Ucits III: a retail challenge or opportunity?

"If I have to contend with one more European Union (EU) acronym (EUA), I will scream!" So may say both European and non-EU hedge fund managers, who have been faced with Mifid, the EU Savings Directive (EUSD) and the ongoing release of Ucits provisions by the EU of late. Yet, argue many lawyers, the latest incarnation of the Undertakings for Collective Investments and Transferable Securities - yes, that's Ucits! - brings advantages, for example a Ucits-compliant product in one European Union jurisdiction can, in theory, apply for and receive a Ucits cross-border passport so it can be marketed freely to retail (and institutional) investors throughout the European Union. While the instruments allowed in Ucits III products are more limited in nature than the pure shorting that is allowed in hedge funds, synthetics and derivatives allow their managers to create hedge fund-like portfolios, often labelled 'absolute return' rather than 'hedge'. This can open up the retail market, and eliminate the problem with hedge funds of complying with different marketing rules for each jurisdiction, for the same product. Sound tempting? Look, before you leap, we asked nine experts; "What is the biggest consideration for hedge fund managers launching into Ucits and retail for the first time, hmm?"katya azzopardi, gvth (Malta)The key consideration should be the investment restrictions that apply to the particular investment vehicle the hedge fund managers decide to set up. The applicable investment restrictions are a fundamental issue not only when it comes to choosing in which jurisdiction the fund is to be set up but also deciding which investment vehicle and indeed the entire structure the managers hope to set up. For instance, in Malta, the maximum freedom with respect to investment restrictions would be provided by setting up a Professional Investor Fund (PIF). PIFs may be promoted to authorised or experienced investors.

Although PIFs are not retail funds, and hence this regime is lightly regulated, the minimum investment in the case of a PIF for experienced investors is $20,000. They therefore grant freedom and flexibility to the managers that other vehicles certainly would not.vincent kuhn, bryan garnier aMBryan Garnier regards the Ucits III initiative as a remarkable advance for both the asset-management industry and retail investors. Creating a single market, in exchange for more transparency - especially about fees and costs - is a great way to "improve the breed", if you will. We look forward to a level global playing field with better-informed investors. So, whatever the additional cost and complexity, our forthcoming range of long-only equities funds will be Ucits-compliant. It is different for our hedge fund business. Based on the ongoing discussions led by AIMA, of which we are proud members, hedge funds will not be Ucits-compliant anytime soon. We do not mind, as dealing only with qualified and professional investors suits us perfectly. I am not sure that hedge funds are suitable for retail investors. Funds of hedge funds, however, are, and should be eligible.john donohoe, carne global financialHedge funds target sophisticated institutional investors. In the retail world, hedge funds are often unable to target retail investors directly and must partner with financial intermediaries who understand their investment processes, and who can ensure that the product is suitable for the end investor. Fee-sharing can also be an issue. Generating the targeted returns is also key. In Ucits III funds, fund managers must know what qualifies as eligible assets and also investment restrictions. Under Ucits III, derivatives can be used for shorting, leverage or managing credit risk. However, the use of these techniques demands more regulatory oversight, especially for a "sophisticated" Ucits. This requires complex risk monitoring such as VaR. Adapting to the compliance requirements of regulated products is also vital. Managers based in the UK are well used to regulation at management-company level but must demonstrate daily that their Ucits product complies.shilpa amin, nomuraDisclosure has long been the mantra for retail distribution. Recently, this has been supplemented by the Financial Services Authority initiative for treating customers fairly (TCF). For hedge fund managers looking to create their first retail Ucits funds, this means that, in addition to ensuring their strategy complies with Ucits' stringent eligibility and spread rules, they will also need to determine whether the strategy can be described in simple, non-technical language and that it is suitable for the retail market, which may include tightly controlling who is able to distribute the fund and how this process is undertaken. Once a manager has grappled with these issues, the key challenge is to get the new fund to market in a timely and cost-efficient manner. Sadly, despite the Committee of European Securities Regulators' (CESR) guidance to regulators to reduce documentation requirements and approval times, it appears that until legislation forces an even playing field, the cross-border arena will remain challenging.alastair smith, societe generale am aiRenaissance, Caxton and Highbridge, three of the biggest names in hedge funds, launched UCITS III funds in partnership with Société Générale Asset Management Alternative Investments (SGAM AI) in September 2006. Few readers would question their ability to succeed, but how about convergence with the traditional investment universe, how has the broader market viewed these funds? Not as a substitute for hedge funds! Instead, the challenge lies in establishing a new way of thinking. More and more institutions and wealth managers are applying the proven skills of hedge fund managers and the flexibility embodied in Ucits III to their traditional onshore allocations. Ucits III funds are beginning to be used to complement equity investments, for instance, by adding a low-beta fund or a diversifying approach, such as a short-term trading fund. Convincing investors of the opportunity represented by Ucits III may take time, but at least we have the support of some of the industry's greatest hedge fund talent. donnacha o'connor, dillon eustaceThe sponsor should consider: the extent to which different types of retail classifications in proposed fund domicile(s) allow access to retail investors in targeted markets; if the proposed fund strategy can comply with restrictions applicable to the retail fund; whether there are tax considerations for targeted retail investors that favour one fund domicile or fund product over another; and, generally, whether additional legal and compliance requirements are worth the pain. Retail funds established outside the EU, and non-Ucits established inside the EU, do not benefit from marketing freedom afforded by the Ucits European Economic Area "single passport," so generally must comply with private placement of foreign securities rules in the investors' home countries, in a similar way to institutional funds, which might require prohibitively high minimums or limit on how many investors can be offered shares, or, in the case of the absence of a clear private-placement regime (e.g. France), might mean substantial legal uncertainty or inability to target retail investors in that country. Moving from a hedge fund environment to that of a Ucits involves a big step-up in terms of regulation.pricewaterhousecoopers, ucits iii news, october 2006A non-listed synthetic bond linked to oil or hedge funds is currently not permissible in (some) countries; it will, however, become permissible if the working paper remains as is in its final form and provided always the SFI does not embed a derivative. Financial indices are now, under certain conditions, admissible, even if their underlying is not...eligible. CESR had already opened the door for commodity and property indices. As regards derivatives, the working document clearly excludes derivatives in commodities. A closed-ended fund would become a transferable security subject to conditions, often difficult to verify - no look-through approach would be required, as for SFI's. If implemented as such in its final form...the draft directive will provoke quite a few changes in some countries' practice as regards eligible assets. Note: PwC's note Ucits III News was compiled in Oct 2006, announcements thereafter will not be included in these notes.neil simmonds, simmons & simmonsMain challenges are to consider seriously where the market for the product in question really lies and accept and embrace the existence of regulation and compliance culture at product level, not merely to firm level. Having decided the retail market (whether mass, or mass affluent) is actually where you want to be, there are clearly constraints on what you can and cannot do in product design. These are less restrictive than one might imagine. For your derivative strategy, focus on 'exposure' management and monitoring as it is usually the 'exposure' to an issuer or counterparty upon which regulations depend. Also getting close to your regulator, having a prime broker willing to adapt their offering for the Ucits market and (of course) a lawyer who understands both cultures is extremely important.gray smith, ogierI believe that from the perspective of an offshore lawyer, the structuring of the fund to ensure that the various competing regulatory requirements can all be met will be of the utmost importance.

On the assumption that the fund manager has a product that is suitable for that particular market, the aim of the offshore lawyer assisting is to create a tax-neutral, flexible structure that enables the product to be marketed to the target jurisdictions without having any adverse tax, regulatory or operational consequences.