ACCESSING GLOBAL MARKETS THROUGH UCITS FUNDS
Global Appeal of UCITS Funds
Undertakings for Collective Investments in Transferable Securities (“UCITS”) are among the most popular forms of investment funds. The UCITS framework was originally developed to facilitate cross-border European fund investments by providing a single investment fund standard (European passport) for all European Union (“EU”) member states. Along with simplifying EU cross-border marketing of investment funds, the European Parliament’s UCITS Directive, which has been amended several times over the years (the “UCITS Directive”)[1], also introduced investor protection standards.
UCITS funds were designed for retail investors in Europe, and the overwhelming majority of fund investments made by smaller European investors are indeed made in UCITS funds. Because of their transparency, liquidity and regulations governing their structure, investment activities and supervision, UCITS funds have also become popular with institutional investors both in Europe and globally outside of the United States. The reasons that fueled UCITS funds’ global popularity are attractive to U.S. institutional investors, particularly U.S. tax-exempt investors.
Using UCITS Funds to Increase a U.S. based Investment Advisor’s Global Reach
The widespread global appeal of the UCITS brand make UCITS funds an interesting vehicle for U.S. fund managers who wish to market their investment strategies to investors outside of the U.S. Because UCITS funds can be marketed to U.S. institutional investors, seed funding for such a global strategy can be raised in the U.S., primarily from tax-exempt investors such as endowments or foundations that will not subject the UCITS fund to ERISA. For the effective use of UCITS funds as part of a strategy to expand a U.S. fund manager’s global reach, a thorough understanding of their foreign and domestic regulatory framework and their U.S. tax implication is required.
Key Features of UCITS Funds and UCITS Fund Management
UCITS funds are mutual funds with significant investor protection features mandated by the UCITS Directive, including investment and leverage limitations, and risk concentration, management, and transparency standards. A key benefit of a UCITS fund from an investor perspective is the requirement to provide fortnightly liquidity. Despite the highly regulated environment in which they operate, there is flexibility in structuring UCITS funds. Notably, UCITS funds can accommodate master-feeder structures familiar to U.S. fund managers.
Under the UCITS Directive, a UCITS fund is required to be domiciled in an EU member state. Because each individual EU country has its own domestic rules and regulations regarding funds and fund management, UCITS funds and UCITS management companies are governed both by the UCITS Directive (as implemented into the domestic laws of the applicable member state) and the member state’s existing internal law. Consequently, a U.S. fund manager wishing to establish a UCITS fund will need to comply with the laws of the relevant EU jurisdictions where the UCITS fund is established and is being marketed, as well as the requirements of the UCITS Directive.
A key requirement of the UCITS Directive for U.S.-based fund managers is the requirement that a UCITS fund must be managed by an EU domiciled management company that is authorized under its jurisdiction to serve as a UCITS management company. Therefore, the first step for a U.S. fund manager wishing to manage and/or advise a UCITS fund is to either set up an EU-based management company or enter into a partnership with an EU domiciled management company that will serve as the management company to the UCITS fund. Under such an arrangement the U.S. fund manager may serve as an adviser to the EU-based management company or, possibly, the UCITS fund, or manage one or more portfolios within an existing UCITS fund.
U.S. Regulatory Aspects Pertaining to UCITS Funds
In addition to complying with the UCITS Directive and the domestic law of the applicable EU member state, U.S. fund managers who are managing or advising UCITS funds also must comply with applicable U.S. federal and state regulation.
For example, a U.S. fund manager should comply with the requirements of Regulation S under the Securities Act of 1933, as amended (the “Securities Act”) when marketing investments in a UCITS fund to European and other non-U.S. investors. While a UCITS fund may be marketed to European retail investors, a UCITS fund may not be marketed to U.S. retail investors without registration of the offering under the Securities Act, and registration of the UCITS fund under the Investment Company Act of 1940, as amended (the “Investment Company Act”). To avoid these registration requirements, the securities of a UCITS fund may only be offered to U.S. investors in a private offering in accordance with Regulation D or Section 4(2) of the Securities Act, and the UCITS fund must satisfy the conditions of the exemptions from Investment Company Act registration under either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
U.S. fund managers sponsoring UCITS funds that are marketed to U.S. investors also must evaluate the eligibility of the European based management company for an exemption from registration as an investment adviser under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). UCITS fund management companies with their principal place of business in an EU member state can qualify for the private fund adviser exemption from the registration requirement under the Advisers Act if they (i) have no clients that are U.S. persons other than private funds, and (ii) manage only private fund assets from a place of business in the U.S. with a total value of less than $150 million.
Depending on the type of relationship and interaction between a SEC registered U.S. fund manager and the unregistered European UCITS fund management company, the SEC’s practice under the Unibanco series of no action letters may have to be complied with. This can pose somewhat of a challenge until the SEC adopts a formal position of the application of the Unibanco doctrine in the context of the post Dodd-Frank adviser registration regime.
One favorable aspect of the UCITS structure is that a UCITS fund is not a “covered fund” as defined in §619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”) as long as the UCITS fund (a) limits U.S. shareholdings to 15% of the securities of the UCITS fund, and (b) is predominantly offered to persons other than the sponsoring banking entity, its affiliates and their employees and directors. Consequently, an adviser or fund manager that is a “banking entity” (as defined in the Volcker Rule) and is generally prohibited from sponsoring a Section 3(c)(1) or 3(c)(7) private fund may nonetheless sponsor a UCITS fund that meets these conditions.
Depending on the nature of the UCITS funds’ investments, a U.S. fund manager who is marketing a UCITS fund to U.S. investors may also have to comply with the regulatory regime under the Commodity Futures Exchange Act.
Moreover, unless U.S. plan asset investors who invest in a UCITS are below the 25% threshold in the aggregate under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), it will be necessary to comply with ERISA.
U.S. Tax Considerations
Most forms of UCITS funds, such as public limited companies, are considered per se corporations under U.S. tax laws that are not eligible to “check the box” to elect to be treated as a partnership for U.S. income tax purposes. Generally, a UCITS fund that is considered a corporation for U.S. income tax purposes will be a “passive foreign investment company” or “PFIC.” Because the PFIC regime is not favorable to U.S. taxable investors, these UCITS funds are better suited for U.S. tax-exempt investors (such as endowments or foundations) which are not affected by the PFIC rules. U.S. taxable investors could be accommodated by structuring the UCITS fund as a legal entity that is eligible to elect partnership tax treatment in the U.S. such as an Irish SICAV.
As an offshore fund, the UCITS fund will need to conduct due diligence on its investors and otherwise comply with the Foreign Account Tax Compliance Act (FATCA).
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This summary is intended to provide only general information on the legal matters addressed herein. It is not a comprehensive analysis of these matters and should not be relied upon as legal advice. If you have any questions about the matters covered in this summary, please contact:
Janet R. Murtha: janet.murtha@wg-law.com | (212) 509 6314
Daniel A. Wuersch: daniel.wuersch@wg-law.com | (212) 509 4722
[1] Currently, UCITS funds are governed by Directive 2009/65/EC (referred to as UCITS IV). The most recent amendment to the UCITS Directive, Directive 2014/91/EU (commonly referred to as UCITS V), was adopted by the EU Parliament on July 23, 2014, and came into force on September 17, 2014. EU member states have until March 18, 2016 to implement national laws affecting the changes mandated by UCITS V.