© Copyright 2015 by K&L Gates LLP. All rights reserved.
Mark Amorosi, Partner, K&L Gates Washington. D.C.
Sean Donovan-Smith, Partner, K&L Gates London
Andrew Massey, Special Counsel, K&L Gates London
Rodney Smyth, Consultant, K&L Gates London

 Retail fund landscape
 Product developments
 Distribution issues
 Specific initiatives
 Future of the industry
3

 European AUM in UCITS exceeding €9 trillion for first time ever
Net assets (EUR bn)
Category
UCITS
Non-UCITS
Total
End 2014
7,955
3,347
11,302
March 2015
9,004
3,547
12,551
% change on previous month
2.5%
2.3%
2.4%
UCITS types
Equity
Balanced
Total Equity and Balanced
Bond
Money Market (MM)
Funds of funds
Other
TOTAL
Source: EFAMA March 2015 Data
Breakdown of UCITS by Category
31/12/2014
No.
12,117
8,740
20,857
7,290
1,037
882
2,517
36,148
Share
37%
27%
64%
22%
3%
3%
8%
Change from 31/12/2013 in %
0.0%
3.1%
1.3%
1.8%
-11.2%
0.8%
-6.2%
1.2% in No.
0
265
265
132
-131
7
-165
440
4

Location of Firm
Headquarters
Top five countries
Source: EFAMA June 2015 Data Source: Prequin Hedge Fund Analyst
5

Investment
Company Total Net
Assets by Type
(1997 – 2014) (in billions)
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: Investment Company Institute
Mutual funds
$4,468
5,525
6,846
6,965
6,975
6,383
7,402
8,096
8,891
10,398
12,000
9,603
11,113
11,833
11,632
13,052
15,035
15,852
Closed-end funds
$152
156
147
143
141
159
214
253
276
297
312
184
223
238
242
264
279
289
ETFs
$7
16
34
66
83
102
151
228
301
423
608
531
777
992
1,048
1,337
1,675
1,974
UITs
$85
94
92
74
49
36
36
37
41
50
53
29
38
51
60
72
87
101
Total
$4,711
5,790
7,119
7,247
7,248
6,680
7,803
8,614
9,509
11,168
12,974
10,347
12,151
13,113
12,982
14,725
17,075
18,217
6

Convergence of Retail and Alternative Funds
Collective Investment Scheme (“CIS”)
(UK definition)
Alternative Investment Fund (“AIF”)
(AIFMD definition )
Regulated CIS Unregulated CIS
Regulated CIS NURS
QIS
UK UCITS
FAIF PAIF
E.g. Limited partnerships, exempt unauthorised unit trusts
Recognised
UCITS
(s.264
FSMA)
Other recognised schemes
(s.272
FSMA)
EuVECA,
EuSEF
Glossary:
Fund
EuSEF: European
Fund
NURS: Non-UCITS
EuVECA:
FAIF:
Funds
European Venture Capital Fund
Funds of Alternative Investment
PAIF: Property Authorised Investment Funds
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ELTIF
Other AIFs
E.g. closed-ended investment companies

2014 2013
2014 Total Funds: 720
2014 Total AUM: €260.031 billion
Commodities
CTA
Emerging Markets
Equity Market Neutral
Event-Driven
Fixed Income
Index FX
Long/Short Equity
Macro
Multi-Strategy
Volatility
2013 Total Funds: 724
2013 Total AUM: €190.071 billion
Source: UCITS Alternative Index
9

Can my hedge fund strategy be used in a UCITS?
 Certain investment strategies can fit within a UCITS fund structure

Traditional equity long/short or market neutral

Absolute return

Multi-strategy/multi-manager

Merger arbitrage/event-driven/special situation

Global tactical allocation

Global macro strategies

Credit strategies/convertible arbitrage/senior debt

Managed futures
 Some hedge fund strategies are not a fit for a UCITS fund

Illiquid strategies

Highly concentrated portfolios

Nonfinancial investments
10

Cumulative flows to alternative strategies mutual funds (2007 –
2014) (in billions)
Total assets under management in alternative strategies funds were $311 billion at the end of 2014.
(Source: Morningstar)
Source: Investment Company Institute
11

 Intense SEC Focus on Liquidity, Valuation, Leverage and
Disclosure
 SEC Alt Funds Sweep Exams
 Derivatives Review
 Enforcement Activity
12

 Why?
 Pricing vs non-ETF UCITS (e.g. index funds)?
 Real-time – not forward
 Throughout the trading day – not just once a day
 Cost vs non-ETF UCITS?
 Both have low annual charges – e.g. 0.30% p.a. S&P
500 and 0.50% p.a. FTSE-100 passive ETFs
(including transaction costs) and 0.09% / 0.35%
(excluding transaction costs)
14

 Choice vs non-ETF UCITS?
 One ETF UCITS manager in the market offers singlecountry funds for Brazil, Indonesia, Mexico, South Africa and Taiwan
 Although compare non-UCITS ETFs: – where another manager offers funds for coal mining, coffee, lean hogs, live cattle and shipping indices – and spot palladium
 “UCITS” label vs non-UCITS ETFs? – “UCITS” suggests the fund is a safe investment (fit for “widows and orphans”)
 Transparency vs non-ETF UCITS? – not really, at least for passive stock market index ETFs – although most ETF
UCITS disclose holdings daily (unlike other UCITS), the index is the index
15

Why not?
 Brokers’ commission on all ETF sales and purchases
– typically, £5/£12.50 flat fee per trade – vs £0 for non-ETF UCITS
 Temptation to “day-trade” ETFs – because priced continuously
 Flat brokerage fees and small day trades don’t mix!
 European ETF statistics: 5.5% of total investment fund AUM = EU 362 billion (30 September 2014)
16

Source: Investment Company Institute
17

percent of US ETF Total Net Assets
Source: Investment Company Institute
18

Source: Investment Company Institute
19

 Less Transparent Actively Managed ETFs
 Systemic Regulatory Impact and SEC Request for
Comment
 Derivatives Review
 SEC ETF Rule
 Custom/Non-Pro Rata Creation and Redemption Baskets
20

 Vehicle to encourage investment in long-term assets (energy, infrastructure, education and research, etc.)
 European passport enabling retail investment
 Composite regulatory regime, including:
 AIFMD
 ELTIF authorisation requirement and prescribed rules
 Prospectus Directive
 ELTIF prescribed rules:
 Investment policy


At least 70% of capital in eligible assets
Other investments limited
 Closed-ended? Redemption restrictions…
 Transparency requirements
22

 Execution-only exemption for noncomplex instruments from appropriateness assessments
 Changes to list of exempt instruments
 Effect on distribution?
 Product and distribution governance
 Manufacturers
 Distributors
 Extension to UCITS managers and AIFMs?
24

MiFID II Investor Protection
Mandatory categorisation of advisory services
Scope of prohibition on inducements/ commission payments
UK Retail
Distribution Review (RDR)
• Independent advice – based on comprehensive and fair analysis of relevant market
• Restricted advice – not independent; subject to prescribed disclosures
• Services:
• Advice
• Platform services
• Retail investment products
• Limited to retail clients
• For platform services, unit rebates permitted
• Independent advice – assess a sufficient range of financial instruments available on the market that must be sufficiently diverse with regard to their type and issuers or product providers
• Restricted advice – not independent; subject to disclosure requirements
• Services:
• Independent advice
• Portfolio management
• MiFID financial instruments
• Not limited to retail clients
• No exception for unit rebates
25

 SEC has attempted to adopt rule changes over the last 10 years to enhance regulation of distribution payments with respect to funds, but has been largely unsuccessful (e.g. point of sale proposal in 2005 and Rule 12b-2 proposal in 2010)
 2013 and 2014 OCIE Exam Priority:
 “The IA-IC Program is focusing on the wide variety of payments made by advisers and funds to distributors and intermediaries, the adequacy of disclosure made to fund boards about these payments, and boards’ oversight of the same. These payments go by many names…most commonly revenue sharing, sub-TA, shareholder servicing, and conference support. The staff will assess whether such payments are made in compliance with….Rule
12b-1, or whether they are…payments for distribution and preferential treatment.”
 OCIE Sweep Exams in 2014-2015
 Speech by Julie Riewe, co-chief, Asset Management Unit on
February 26, 2015:
 “We…anticipate enforcement action from the Distribution in Guise Initiative, where we are axamining, among other things, conflicts presented by registered fund advisers using the fund’s assets to grow the fund and, consequently, the adviser’s own fee.”
26

Area UCITS V requirement
Remuneration • Remuneration policies and practices promote sound and effective risk management
• Staff whose activities have material effect on risk profile of UCITS or management company
• Remuneration committee (if proportionate)
• Fixed and variable remuneration appropriately balanced with fixed component sufficient for variable component to be fully flexible
• For variable component, at least 50% to consist of units of
UCITS/equivalent ownership interest; at least 40% to be deferred.
• Disclosure in prospectus and annual report
Depositary
Sanctions
• Depositary eligibility
• Single depositary expressly required
• Written agreement with prescribed contents
• Specification of functions:
• cash monitoring
• custody
• oversight
• Delegation restricted to custody function only
• Strict liability for financial instruments held in custody
• Prescription of administrative sanctions and processes, categories of
UCITS breaches, publication, and reporting to ESMA
28
AIFM




 (in part)









 (in part)
-

PRIIPs
Investment funds (incl. UCITS)
Insurance investment products
Not PRIIPs
Shares and bonds held directly
General insurance and life insurance
Structured products (deposits; securities) Pensions
PRIIPs KID
For PRIIP available to retail investors
Pre-contractual; stand-alone
Max three sides
Prescribed statements and sections
• What is this product?
• Risk-reward profile
• Compensation scheme
• Costs
• Term/minimum holding period
• Complaints
• Other relevant information
UCITS KIID
For all UCITS
Pre-contractual; stand-alone
Max two sides (three for structured fund)
Prescribed statement and sections
• Objectives and investment policy
• Risk-reward profile
• Charges
• Past performance
• Practical information
29

EU Money Market Fund Reform – Current Proposals
 Status: In “trilogue” – European Parliament, Commission and
Council (i.e. Member States)
 Latest published proposals
 Three types of MMF re. NAV
 CNAV (< 10% of CNAV and LVNAV) – divided into:
 “retail” – but this means only charities, non-profit organisations, public authorities and public foundations
 “public debt” – 99.5% invested in public debt instruments (i.e. sovereign debt) – so, no derivatives, securitisations or bank paper
30

 LVNAV (> 90% of CNAV and LVNAV)
 May be redeemed at CNAV if actual NAV within 0.20% of CNAV
Authorisation for only five years at a time
 Neither CNAV nor LVNAV
 Two types of MMF re. residual maturity
 Short-term – maximum 397 days
 Standard – maximum two years
 Daily valuation
 No external support (such as guarantees) – to avoid investor uncertainty and financial contagion
 Weekly investor reporting – liquidity, credit, portfolio, WAM (interest),
WAL (principal), proportion held by top five “investors”
 Will extend to EEA
 EU MMF statistics: c.15% of total investment fund AUM = approximately EU 1 trillion (September 2013)
31

U.S. Money Market Fund Reform – Key Changes
 Floating NAV
 Institutional MMFs will be required to price their shares based on a “floating” NAV
 Government and retail MMFs may continue to maintain a stable NAV of
$1.00/share
 Liquidity Fees and Gates
 All MMFs will be permitted to impose liquidity fees and temporarily suspend redemptions (impose “redemption gates”) during periods of market stress
 In certain cases, MMFs (except govt MMFs) will be required to impose liquidity fees
 Diversification: MMFs must meet enhanced diversification requirements
 Stress Testing: MMFs must satisfy enhanced stress test requirements, including ability to maintain liquid assets of at least 10% and to “minimize principal volatility” in response to certain events
 Disclosure: MMFs must satisfy new disclosure requirements, including new Form
N-CR and website disclosure and amended registration statement and Form N-MFP disclosure
32

 FCA identified that UK fund charges higher than overseas equivalents
 FCA thematic review (TR14/7):
 Findings ( cause?
): Investors lack of clarity regarding costs of investment
 Solution: Consistent use of ongoing charges figure (“OCF”) in all marketing materials
 Investment Association paper on disclosure of costs and charges:
 Advocate consistent approach based on OCF
 But grappling with how to fairly represent funds that are expensive to operate?
33

Mutual Fund Fee Litigation Developments
 Extraordinary wave of Section 36(b) cases challenging mutual fund advisory, administration and other fees in the US
 Common attribute of most of the cases is sub-advisory relationships
 Cases fall into two categories: defendants either employ a sub-adviser, or serve as a sub-adviser to other funds employing a similar investment strategy
 Premise of the complaints is that sub-advisers ostensibly perform all substantial services for a fraction of the advisory fees, assertedly rendering the advisory fees “excessive” in relation to the purportedly inconsequential additional services performed by advisers
 Focus on sub-advisory relationships can be traced to Curran v. Principal
Management Corp. (S.D. Iowa 2010), holding that allegations that an adviser charged far more in fees than it paid its sub-adviser gave rise to a reasonable inference that advisory fees were excessive
34

Future Legal Trends for European Fund Industry
 Continued product innovation fueled by investor demand
 Constraints on UCITS fracturing of AIF categories
 Enhancing liquidity toolkit
 Increased operation and compliance costs
Consolidation
 Increased market and regulator fee pressure
 More enforcement action; bigger penalties
36

Future Legal Trends for US Fund Industry
 Continued innovation and regulatory developments impacting product development, including exchangetraded products and alternative and other specialized products
 Increasing focus on risk management
 Challenging regulatory environment, with focus coming from multiple regulators and from multiple areas within the
SEC
37