Jesus Mardomingo and Jorge Canta of Madrid-based law firm Cuatrecasas outline Spain's new legal framework for collective investments.
Following a process taking more than one year, the new Collective Investment Institutions Regulation (the Regulation), intended to modernize the Spanish industry, was approved on 4 November 2005.
The most relevant issues included in the final version of the Regulation are discussed below.
1. Eligible Assets
The regulation provides for specific rules applicable to:
(i) Investment in non-harmonized Collective Investment Institutions (CII), in which daily value would be required.
(ii) Use of derivatives, permitting the use of credit risk and volatility as underlying for derivatives and establishing the rules applicable for the use of index as underlying, including specific rules preventing the use of index-derivatives to invest in non-eligible assets.
(iii) Regulation of 10 per cent of "soft regulated" assets, which include non- harmonized UCITS, subject to no further requirements; assets with less liquidity; hedge funds or venture capital companies.
2. Alternative Investments
Most of the issues the Spanish Industry raised in the approval process have been accepted. The Regulation incorporates some of the industry demands and establishes a less restrictive regulatory framework by, for example, eliminating the requirement of daily NAV and instead requiring the funds to provide it quarterly or twice a year if required by the investment policy.
Both alternative investment funds (Free investment CII, i.e. single manager funds) and funds of alternative investment funds (Funds of Free investment CII, i.e. multi-manager funds) are regulated.
The principal characteristics of single manager funds and multi-manager funds are as follows:
Free investment CII
• In the first draft only institutional investors could acquire single manager funds, but in the final version only a minimum investment of EUR 50,000 is required.
• Marketing activities can only be carried out when addressed to qualified investors (the first draft established that no marketing activities could be carried out). The final version of the Regulation defines "qualified investors" as those defined in the Prospectus Directive.
• Minimum number of unit- or shareholders of 25.
• As previously stated, the NAV must be calculated quarterly. Nevertheless, if
required by a particular type of investment, it can be calculated twice a year. The subscriptions and reimbursements shall be carried out with the same frequency.
• There is no restriction to investment in any kind of assets, including credit derivatives, irrespective of the underlying assets. The only requirement is for the investment policy to follow the general principles of liquidity, diversification and transparency.
• There is no restriction on derivative leverage.
• Possibility of indebtedness of up to 5 times the value of the single manager fund's assets.
• Possibility of pledging the fund's assets.
Funds of Free investment CII
• No limit on investors to whom the product can be sold.
• Minimum investment of 60 per cent of the multi-manager fund's assets in other Spanish Free investment CIIs, other similar foreign funds domiciled in OECD countries, or funds whose management has been entrusted to a management company subject to supervision in an OECD country.
• Maximum investment of 10 per cent of the multi-manager fund's assets in a single CII.
• The NAV must be calculated quarterly. Nevertheless, if required by a particular type of investment, it can be calculated twice a year. The subscriptions and reimbursements shall be carried out with the same frequency.
According to the above, it seems that finally Spain would have a flexible regulatory framework for the launch of hedge funds.
The final version of the Regulation establishes that the CNMV will set out the specific requirements that would be imposed on Spanish management companies planning to manage alternative investment products.
However, the Regulation establishes the minimum requirements as:
• Having enough human and material resources to ensure adequate risk management, including control and risk measuring systems, which makes it possible to carry out a previous valuation of the investments and constant investment tracking.
• Having adequate investment selection procedures.
3. Exchange Traded Funds (ETFs)
The Regulation details the legal regime applicable to ETFs, and has solved the tax problems that stopped the growth of this product in Spain in the past. In general, the specific ETF regime would be applicable provided that (i) the investment policy consists of a reproduction of a financial market index and (ii) the fund's units are listed on an official market.
4. Rules concerning sale of Spanish funds abroad
One of the relevant issues raised by the Spanish industry was the elimination of barriers to distribute Spanish funds abroad. In general, the obligation to identify the final investor, the prohibition to use nominee accounts, and certain tax withholding obligations prevent Spanish fund managers selling their products abroad.
However these problems seem to be solved since the Regulation expressly establishes the regime that would govern the commercialization of Spanish funds abroad. Under this regime the foreign distributor would be subject to certain reporting obligations to the investors and the Spanish fund manager. The Regulation has left the Spanish tax authorities to resolve the withholding tax issues and the reporting obligations that would apply, although it seems that it would not be a problem to distribute funds abroad.
5. Distribution of foreign CII in Spain
Another issue that could concern the industry, but in this case the foreign one, is the distribution of non-harmonized CII in Spain. In relation to this, there are not many new matters. However, the register of a non-UCITS fund requires compliance with tight requirements, amongst others, having equivalent investor protection in the country where the fund is domiciled.
The main questions to be solved are (i) what would be the CNMV's position when checking compliance with the requirements set out in the Spanish regulation for the registration of non- harmonized CII, (ii) whether the prospectus directive, under which a EUR 50,000 minimum financial product investment can be freely marketed in Spain would be applicable to non- harmonized CII, and (iii) which tax regime would be applicable to non- harmonized CII.
6. Funds Management Companies
The doubts about the activities to be carried out by Spanish management companies have been resolved and according to the Regulation, based on the CESR criteria, these companies would be entitled to carry out the following activities: (i) fund administration and fund asset management; (ii) portfolio management; and (iii) fund distribution, including third party funds. Certain rules have been included regarding the delegation of functions by the management companies.
7. Fees Regime
The Regulation has introduced several rules regarding the fees collected by the Fund manager and the custodian entities, providing restriction when (i) the fees are calculated on the basis of the fund's performance and (ii) when the fund is investing in funds within the fund management group.
8. Investor protection
The Regulation introduces several provisions to ensure adequate investor protection.
It establishes all the aspects that have to be included in the Prospectus and Simplified Prospectus, details the loyalty and diligence duties of management companies, and establishes conduct of business rules for management companies, custodians, distributors and investment companies, in order to avoid conflicts of interest.
After a very long and complex approval process, the Spanish funds industry has reached the competitive legal framework necessary for a country in which most of the public savings are invested in funds.
However, several questions of interest to the international industry are still outstanding, particularly those related to the possibilities of marketing foreign non-harmonized CII in our country.
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