In September 2021, the European Fund and Asset Management Association (EFAMA) reported that net assets in UCITS and Alternative Investment Funds (AIFs) reached €20 trillion for the first time ever at the end of June.1 Roughly a quarter of those assets are in cross-border UCITS funds.
Within this successful trajectory, €170 billion has poured into cross-border UCITS, with €135 billion from European investors in the first half of 2021, compared to total inflows into UCITS of €235billion. As that growth looks set to continue, several recent changes will impact how cross border fund managers set up UCITS cross border focused funds – typically in Dublin and Luxembourg - and distribute them in Europe, and how they partner in the ecosystem of industry participants.
New Rules for Cross-border Funds
In August 2021, most of the provisions of the EU cross-border fund distribution directive2 came into effect. Although each European country has not yet transposed the directive into local law, the directive will impact managers looking to distribute products into Europe. Many fund managers have only recently started looking at the practical ramifications of how it affects them.
While most of the European regulatory output in recent years has had some impact on distribution, this latest directive was constructed with the specific purpose to effect cross border distribution. The passporting nature of UCITS has historically been its calling card, and that meant that fund managers could register their funds in one domicile and sell them in another market. However, in practice, the reality was that countries across Europe have created many different rules and regulations within the UCITS world and discovering and reacting to them has been a frustrating process for many fund managers. This directive was written in an attempt remove some of those jurisdictional nuances and in theory make the selling of cross border funds more cost effective and to the benefit of the end investor.
Change of Agent Rules
As fund managers have reflected on the directive, probably the most frequently raised aspect has related to paying agent or facilities agents. Approximately half of the European jurisdictions had requirements for a local paying agent to be engaged by fund managers, but the extent of their role differed from country to country. For example, for some countries that meant simply stating on your prospectus the local agent in place, but in practice they played an almost non-existent role in the investor experience. In other countries, such as Italy and France, the paying agent is involved in the day-to-day operating of a fund in terms of opening accounts for investors and working with the transfer agent.
What’s changed in the directive is quite significant in that the rules state that a fund manager does not need to have their local paying agent physically present in a particular country. It now needs to offer a facility for a paying agent across all European countries. So, for fund managers who have had as many as a dozen paying agent relationships across multiple countries in Europe that they're distributing in, they can continue with those relationships, but they now need to figure out who their facilities agent or paying agent can be in all the other European countries they’re distributing in. This means that fund managers who have historically been distributing in those other countries now need to have a facilities agent in place. The facilities agent needs to be able to provide a service in the local language of that country or in a language that has been approved by the regulator.
This has somewhat complicated managers’ ability to continue distributing into these countries where they have done so for many years but haven't had a need for local agent relationship to be in place. On the other hand, managers with multiple paying agents operating for them in Europe have commenced looking at options to consolidate those relationships into one, in an ideal case, or as few as possible. Fund managers begun to have those conversations with their paying agents in the last few months about whether they can offer those services across multiple markets.
In addition, some parties have begun providing new services in the last few months, extending their service remit across all European countries. While the new directive went live on August 2, 2021, the transposition of that directive hasn't been completed by every local government yet. So, there's still time for managers to appoint their facilities agents, or at the very least progress their conversation with their existing network of agents in the hope they will extend their offering.
Change of Pre-marketing Rules
Another frequent topic of conversation for managers relates to the new pre-marketing rules. The directive creates a uniform definition of what pre-marketing is and a uniform set of rules of what you need to do and when to engage in the pre-marketing process. Pre-marketing enables distributors to gauge the appetite for their product in a country, by registering with the local regulator and intending to pre-market in that country. Under the new rules, the need to initially pre-market your fund should be uniform across countries.
The potential adverse effect of this is the impact on reverse solicitation. For example, once pre-marketing has been triggered by a manager, any investor opening accounts and investing is deemed to have done so as a result of this pre-marketing. This is regardless of whether or not the investor had been in discussion with the manager or not, and the later example, known as reverse solicitation. Regardless of what prompted the investor to take action, the new rules stipulate that while in the pre-marketing window of 18 months, a full fund registration by the manager with the local regulator is now required.
The third most frequent topic of conversation is around fund declassification. While this is only in place for AIF’s and not UCITS, it means if you’re closing a fund in a particular market you cannot reopen that fund or a similar fund for the next 36 months under that pre-marketing notification process. As managers think about closing or opening funds, they need to consider if there really is no immediate or short-term asset raising opportunities for them in this jurisdiction. These are the three main considerations relating to the directive for cross border managers as it relates to distribution and their activity in Europe.
Rethinking the Distribution Ecosystem
Given the breadth of what it takes to operate a successful distribution strategy in the UCITS space, an associated ecosystem clearly exists and success across its component parts is necessary to provide managers with the best opportunity to sell their product. This ecosystem caters to a vast array of roles and responsibilities, from the product creation, to sending out transactional contract notes to investors and making sure that money gets moved.
With this in mind, fund managers should constantly be reviewing the different partners, be they internal teams, or external service providers, who currently play a role for them in any aspect that touches on distribution. Many years ago, asset managers were more comfortable owning all of these roles and responsibilities themselves, but we've evolved to the point where the vast majority are happy to have third parties working with them. There are about a dozen different roles in the distribution ecosystem that continue to grow in their importance in helping managers be successful in their asset raising endeavors.
Looking at some of these roles, one that stands out is the KYD, or ‘know your distributor’ component. The concept of KYD has come to the fore in the last few years where the UCITS board is more than ever expected to display a more hands on knowledge of their distribution network. Showing that they understand their distribution footprint, who is distributing their funds for them, how they’re doing anti-money laundering checks and how are they performing know-your-customer checks is now part and parcel of a proper KYD undertaking.
While some fund managers continue to own the KYD process in house, we see more and more fund managers engaged with third parties to operate that due diligence process on the distributors. For example, if you have 100 distributors working with you across various distribution channels you will have to do due diligence on each of them. This takes time and effort, with very little efficiencies available. Engaging a KYD third party firm to help in this space has proven hugely beneficial for many managers.
Given that it’s very often the same institutional investors that most fund managers target across the world, if you were to engage with a KYD firm it’s likely they've already done the due diligence on 90% of those already for other fund managers. So right away, you've got 90% of your due diligence done. For those remaining 10% they'll happily complete the KYD process for you because they’ll get further payment from you and have a greater distributor reach for all existing and new clients of theirs. With such a win-win business model, it’s not surprising that we’re seeing managers gravitate more and more to these external providers.
Other partners we see fund managers engage with are fund data providers, often used in the distribution of prospectuses, KIID documents, or sending out the NAVs. Given that investors continue to expect more data from fund managers, there is a need to consider who is to perform these key functions? As some of these data providers extend their own offerings, an increasing amount of managers are consolidating more investor related information dissemination with fewer partners.
Finally, another part of the distribution ecosystem we’re seeing interest growing in is the use of third-party marketeers. Whether it’s for assistance in penetrating new markets or to increase brand awareness in existing markets the use of third-party marketeers can make perfect sense to a fund manager. Yes, there’s some heavy lifting at the start of the relationship in gaining product knowledge, aligning culture and indeed agreeing on target investors and distribution channels, but managers continue to utilize these service providers across much of Europe.
Killian Lonergan is in the Market Intelligence team at BBH
In a series of upcoming video interviews, the Market Intelligence team will introduce an ‘Exchange of ideas’ series with service providers in the cross-border distribution ecosystem to share insights on how fund managers can navigate the new rules and best sell their product.
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