Citi 2018 FinReg Outlook

However, there is a cohort of EU policymakers who would like to see this changed and have the UCITS rules incorporate third-country provisions. These provisions would govern what activity can be conducted in non-EU countries, and what must be done within the EU. The catalyst for this push is the UK’s decision to leave the EU. A large percentage of the assets held in UCITS funds are managed from London. Some policymakers think that once the UK exits the EU it should no longer be able to be a major asset management hub for European funds. Any changes to the UCITS substance rules could have a significant impact on the global asset management ecosystem. UCITS funds have become a truly global product without third-country provisions. UCITS funds domiciled in Ireland or Luxembourg are just as likely to be managed in New York or Hong Kong as they are in London or Paris. The industry is concerned that any changes made to restrict the UK’s access to UCITS may have unintended global ramifications. CLOSING THE MIFID LOOPHOLE In the run up to the implementation of Markets in Financial Instruments Directive (MiFID) 2 a number of high-profile hedge funds exchanged their MiFID authorization for an AIFMD authorization. By changing to the AIFMD license, hedge funds can avoid MiFID 2’s detailed transaction reporting and annual public trading execution disclosures. This move did not go unnoticed by policymakers. Markus Ferber, the chief architect of MiFID 2, has noted that he expects the differences between AIFMD and MiFID 2 to be closed as quickly as possible. Given one of the key policy goals of regulators is to reduce so-called regulatory arbitrage, the use of AIFMD to avoid MiFID 2 reporting requirements is likely to be short lived. MARATHON, NOT A SPRINT The process of changing the AIFMD and UCITS rules will not be quick. A key factor in any timeline is what elements can be enacted tactically, without amending the primary legislation. For example, removing some of the UCITS distribution barriers probably will not require changes to the main regulation. However, closing the AIFMD-MiFID loophole or creating a third-country regime for UCITS would require alterations to the regulatory frameworks. These reviews ultimately may lead to AIFMD 2 and UCITS 6, which will be multi- year efforts. Given the potential impact of some of the proposals, this extended timeframe will certainly be welcomed by the industry. Since it is only the beginning of the review process, asset managers should be engaged from the outset to ensure their voices are heard as new proposals are drafted. The European Securities and Markets Authority (ESMA), in conjunction with the European Banking Authority, is undertaking a study of the cost and performance of UCITS funds. The focus of the study will be on the difference between active and passive investing, and the impact of costs and charges on long-term returns. The study will include: The review of UCITS fees is in step with the increased global focus on asset management costs. The results of the study will probably be published in the second half of the year, so any policy action is unlikely to begin until 2019 at the earliest. The regulatory focus will only add to the secular pressure on fees that asset managers are already feeling. ESMA TAKES A LOOK AT FEES A review of the extent to which active managers beat their benchmark. A continued investigation of ‘closet indexing,’ where funds charge higher fees but are, to all intents and purposes, passively managed. An investigation of performance fees and whether there are divergences in their use across the EU. Citi Custody & Fund Services – FinReg Outlook 2018 13 12