadly, any product that embeds a derivative, whereas at present investors can access the same underlying exposure via different wrappers which have different rules.

Germany takes the lead

But not everything is proceeding at the same pace in each country. For example, in Germany financial regulator BaFin has moved ahead with its own rules, and the July 1 changes on Ucits will be accompanied by a requirement for a two-page investor information document on all structured products.

These products are typically set up as a certificate with the counterparty risk of the provider, and a pay-off based on derivative exposure. Germany has the largest structured products market in Europe with total outstandings of about €110bn.

The mandatory ProduktInformationsblatt (PIB), which must now be issued with each new product in Germany, is commonly referred to by bankers and lawyers as the 'beipackzettel', which is the sheet of paper in a box of medicine or tablets which sets out the recommended dosage and possible side-effects.

"The EU regulations have to be implemented by national regulators, and the way they are implemented is typically characterised by the historic understanding of how regulation should work in each individual country," says Wolfgang Gerhardt, head of financial products, Germany, at Bank Vontobel Europe in Frankfurt, who was a member of the European Securities Markets Expert Group (ESME) which advised the EU on securities markets directives.

"Following the 2005 Prospectus Directive, individual countries interpreted the new rules in different ways. For example, in Germany the regulators published a circular on advertising, but did not exercise any control over the individual advertising of investment products, whereas in Italy and Belgium, all marketing materials had to be submitted," says Mr Gerhardt.

Alain Dubois

There is now a broad acceptance among EU member states that regulations have to be put in place at a European level rather than a national level

Alain Dubois

Information on structured products

Mr Gerhardt notes that the KIID concept introduced at EU level for investment funds will be extended in the coming years to other retail products, so that the PIB in Germany is likely to be replaced by some new EU regulation. But while the PIB has to be provided by the distributor of a product, the KIID has to be provided by the issuer – this difference in approach will have to be addressed.

"The Prospectus Directive said that a simplified prospectus, and especially the summary, should provide investors with easily analysable and comprehensive information, but in reality it never fulfilled this requirement, so the PIB, or beipackzettel in Germany, is a step in the right direction," says Mr Gerhardt.

He argues that structured products providers in Germany have to make the best of these new regulations, and use the PIB as an information platform to improve the knowledge of German retail investors about how structured products work.

Heiko Weyand, director of marketing for retail products at HSBC Trinkaus in Düsseldorf, agrees that giving retail investors standardised product information in the form of a three-page PIB, including management fees being charged by the provider, commission paid to distributors, how the pay-off works and what the risks are, is a good idea. However, he is concerned that having to sign documents saying that the advisor has provided them with the PIB and that they have read and understood it may be seen as an additional hurdle for retail investors.

"Banks may also feel that the regulators are trying to limit the purchase of structured products by retail investors. But structured products providers in Germany have progressed well with putting all the documentation in place for new products launched from July 1 onwards, as well as preparing PIBs for existing products," says Mr Weyand.

The end of gold-plating

In France, there is so far no new documentation required for structured products, but banks have been busy complying with the Ucits IV rules on structured funds which came in on July 1. The new Ucits IV regulations are not just a new set of rules that have to be adjusted to and followed by the letter. They also mark the beginning of a new era where individual members states do not formally set out their own rules to provide added protection for retail investors – a process known as gold-plating.

Ucits IV makes the passporting of products from one jurisdiction to another much easier, so any gold-plating of structured funds or structured products would simply encourage providers to set them up in one country, such as Luxembourg, and then simply passport them into France, the UK or Germany.

"There is now a broad acceptance among EU member states that regulations have to be put in place at a European level rather than a national level, and that member states should avoid adding a second national layer to the European one," comments Alain Dubois, Chairman of Lyxor Asset Management, a wholly owned subsidiary of Société Générale which specialises in index tracking, alternative investments and structured and quantitative asset management.

"There is a long term trend to expand the idea of the three page KIID for structured funds to all similar retail products in Europe, and the Prips Directive proposal from the European Commission that is expected to be released during the second half of 2011 will extend the requirement to produce a KIID to all packaged retail products," says Mr Dubois.

Back-door barriers

Mr Dubois notes, however, that individual countries will still have to clear marketing materials, and that this could allow individual countries to all but prohibit the distribution of certain products that they feel are unsuitable for the retail market. In France, for example, this could include retail products that are based on hedge fund strategies, many of which have been structured to be UCITS compliant.

This issue is being addressed as part of the review of MiFID, where some regulators such as those in France and Italy have suggested that Ucits might be split into complex and non-complex categories. Complex Ucits, including so-called 'Newcits' or structured funds, would incur restrictions on mass retail distribution.

"At the moment, Ucits are non-complex by definition, so this is one of the key political debates currently taking place. Product providers are against the idea of creating a new category of complex Ucits, since the whole point of Ucits IV has been to create a single category of products that can be easily passported from one country to another and sold across the EU to all types of investors," says Mr Dubois.

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