Article 92 UCITS Directive. A Guide to Digitalisation of Local Facilities

Freedom of movement — for people, goods, services, and capital – is the core tenet of the European Union. In the realm of investment funds, treated as goods of financial nature, UCITS, AIFs and now also ELTIFs enjoy freedom of movement cross-border in Europe under the so-called marketing passport regime. 

Yet for investment funds, the real-world implementation of the principle of freedom of movement across the single market is riddled with friction and hurdles. Primarily due to administrative and structural barriers at the level of individual member states, combined with some protectionism in certain cases.

Within the context of the action plan of the European Commission known as the Capital Markets Union, several reforms of outdated regulatory mechanisms have seen the light. The most relevant is the Cross Border Distribution Directive, which reformed both the UCITS and AIFMD directives.  

Article 92 UCITS Directive and the Local Facilities Requirement

Pushing forward one of the most pressing items on their agenda, European policymakers wanted for fund distribution to embrace digitalisation too, with a view to transfer to it its cost efficiencies. As a result, the Cross Border Distribution Directive radically transformed Article 92 UCITS directive, which governs the provision of local facilities for UCITS marketed to retail investors in host member states in Europe. The same directive also introduced the requirement to offer similar facilities for AIFs marketed to retail investors.

Under its original version, Article 92 UCITS directive imposed on UCITS or their management companies to establish local facilities with a physical presence in each host member state where a UCITS was marketed and offered to retail investors. These facilities served as brick-and-mortar points of contact, handling investor inquiries, subscription and redemption orders and storing fund-related documentation. However, inconsistent interpretation across EU member states created operational and cost inefficiencies. 

While some jurisdictions mandated the appointment of local credit institutions, others allowed more flexible arrangements, if at all. A local external third party was mostly required to perform the tasks of the facilities, thus creating an additional cost of doing business in a new market for those UCITS intending to expand their distribution roadmap in multiple European member states. The requirement and the cost attached to related compliance effectively translated in an invisible barrier that undermined the foundational principle of freedom of movement in the single market. Save for some notable examples in certain European member states, the facilities never performed a true active role in the distribution of funds.

Two concurrent forces determined the end of the facilities under Article 92 UCITS directive as we knew it. On the one hand, the pressing need of European policymakers to revive European capital markets, thus removing obstacles for smaller funds to operate cross border in other markets. On the other, the realisation that investors are engaging increasingly more in a digital fashion when it comes at their investments, rather than in an in person manner in a physical office as it had been the case in the recent past.  

A New Era for Article 92 UCITS Directive

The reformed Article 92 UCITS directive marked a decisive shift toward digitalisation in European fund distribution. The amended provisions of article 92 UCITS directive now explicitly prohibit member states to impose on UCITS and their management companies that facilities are arranged and offered necessarily both via physical premises and through an external third party. Implicitly, the reformed provisions of article 92 UCITS directive allow for local facilities to be provided electronically, both online (email/internet website) and over the telephone. The reformed Article 92 UCITS directive introduces a modular framework, permitting different entities, UCITS management companies included, to perform the different facility functions. This flexibility allows fund managers to design custom operational workflows, enhancing efficiency without compromising regulatory compliance.

Language remains the only hard requirement. Local facilities must still be offered strictly in the official language of the host country. This means that while the infrastructure of the facilities can be digital, the user experience must be tailored to the official language or languages spoken in the given host member state where the funds are distributed. 

Operational, Legal and Governance Implications

There are many moving parts involved in the transition to a digital facilities agent from a legacy brick-and-mortar one. The change of a service provider for a fund always necessitates some governance restructuring, legal contract updates and operational system alignment with involvement of various departments within a fund management firm. 

For distribution being one of the key managerial functions of management companies, albeit most often delegated, it is always the board of a management company to have the final say on the appointment of new third parties related to distribution. Boards of fund management companies must also assess and resolve on broader regulatory and operational implications of the transition in each host member state of distribution before approving a transition to a digital facilities agent. There are still European domiciles where, for a combination of local tax and distribution dynamics, transitioning to a digital facilities agent is not yet a workable option. 

From a strict regulatory standpoint, the new arrangement for the facilities will have to be notified to national competent authorities in the host member states concerned. Given that the change in the facilities is classified as a change in the so-called marketing arrangements for a specific host member state, related notification to relevant national competent authorities shall be made at least one month in advance of the actual change being implemented. 

Then there is also work for legal teams to update service agreements, revise fund prospectuses, and potentially notify investors of the changes to be made to the facilities. 

Processing Investor Payments under Article 92 UCITS Directive

Two tasks to be performed as part of the facilities under Article 92 UCITS directive require a deeper scrutiny. These are handling investor payments and liaising with local regulatory authorities. The directive allows flexibility in assigning these functions to third parties, which is essential since payment processing is a regulated activity. These tasks should have weight on a potential decision for UCITS and their management companies to insource the function of the facilities as it is now possible under the new regime.

Typically, distributors or fund administrators handle the tasks related to payments. Management companies may want to think carefully about the implications of being perceived as engaging directly with retail investors or handling payments to them when assessing the option to insource the facilities role. That is in relation to the actual scope of their existing licensing, if that includes also the ability to deal with retail investors as well as the ability to hold client money. Many management companies will find that related risks are not in line with their overall risk appetite. 

Facilities represent a point of contact not only with investors but also with national competent authorities. Striking a balance between legal expertise and cost efficiency is crucial here and will dictate the choice of the right outsourced facility provider. Data management firms may lack the regulatory acumen, whereas law firms may offer more depth at an unsustainable cost and most of the times without digital premises for the facilities as such.

Article 92 UCITS Directive as a Catalyst for Cost Efficiency

The reform of Article 92 UCITS directive addresses long-standing inconsistencies and reduces distribution costs related to entering new markets. Some may say that is also supports compliance with new value-for-money principles to be introduced potentially in Europe.

The European Commission’s Retail Investment Strategy, if it ever sees the light, focuses on ensuring value for money for investors. UCITS will have to demonstrate that they operate in a cost-efficient manner, by avoiding undue costs. 

The reformed Article 92 UCITS directive supports this initiative by enabling the elimination of high-cost, low-value physical local facilities. The cost incurred by UCITS to continue to provide the facilities in the old fashion manner will for sure be considered an undue cost.