UK: Financial Services Quarterly Report - Fourth Quarter, December 2010 (Part 1)

The Changing Regulatory Landscape

Authored by Peter Astleford and Jim Baird

Over the last two years, there has been an incessant flow of new regulatory initiatives, largely as a response to the recent global financial crisis. The coming of the new year will mark the arrival of some key changes and a phase of ongoing origination, consultation and implementation that is set to continue for years ahead.

On 1 January 2011, Europe will see the European Securities and Markets Authority ("ESMA") replace the Committee of European Securities Regulators ("CESR") as part of a reform of the EU financial supervisory framework. Where CESR acted in an advisory role to the EU Commission, ESMA will assume greater responsibilities and have new rule making powers, including the ability to adopt technical standards that will bind EU national regulators in determining the proper implementation of EU laws. ESMA will also have the selective ability to impose restrictions directly in crisis situations.

While some continuity will be provided by ongoing delegated staff and assistance from national regulators, assuming the extended brief and responsibilities will be an enormous task for an organisation that is still recruiting its staff and establishing its operations. It would therefore not be surprising if the rulemaking process is subject to delays and other teething problems.

One of ESMA's first mandates will be to lead the process for secondary implementing legislation for the proposed EU Alternative Investment Managers Directive (the "AIFM Directive"). This controversial piece of European legislation. (which was approved by the European Parliament last month and is expected to come into effect in the first half of 2013) will introduce a pan-European regulatory regime for managers of alternative funds (and indirectly the funds they manage).

Following its transposition into national law (expected in 2013), almost all funds managed or marketed in Europe will be governed either by the AIFM Directive or the UCITS Directive (the existing European regime for retail funds).

The coming of the new year will mark the arrival of some key changes and a phase of ongoing origination, consultation and implementation that is set to continue for years ahead.

While the AIFM Directive introduces some positive features, such as the passport allowing marketing of funds to professionals across the EU (and the prospect of a similar passport for non-EU funds in five years' time), many believe the AIFM Directive has been an overreaction to the recent crisis and question whether the inevitable regulatory burden and significant associated costs justify the limited investor protection or risk-reduction benefits (see Depositary Liability Under the EU AIFM Directive in this Report). Indeed significant provisions in the AIFM Directive (which is focussed on professional investors) go further in seeking investor protection than those currently imposed for the retail sector under the UCITS regime. We can expect that this will result in a "raising of the bar" for the UCITS regime (as is proposed in the recent UCITS consultation) in a new UCITS V Directive.

The AIFM Directive also includes rules on remuneration of risk takers and other highly paid staff that are based closely on similar provisions introduced in the recently amended European Capital Requirements Directive ("CRD III"). These rules include a requirement to defer between 40 and 60 percent of variable remuneration and for 50 percent of variable remuneration to be paid in shares or similar interests. For UK firms, the provisions in CRD III will be reflected in the Financial Services Authority's ("FSA") revised Remuneration Code and will need to be implemented by 1 January 2011. However, as we go to press, the FSA is delaying publication pending its analysis of official guidance published by the Committee of European Banking Supervisors ("CEBS") on 10 December, which will give UK firms only weeks to implement the FSA's code (although some allowance for later implementation will be made). Both the AIFM Directive and CRD III rules contain a proportionality concept that might allow some flexibility, particularly for smaller firms for whom some of these requirements would be difficult to implement. However, even at this late stage, it is not clear how much flexibility will be provided in practice.

In the UK, changes proposed by the coalition government (expected to be in place by 2012) will see the abolition of the FSA and the creation of a new prudential regulator operated by the Bank of England, a new Consumer Protection and Markets Authority and a new agency to tackle serious economic crime. In Ireland, the Financial Regulator has already given way to a resumption of powers by the Central Bank.

Meanwhile in the United States, work has begun in earnest to implement the comprehensive Dodd-Frank Act adopted in July. The Financial Stability Oversight Council, a new regulatory body with general authority for systemic risk oversight, has begun to meet, and it and various federal financial agencies are seeking public comment on the regulations to be adopted. A general theme in the comments received from the financial industry across several areas is to urge the government to exercise its new powers cautiously and only when there is a clearly identifiable systemic risk that can be remedied by the regulation in question.

From July 2011, the Dodd-Frank Act will eliminate the private fund adviser exemption that many private fund advisers (both U.S. and non-U.S.) rely on and replace it with narrower exemptions for foreign private advisers, "mid-sized" private fund advisers and venture capital fund advisers. The Dodd-Frank Act will, however, require such exempted advisers to submit various reports to the SEC (pursuant to rules that are expected to be adopted prior to July 2011). Mirroring similar provisions in the EU AIFM Directive, the SEC has already proposed certain additional reporting requirements that would be applicable to registered investment advisers as well as mid-sized private fund advisers and venture capital fund advisers that are exempt from registration. These proposed reporting requirements would require information about private funds managed by advisers that are subject to the reporting requirements.

The debate as to whether all these changes are justified by the benefits they may bring will go on.

The Dodd-Frank Act also provides, for the first time, a comprehensive regulatory framework for the U.S. over-the-counter ("OTC") derivatives markets. The provisions include: mandatory clearing and exchange trading for eligible derivatives contracts; new regulatory capital and margin requirements on OTC swap dealers and most large OTC swap participants; and a requirement for swap dealers and major swap participants to register with the SEC and/or CFTC and to continuously disclose detailed information regarding their derivatives trading. In the year ahead, the SEC and CFTC will likely find difficulties in implementing the rules necessary to migrate an unwieldy OTC derivatives market to a cleared and exchange-traded platform.

The U.S. initiative on clearing of derivatives is mirrored by similar proposals for a European Regulation on OTC Derivatives, central counterparties and trade repositories. The European proposals, in addition to centralised clearing of many standardised OTC contracts, would impose additional reporting obligations, common rules for central counterparties and additional measures to reduce credit and operational risk in relation to derivatives trading.

The debate as to whether all these changes are justified by the benefits they may bring will go on. Indeed there is still scope for lobbying for change in the EU's primary or secondary implementing legislative processes. However, the European and G20 political process will ensure, whatever the views of the industry, continued and extensive rewriting of the framework and rules for the global and European financial services business. This will give rise to a prolonged period of transition involving significant change, uncertainty and cost in meeting the increased regulatory burden as well as one-off implementation and, in some cases, restructuring costs. The challenge particularly for the industry in the United States and Europe will be effectively implementing change while minimising the cost and maintaining competitiveness in a global market.

The following articles look at some of the key ongoing changes in more detail. In addition, regular legal updates on a broad range of topics relevant to our clients can be found at http://www.dechert.com/ practiceareas/practiceareas.jsp?pg=legal_update&pa_ id=19&pn=1

Key Investor Information Document: Friend or Foe?

Authored by Michelle Moran, Antonios Nezeritis and Angelyn Lim

The UCITS IV Directive¹ introduces the key investor information document ("KII"), which reflects the most prescriptive piece of UCITS legislation emanating from the EU. Whilst the idea for the KII was generated some five years ago, the intervening financial crisis has resulted in its aims of delivering transparency and true comparability of UCITS funds resonating with EU and non-EU regulators alike.

Within the EU, national regulators are examining the EU provisions prescribing the distribution of the KII prior to an investor subscribing for shares in a UCITS fund. This article focuses on those EU requirements and comments on the approach being taken by regulators in the principal fund jurisdictions of both Europe and Asia, namely, the UK, Ireland, Luxembourg, Hong Kong and Singapore.

Background

Among the key provisions of the UCITS IV Directive is the replacement of the simplified prospectus ("SP") by the key investor information document. The KII is a short, uniform, pre-contractual document aimed at communicating the essential elements of a UCITS fund to investors, enhancing transparency and allowing direct comparisons to be easily made between UCITS funds and between sub-funds or share classes of the same UCITS fund.

The KII will replace the SP introduced pursuant to the UCITS III Directive. Since its inception, it has become clear that the SP has not fulfilled its intended purpose for various reasons, including:

• National regulatory practices resulted in certain Member States imposing their own rules on the content requirements of the SP, making comparisons between UCITS funds and between sub-funds or share classes of the same UCITS fund difficult.
• Disclosure requirements of the SP resulted in UCITS funds with multiple sub-funds and multiple share classes producing lengthy SPs, defeating the purpose of a simplified document.
• Information in relation to the risks associated with investing in a UCITS fund has not been easily identified in the SP.
• The requirement for a total expense ratio is problematic as the methodology used requires validation by a UCITS fund's auditors that can delay the drafting/updating of the SP.

Features of the KII

The KII seeks to address the shortcomings of the SP by providing a meaningful, user-friendly and comparative document for investors. The UCITS IV Directive and its implementing measures specify the main principles to be followed in preparing the KII, including requirements concerning its language and layout and the main information to be disclosed.

To support this the Committee of European Securities Regulators ("CESR") has undertaken significant industry consultation and has provided guidance on, inter alia, clear language and layout of the KII, the transition from SP to KII, and a KII template.

The KII must be provided to investors "in good time" before their proposed subscription to a UCITS fund. The KII constitutes pre-contractual information for which the management company/self-managed investment company is responsible and liable. The KII should be kept up to date and should be reviewed and revised as appropriate, and in any event, at least once every 12 months (as past performance needs to be updated annually). The KII must be made available no later than 35 business days after 31 December. As a matter of good practice, the KII should be reviewed before the management company/self-managed investment company enters into any initiative that is likely to result in a significant number of new investors. If changes are being made to a UCITS fund's prospectus or its constitutional document, the updated KII must be made available before the change comes into effect.

The KII may be offered to investors in a durable medium other than paper or by means of a website, subject to certain criteria. A paper copy shall be delivered to investors free of charge upon request. The KII must also be available on the website of a UCITS fund or its management company/self-managed investment company.

Types of KII

Multiple sub-funds. Where an umbrella UCITS consists of two or more sub-funds, a separate KII must be produced for each sub-fund.

Multiple share classes. Where a UCITS fund consists of more than one share class, a single share class KII, a multi-share class KII or a representative share class KII may be produced, provided the document does not exceed two pages of A4 sized paper (three for structured UCITS funds). Where a representative share class is used, the class selected must be fair, clear and not misleading to investors in the other share classes. Also, reference to the fact that a representative share class is used should be included in the "Practical Information" section only.

Main Content of the KII

Objectives and Investment Policy

The KII must describe the essential features of a UCITS fund, including the main categories of eligible financial instruments in which it will invest, with reference to any particular geographic, industrial or other market sector targets. Where benchmarks are used, they must be described. This section must disclose whether dividend income is distributed or reinvested and state that investors may redeem on demand, together with an indication of dealing frequency. This replaces the distribution section in the SP. Minimum holding periods, if any, also must be disclosed.

Risk and Reward

The KII must set out the risk and reward profile of a UCITS fund by way of a synthetic indicator presented on a numerical scale, with the UCITS fund assigned to one of the categories of risk. CESR has recommended that the UCITS fund be ranked over a scale of 1 to 7 according to its volatility. The European Securities and Markets Authority ("ESMA") (the body that will replace CESR in 2011) will develop binding technical standards in relation to the methodology to be used to calculate volatility.

The synthetic indicator must be supplemented by a narrative explanation of the indicator and its limitations. Appropriate guidance and warnings must also be set out in relation to the risks that are materially relevant to a UCITS fund and not captured by the synthetic indicator.

Charges

The KII must set out a UCITS fund's charges in a prescribed table, together with a brief narrative explanation. The table outlines the maximum subscription and redemption charges payable by investors as well as a single "ongoing charges" figure representing all charges taken from a UCITS fund over a year and based on the figures for the preceding year. If no charge is applied, the table should indicate "not applicable". Any further charges taken from a UCITS fund under specific conditions (for example, performance fees or switching fees) must also be disclosed. For new UCITS funds, the "ongoing charges" may be estimated. Unlike the SP, there are no requirements to include a total expense ratio and a portfolio turnover rate in the KII.

Past Performance

The KII must contain information about a UCITS fund's performance for the past ten years, presented in a bar chart on a calendar year basis (including the performance of a benchmark, if referred to in the "Objectives and Investment Policy" section). In circumstances where a UCITS fund has a track record of less than five complete calendar years, a bar chart covering only the last five years must be used (the years for which data is unavailable should be left blank). For a UCITS fund with a track record of less than one year, a statement must be included explaining that there is insufficient data to provide a useful past performance indication to investors. Past performance figures must be rounded to one decimal place and the size of the bar chart should not exceed a half page in length.

A simulated past performance may be permitted in certain circumstances, provided it is fair, clear and not misleading. In such cases, there must be a prominent disclosure in the bar chart that the performance has been simulated.

Practical Information

The KII must set out information regarding the UCITS fund's custodian, where and how investors can obtain further information about the UCITS fund and its sub-funds and share classes and where to obtain the latest price information. The KII must also include: information regarding any switching rights between sub-funds; a common declaration of the existence of other share classes with cross reference to the prospectus; disclosure regarding the representative share class, if any; a disclosure that the tax legislation of the UCITS host's Member State may impact investors; and a statement that the management company/selfmanaged investment company may be held liable for information in the KII that is misleading, inaccurate or inconsistent with the prospectus.

Implementation

Management companies/self-managed investment companies need to prepare for the implementation of the KII as soon as possible. Additional resources may be necessary, although some smaller companies may choose to outsource the KII function. Management companies/self-managed investment companies should ensure the involvement of all key areas of the business so as to complete all of the information necessary for each KII. In addition, significant investment will be needed on an ongoing basis to ensure that each KII produced is current and up to date.

UK, Ireland and Luxembourg

The UCITS IV legislation has yet to be transposed into the national legal systems of Member States and national regulators have yet to publish guidance on how the KII will be implemented. However, it is expected that the EU rules outlined herein will be implemented in the legal systems of the UK, Ireland and Luxembourg in full, with relatively minor national variations relating to timing of transition and accommodation of local marketing practices. This is consistent with the aim of having a standard UCITS funds' pre-subscription disclosure document, thereby moving closer to a single market across all Member States.

Singapore

On 21 October 2010, the Monetary Authority of Singapore ("MAS") issued Guidelines ("Guidelines") on the Product Highlights Sheets ("PHS"). The Guidelines will apply from 1 March 2011 to all funds registered for retail distribution in Singapore, and set out three different PHS templates that serve as the minimum standard—in relation to (i) unlisted debentures in the form of asset-backed securities and structured notes, (ii) exchange-traded funds and notes and (iii) unlisted collective investment schemes.

The PHS must be written in plain language in a "Q&A" format prescribed by the MAS and should describe, among other things: the product's permissible portfolio investments; the profile of customers for which the product is suitable; and the likely risk areas that could cause a customer to incur a loss. Issuers should include any additional key information that is necessary for investors to understand the product (and should not merely make reference to information in other sources, such as the prospectus). The PHS cannot contain any information that is not included in the prospectus or any false or misleading information. In the case of a collective investment scheme, where multiple sub-funds are covered in a single prospectus, a separate PHS should be prepared for each sub-fund.

The PHS should not exceed four pages and may include diagrams, corporate logos and a glossary of technical terms, if appropriate. Issuers are encouraged to include links to online copies of disclosure documents, educational resources or explanatory material.

Similar to the KII for European jurisdictions, the PHS must be provided to investors together with the prospectus, before the sale of an investment product. As things currently stand, from July 2011, a KII will be distributed together with a PHS when a registered fund is promoted to retail investors in Singapore.

Hong Kong

In line with global trends emanating from other jurisdictions, and its general enhanced risk disclosure regime, the Hong Kong Securities and Futures Commission ("SFC") introduced the requirement for a Product Key Facts Statement ("Product KFS") disclosure document in June of this year.

The Product KFS is intended to be a summary of the key features (and, in particular, the key risks) of the relevant fund, set out in plain language. The SFC's intention is that the Product KFS of every SFC-authorized fund should look very similar in terms of layout and sub-headings, so as to facilitate reference and comparison by the retail investor. To this end, the SFC has provided, on its website, illustrative templates of the Product KFS for six types of investment products (i.e., guaranteed funds, exchange-traded funds, index funds, investment-linked assurance funds, unlisted structured investment products and general funds). It will shortly be introducing two additional templates— one for synthetic exchange-traded funds and the other for RMB bond funds, both of which have proven, in the recent past, to be very popular retail investment products. For further information regarding the Product KFS requirements, please refer to "Retail Fund Authorization In Hong Kong: The Moving Goalposts," available at http://www.dechert.com/library/Financial_ Services_Report_09-10(asia).pdf .

The SFC has, thus far, adopted an extremely hands-on approach to finalizing/approving the language of, and disclosure in, each Product KFS that has come onto the market. It should be noted that, to date, only equity and bond funds have been authorized with Product KFS. No alternative fund (i.e., hedge fund, exchange-traded fund or managed futures fund) has yet to issue a Product KFS

Industry groups in Hong Kong had lobbied the SFC to consider an arrangement whereby the KII might be accepted as a fund's summary document in place of a Product KFS. However, given that the SFC has indicated that it does not believe that risk-rating should be reflected in the offering documents of an investment product, it is not surprising that this lobbying movement did not find favour with the SFC, and it may be unlikely to do so in the future. As things currently stand therefore, from July 2011, a UCITS that is authorized in Hong Kong will be required to distribute both a KII and a Product KFS when it is promoted to Hong Kong retail investors.

Communication and Coordination Among National Regulators

Although a number of jurisdictions have been introducing very similar concepts of additional summary disclosure documents, it is not clear whether there has been the appropriate degree of inter-regulator communication and coordination. In particular, funds with cross-border registrations would have more than a passing interest in having streamlined documentation that, ideally, may be used in more than one jurisdiction.

Footnotes

1 EU Directive 2009/65/EC (the "UCITS IV Directive") was adopted by the European Parliament and the European Council on 13 July 2009 and entered into force on 7 December 2009. EU Member States must implement the UCITS IV Directive into their national legislation by 1 July 2011. The UCITS IV Directive replaces the previous Directive 85/611/EEC (the "UCITS III Directive").

Germany: Ahead of the Game on the KII

Authored by Angelo Lercara

There are currently two legislative proposals in Germany that aim to introduce a short, easily readable and understandable document that contains key information for investors in financial instruments: the Key Investor Information Document ("KII") under UCITS IV, and the information leaflet under the draft German Investor Protection Act.

Expedited Implementation of the KII in Germany

The first legislative proposal is based on the so-called UCITS IV Directive, which is more fully discussed in Key Investor Information Document: Friend or Foe? in this Report. The UCITS IV provisions will be implemented in amendments to the German Investment Act. The Committee of European Securities Regulators ("CESR") has agreed on the date of 1 July 2012 as the latest date for the implementation of the KII in all Member States.

The draft amendments to the German law would provide for an earlier implementation of the KII than required by the CESR agreement—UCITS set up in Germany would be required to issue a KII to investors from 1 July 2011, instead of 1 July 2012. However, this expedited requirement relates only to German funds (approved by the Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). The draft amendments also contain a grandfathering clause for non-German UCITS admitted to public distribution in Germany prior to July 2011. These UCITS must provide the BaFin with a KII as soon as a KII is required to be produced under the rules of the relevant home state of the UCITS, and in any event by 30 June 2012.

It is unclear whether the grandfathering clause would also be applicable to UCITS currently in existence that are registered for public distribution in Germany after 1 July 2011; the draft amendments do not explicitly address this situation. In our opinion, the grandfathering provision should also be available for such UCITS, since the German Investment Act cannot require supervisory authorities in other EU countries to approve KIIs before the relevant home state rules would impose such an obligation.

The Information Leaflet Under the Draft German Investor Protection Act

Under a separate legislative initiative, the German Ministry of Finance has published a draft Act to strengthen investor protection and improve capital market efficiency. The German Investor Protection Act would introduce, among other requirements, the obligation for intermediaries deemed to be investment services firms to provide retail clients with a short and easy to understand information leaflet (Informationsblatt) before a transaction is concluded and where investment advice is provided. According to the draft, if the financial instruments that are subject of the investment advice are shares of a UCITS, the information leaflet may be replaced (the draft act says "substituted"—("tritt an die Stelle") by the KII.

The information leaflet will be introduced by an amendment of section 31 of the German Securities Trading Act (Wertpapierhandelsgesetz, the "WpHG") that contains the general code of conduct rules for investment services firms.¹

As discussed above, the obligation to provide the KII would not be imposed until 1 July 2011, at the earliest. Should the Investor Protection Act be enacted before that date, an intermediary that markets German UCITS would need to produce an information leaflet during the period of time between the introduction of the information leaflet and 1 July 2011.

Possible Grandfathering

Currently, the German Ministry of Finance (responsible for drafting both sets of rules discussed above) seems to be of the view that if the information leaflet regime is introduced before 1 July 2011, German UCITS may "ignore" the information leaflet and may continue to use the simplified prospectus until 1 July 2011, when provision of the KII will be mandatory.

The situation is unfortunately unclear for foreign UCITS, and the Ministry of Finance has not yet taken a position on this matter. However, it is likely that foreign UCITS will benefit from the same grandfathering rule and that, until 1 July 2011 such UCITS may use the simplified prospectus instead of the information leaflet.

It is also still unclear whether a foreign UCITS that, according to its home state rules, is not required to produce a KII before 1 July 2012, will be required to produce an information leaflet in Germany from 1 July 2011 or may continue to use its simplified prospectus until 1 July 2012.

Potential Consequences for Foreign UCITS

Distribution Through Exempt Financial Advisors

The Markets in Financial Instruments Directive ("MiFID") includes a provision allowing EU Member States to exempt from the application of MiFID: persons who provide investment services limited to the receipt and transmission of orders for units in collective investment undertakings; and persons who provide investment advice in relation to such financial instruments and who, in the course of providing such advice, are only allowed to transmit orders to certain licensed entities.

Germany is one of the Member States that has made use of this exemption. The German Banking Act provides an exemption from the license requirement under such Act for "Exempt Financial Advisors"— persons that provide investment broking, contract broking and investment advice in respect of funds (such as foreign UCITS) that are registered for public distribution in Germany, provided such person does not receive or hold monies or shares from or for investors.

An Exempt Financial Advisor is not considered to be an investment services firm and therefore is not subject to the provisions of 31 et seq. WpHG. As a consequence, Exempt Financial Advisors will not be subject to the newly introduced requirement to provide retail investors with an information leaflet. However, there has been suggestion that the German government may plan to further regulate Exempt Financial Advisors and that a comparable requirement will be imposed on these advisors to provide an information leaflet in the near future.

Distribution Through Licensed Financial Services Providers

Any other regulated investment services firm will be required to comply with the new rules. As discussed above, the obligation to produce the information leaflet under the WpHG will not be directly applicable to the UCITS. It will be an obligation of the investment services firms acting as intermediaries between the UCITS and the clients. However, it may be anticipated that these German distributors will require the domestic and foreign UCITS to produce such an information leaflet in order to continue distribution.

The Information Leaflet

The information leaflet for non-complex financial instruments, such as (currently still) shares of UCITS, may not be longer than two pages of A4 size. It must contain the essential information regarding the financial instrument, set forth in a clear and coherent manner to enable an investor to judge (and make comparisons to other financial instruments) in a best possible way: the type of financial instrument, its functionality, the risks and costs related thereto, and the chances of a repayment of the capital under different market conditions.

The information leaflet may only relate to one financial instrument, and it must not contain any marketing information nor any information that does not relate to the above-mentioned purpose. It may be made available in electronic format.

Outlook

As of the date of this publication, it is not foreseeable how the information leaflet obligations will be applied to foreign UCITS that are not required to make a KII available before 1 July 2012. Information in this respect has not been forthcoming from the BaFin or the Ministry of Finance, and it seems the result will depend on the further legislative procedure and the outcome of the relevant hearings.

In a worst case scenario, foreign UCITS would have two potential options:

• They could produce an information leaflet for the interim period until the KII is available in their home state, which would lead to additional cost and workload uniquely for the German market; or
• They could ensure that a KII is available in the German language by 1 July 2011. However, under this alternative, the UCITS would not benefit from the grandfathering provided for by the UCITS IV Directive and confirmed by CESR.

Footnotes

1 The obligation to provide an information leaflet would not apply with respect to professional investors as defined in section 31a para. 2 of the WpHG. These generally include, among others: investment services enterprises; authorized or supervised financial institutions; insurance undertakings; collective investment schemes and their management companies; pension funds and their management companies; enterprises whose investment service is solely to provide proprietary business on a German stock exchange or derivatives market; proprietary trading, principal broking services or contract broking on derivatives markets; quotation of prices as market maker on derivatives markets; exchange traders and commodity derivatives dealers; certain other institutional investors; and entities offering the securitization of assets and other financing transactions.

Proposed Changes to the Luxembourg Law on Undertakings for Collective Investment

Authored by Marc Seimetz, Antonios Nezeritis and Kristel Gilissen

EU Directive 2009/65/EC (also often referred to as the "UCITS IV Directive"), which was adopted by the European Parliament and the European Council on 13 July 2009, entered into force on 7 December 2009. Although EU Member States only have to implement the UCITS IV Directive in their national legislations by 1 July 2011, Luxembourg has already taken the lead in the implementation process and deposited a bill with the Luxembourg Parliament on 6 August 2010 in order to implement Level 1 provisions of the UCITS IV Directive into national law (the "Bill"). The aim is to have the Bill adopted before the end of this year with the new law (the "Law") ideally entering into force as of 1 January 2011.

Apart from the implementation of the UCITS IV Directive, the Bill also addresses non-UCITS IV related changes that will have an impact on the Luxembourg investment fund legislation. This article summarizes the non-UCITS IV related changes proposed in the Bill.

Cross-investments Between Sub-funds of the Same Umbrella Structure

The important proposed change to allow crosssub- fund investments has long been awaited by the Luxembourg fund industry.

The Bill allows cross-sub-fund investments within both corporate and contractual types of funds, subject to several conditions. The investment by one sub-fund into another sub-fund of the same UCITS (or of the same non-UCITS retail fund) ("Target Sub-Fund") is not permitted under the current legislation, due to provisions in Luxembourg corporate law that restrict the acquisition by a company (such as a Société d'Investissement à Capital Variable (SICAV) in the form of a Société Anonyme (SA)) of its own shares. Although there existed no specific similar rules for contractual type funds (i.e., Fonds Communs de Placement (FCP)), the same approach was taken so as not to provide preferential treatment to FCPs.

Although EU Member States only have to implement the UCITS IV Directive in their national legislations by 1 July 2011, Luxembourg has already taken the lead in the implementation process.

The conditions for cross-sub-fund investments are the following:

• For UCITS funds, the standard UCITS investment rules and restrictions apply, which means that:
• • a sub-fund cannot invest more than 20% of its net assets in a Target Sub-Fund;
  • a sub-fund may acquire all the shares of the Target Sub-Fund, provided that those shares do not represent more than 25% of the aggregate number of shares issued by the UCITS as a whole;
  • a sub-fund may invest 100% of its net assets in additional sub-funds as long as the conditions above are complied with; and
  • a sub-fund may not invest in a Target Sub- Fund if the latter is permitted to invest more than 10% of its net assets in UCITS and other undertakings for collective investment.
• Circle investments are not permitted, which means that the Target Sub-Fund may not in turn invest in the sub-fund that is invested in the Target Sub-Fund.
• The double charging of management fees, subscription and redemption fees is prohibited.
• The voting rights that are attached to the acquired Target Sub-Fund's shares are suspended.
• The net asset value of the acquired Target Sub- Fund's shares will not be taken into consideration for the calculation of the net assets of the UCITS or the non-UCITS for the purposes of verifying the minimum threshold of 1,250,000 €. '
• A sub-fund of a UCITS or non-UCITS cannot become a feeder sub-fund of another sub-fund of the same UCITS or non-UCITS.
• Cross-sub-fund investments will be permitted as from the date of the entry into force of the Law, provided that the articles of incorporation of the fund have been duly amended by such date.

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