BOSTON -- The staggering growth of UCITS (Undertakings for Collective Investment in Transferable Securities) throughout Europe, Asia and Latin America has led to a proliferation of new investment products and trading opportunities, but restrictive investment mandates and tax requirements in the U.S. are causing some U.S. investors to feel left out of the game.
"The folks in Washington don't seem to realize there is business outside our borders," said Alan Reid, CEO of Forward Funds, speaking at the 21st Annual Conference on the Globalisation of Investment Funds, held this year at the Boston Harbor Hotel. "We are seeing growing demand from offshore companies, and the demand for UCITS is staggering."
UCITS are designed to act like a European passport that allows structured products and collective investment schemes to operate throughout the European Union without cross-border marketing barriers.
"The benefit to the passport is that once you are authorized, you have access to all 27 member states," said Didier Millerot, Deputy Director General of the European Commission's internal market and services unit. "If you want to be UCITS, you have to comply. It's difficult to argue that they can't fit into a framework."
As long as the participating countries can agree to the same framework, there's no reason why more countries can't get on the UCITS bandwagon, he said.
International Tax Advantage
"The U.S. doesn't have a good international vehicle," said Dan Kingsbury, president and CEO of Pioneer Investments. U.S. registered investment companies are not tax-advantaged for international trading, he said.
Kingsbury said roughly a third of all investments in the U.S. are focused on global and international mandates, but current requirements under the Investment Company Act of 1940 make it very difficult for U.S. firms to invest in emerging markets like Brazil, Russia, India and China.
"There is a big opportunity outside our shores," Reid said. "We need to compete on a global basis."
Recent directives have allowed UCITS to incorporate a wide range of financial instruments, including money market funds, derivatives, index-tracking exchange-traded funds and funds-of-funds, but many individual member nations have imposed additional regulatory requirements aimed at protecting local asset managers that have resulted in the restriction of operations.
Many regulators are concerned about the growing pressure for more alternative investment products in UCITS, said Martina Kelly, a senior official at the Irish Financial Services Regulatory Authority. Regulators must not only make sure that the product can meet UCITS requirements, but they also must be able to understand the product, she said.
"We try to ensure that our products are clear, and we strive to achieve functionality," Kelly said.
"Our intention is not to hamper innovation," said Jean-Marc Goy, counsel for international affairs at Luxembourg's Commission de Surveillance du Secteur Financier. "Complicated products are not necessarily risky products."
The vast majority of ETFs in Europe are passive and based on an index, making them ideal for use as UCITS. The passive nature of ETFs has historically made it easy for investors and regulators to check the contents, but a new wave of actively managed ETFs, commodity-based ETFs and derivative-filled investment products has some experts worried.
"Until recently, ETFs had been a passive strategy," Kingsbury said. "Going forward, there will be more demand from advisors who want ETFs as building blocks and others who want it imbedded in the products."
"Some products are too complicated to be marketed to retail investors and should be reserved for institutions who better understand their risks," said Patrice Bergé-Vincent, head of the asset management policy department at the French regulator Autorité des Marchés Financiers, and member of the International Organization of Securities Commissions (IOSCO).
While active ETFs have many potential advantages, money managers are still hesitant to use them due to their requirement for full transparency of their underlying holdings on a daily or real-time basis.
"The whole concept of an ETF is that you know the investment value at any time," said one executive, during a discussion group on new products emerging under the ETF cover. "This means the manager has to disclose underlying portfolio."
Many portfolio managers don't want to reveal their strategies for fear that doing so would allow high-frequency traders to step in front of trades and make their ETFs dysfunctional, with extremely high bid/ask spreads.
"Some firms have trading strategies that are put in place over a number of days," said Tom Faust, chairman and CEO of Eaton Vance. "This has to be addressed in some way."
ETFs provide a natural way of separating the cost of long-term liquidity, but ETFs that trade regularly should take on that cost, rather than have the cost socialized by all the other investors, Faust said.
Experts are also worried about the increasing use of derivative instruments in ETFs and UCITS. The complicated nature of derivatives allows these products to invest in a wide range of risky areas-such as high-yield bonds, collateralized debt obligations and credit default swaps-in such a way that investors, regulators and even the product's creators have a difficult time understanding how they generate their returns.
"I'm concerned that a lot of UCITS are being driven by derivatives," said another executive during the roundtable. "You keep saying they're really cheap. That's like going to McDonald's because it's cheap, but you're not looking inside the hamburger."
Accountability/Suitability
One of the proposed directives for UCITS IV aims to solve the fiduciary burden the U.S. is struggling with by separating product accountability from investor suitability.
Appropriateness comes into play when evaluating a product, such as an ETF based on the S&P 500 Index; and suitability looks at the investor's situation from a holistic perspective.
"If an investor already has an S&P 500 ETF in their portfolio, it may be an appropriate product, but it's not suitable for them," said one regulator during the ETF roundtable. "On the other hand, an S&P 500 ETF with a fee of 4% would not be appropriate if similar products had fees of 1%. Suitability includes appropriateness, but not the other way around."
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