Many global asset managers are considering launching an ETF in the European market. International diversity is an extremely useful way to mitigate risk and set yourself up to capture opportunities. 

However, global asset managers need to understand the key difference between how Undertakings in Collective Investments and Transferable Securities (UCITS) ETFs work compared to 40-Act ETFs. 

Portfolio managers and CIOs need to understand the structural differences and similarities between the two. Compliance officers and legal counsel need to understand the regulatory filings needed and the legal landscape. Operations and distribution teams, meanwhile, have to have a mastery of infrastructure and the UCITS passport to best position the product for success.

Which UCITS rules do asset managers need to know?

In order to be UCITS compliant with the European Commission, there are several key rules global asset managers should know regarding UCITS funds. 

Here are the most critical:

• A UCITS exchange traded fund must be licensed in an EU state of origin.
• The fund issuer must give proper legal notification to the nation that is the state of origin.
• The fund’s website must provide a key investor information document (KIID) on its website.
• The fund must provide a prospectus to its investors.
• Every time a fund issues, sells, or redeems shares it must make pricing notifications available to investors.

Regulations vary from country to country

UCITS governs funds throughout the European Union, but it is important for asset managers to note that member states have their own specific regulations. Understanding these specific requirements can enable issuers to build funds that will be compliant throughout Europe. 

Here’s a snapshot of some of the unique regulations for different regions:

• United Kingdom. Following Brexit, funds from the EEA are no longer passported automatically into the UK. The Financial Conduct Authority (FCA) requires funds to apply for their Overseas Funds Regime (OFR) to market to UK retail investors. This means aligning with specific UK consumer protection standards.
• Germany. BaFin, Germany’s federal financial supervisory authority, enforces the German Capital Investment Code (KAGB). This code includes German language requirements for marketing, fees for passporting, and specific rules for asset class segregation. The German market also places heavy restrictions on derivatives.
• France. France’s Autorité des marchés financiers, like BaFin in Germany, have language requirements and disclosures for marketing materials. They also require a fund’s prospectus to define a target index, regardless of fund type and impose limits on risk and other protections. 
• Austria. The Financial Market Authority (FMA) in Austria, much like in Germany, requires funds to have a KIID in German. They also require the prospectus, fund rules, and reports to be in German and charge yearly fees. Though they have no specific restrictions on marketing materials, they do need all materials to adhere to transparency standards.
• Belgium. Belgium’s Financial Services and Markets Authority (FSMA) requires mandatory pre-approval of marketing materials. It also has comprehensive and specific local language requirements and strict criteria for different share classes. The UCITS “trash ratio” of 10%, which allows funds to invest up to 10% of their holdings in assets that are not strictly eligible under the UCITS directive, is strictly interpreted in Belgium, and may include assets that are considered eligible elsewhere. The FSMA errs heavily on the side of consumer protection.
• Ireland. Ireland is the domicile of a vast majority of UCITS ETFs because of its favorable tax policies. The Double Tax Treaty with the United States reduces withholding tax on dividends from U.S. equities to 15%, with most other European jurisdictions being double that. Because of this, there is also a concentration of expertise in Ireland, making it a hub of financial services in the EU. Irish UCITS funds must have at least two Irish resident directors, and they require Irish legal counsel as well. 

The six countries described above represent some of the most commonly targeted markets for U.S. issuers, but there are 27 UCITS domicile countries in total. 

What’s important to remember, particularly for legal counsel and compliance teams, is that even though the UCITS ETF can passport with relative ease to many different countries, each jurisdiction interprets the regulatory requirements in a unique way. Understanding where your product might easily list and where there might be friction is also important for distribution teams.

Check out: Choosing the right ETF wrapper for your strategy

Key differences between UCITS and US ETFs

Over 90% of the entire global ETF market consists of U.S. ETFs and UCITS ETFs, but there are some key differences between the two. 

Most notably, U.S. ETFs are governed under the Investment Company Act of 1940 and the Securities Act of 1933. They offer favorable tax rates for U.S. investors and typically distribute more income and have fewer restrictions on securities lending.

UCITS ETFs must comply with the Undertakings in Collective Investments and Transferable Securities (UCITS) Directive. They tend to have more stringent consumer protection requirements. UCITS ETFs do not allow for more than 10% of a fund to be allocated to a single security.

5/10/40 rule and the 25/5/50 rule 

It is worth understand that UCITS ETFs follow a 5/10/40 rule. This means that, generally speaking, no more than 5% of a fund's allocations can go to a single holding. There can be an exception to this that allows for up to 10% of allocations to go to a singl eholding, however, these exceptions can not surpass 40% of the total holdings.

In the U.S., the 25/5/50 rule covers similar ground. A fund can not generally allocate more than 5% of its holdings to a single issuer, however exceptions can be made that allow for up to 25% to go to a single issuer. The total amount of holdings above 5% in a fund can not exceed 50% of the total fund holdings.

How to launch an ETF in Europe

The ETF ecosystem is expanding, giving fund managers more reasons to bring products to Europe. These products have the chance to become early opportunities for investors. 

Whether you’re a portfolio manager with an interesting product idea or legal counsel for an asset manager, you need to understand what launching a UCITS ETF in Europe involves. The ESMA rulebook has a complete breakdown, but here are some of the high-level points of interest.

Structure the fund

Deciding on the structure of your fund is the first step to launching a fund in Europe. CIOs, portfolio managers, and legal counsel need to understand the fund structure. 

The UCITS ETF structure has certain requirements and limitations, but the Alternative Investment Fund (AIF) is a more flexible option that is worth exploring. The key difference between a UCITS and AIF product is that UCITS will generally focus on listed stocks and bonds while AIFs can invest in unlisted shares, infrastructure, real estate, and other more complicated instruments. It is worth noting that the liquidity of an AIF tends to be much lower than a UCITS ETF.

If your product is targeting retail investors, then you probably want to prioritize liquidity and go with a UCITS ETF. If you are primarily interested in more sophisticated investors with higher risk tolerance seeking higher returns, it's worth considering an AIF.

Appoint a management company and depositary

Of note for legal counsel and operations teams, UCITS ETFs require the appointment of a management company and a depositary. Because of its tax advantages, Ireland is a popular domicile for UCITS ETFs and has a burgeoning ecosystem of management companies and depositaries that asset managers can assign to these roles.

Though an affiliate of the promoter can be assigned as the management company, it is increasingly more common for fund managers to appoint a third-party. Management companies are subject to minimum capital requirements and must be authorised by a Central Bank in either the domicile state or in another EU member state.

A depositary’s main function is keeping the assets of the UCITS secured as well as oversight and cash monitoring. 

Submit regulatory filings and obtain approvals

UCITS ETFs and AIFs are highly regulated and require legal teams to submit applications for fund approvals. Some of the regulatory requirements include:

• Filling out the relevant Central Bank Applications. 
• Fund documentation including prospectus, supplements, and other material.
• Letter of application.

Other forms may be required, and there will be notes from the Central Bank that must be cleared. Once everything is reviewed and in order, a cover letter and final executed document needs to be submitted by 5:00 PM on the day prior to the approval date.

Submit notification letters

Something sales, business development, and product specialists in particular need to know is that one of the main advantages of a UCITS ETF is its ability to passport to different countries. However, in order to do this, fund managers must submit a notification letter to the regulator of the home domicile. 

From there, the home regulator will send a notification to the host regulator within 10 business days. It is also important that all required documents are available on your website. These will likely include the prospectus and the KIID.

Meet MiFID II and PRIIPs KID requirements

Compliance offers and legal counsel should note that in order to help investors assess the value of their investments and understand the associated charges with clarity, UCITS ETFs must meet requirements laid out in the Markets in Financial Instruments Directive II (MiFID II) and the Packaged Retail and Insurance-based Investment Products (PRIIPs) regulations.

The Key Investment Information Documents (KIID) that UCITS ETFs require can meet the PRIIPS Key Investment Documents (KID) requirements, but the European Commission might ask a UCITS fund to produce a PRIIPS KID instead of a UCITS KIID. 

MiFID II contains a requirement for firms to disclose an aggregate cost figure. This figure needs to cover the entire value chain and give investors enough information to ascertain the total cost of investing in the product. Clients will also have the right to request an itemized breakdown of the costs. 

Build operational infrastructure

Once your product has a management company, a depositary/custodian, and a transfer agent, it is important to bring in authorized participants and market makers. They will be the cornerstone of your UCITS ETF’s liquidity. Leveraging automated systems that can facilitate communications for daily creation and redemptions can be extremely helpful and useful for operations analysts and legal counsel to understand.

Cross border settlements, which outline a post-trade framework, are particularly critical, as the key advantage of passporting is the ability to sell a security from one domicile to a buyer in another. It is worth noting that though many European ETFs operate on a T+2 (trading day plus 2 days) cycle, some markets are shifting to T+1, which means there is pressure to ensure fast, efficient settlement. 

Related: Best practices for launching an ETF

Common mistakes when entering European markets

As U.S. asset managers look to expand into Europe, having a partner with experience in the European market - such as VettaFi - is a tremendous advantage. 

Here are some of the most common mistakes that U.S.-based asset managers make.

Regulations

The regulatory complexity of the EU is challenging for many U.S. firms to wrap their heads around. The Alternative Investment Fund Manager Directive can be a stumbling block that results in slower, more expensive start ups. Europe’s stringent ESG requirements are very easy to underestimate as well. 

Additionally, there are tax reporting requirements that can be daunting. These requirements aren’t just on reporting to European agencies and banks but to U.S. regulators as well. 

Because the 40-Act ETF has a tremendous flexibility in structure, it can be easy for a domestic issuer to accidentally bring over a non-compliant structure.

Operations

It may seem obvious, but the time zone difference between the U.S. and Europe can result in a host of issues. It can be hard for U.S. and European teams to meet face-to-face to align on decisions quickly. Because of this, operational efficiency is often slower than anticipated, creating communication bottlenecks. 

Many U.S. asset managers will assume that domiciling their product in London makes the most sense, given the language similarity. However, Dublin and Luxembourg are generally the superior choice for U.S. firms looking to expand. 

Distribution and marketing

One of the most expensive errors an asset manager can make is fully launching a product without understanding how to market it. It is common for U.S. firms to think of Europe as one country when the reality is that it is many countries with different kinds of investors seeking different solutions. A “one size fits all” stance will often be ineffective. Tailoring your approach is required, and assuming that U.S.-style sales model will translate in Europe is folly.

Because passporting offers a swift and efficient way to bring a new UCITS ETF into a different domicile, U.S. issuers will skip out on pre-marketing and exploring demand. This can result in a very expensive launch that immediately gets tripped up by a lack of market for the product. 

U.S. brand equity will not go far in Europe, and even big brands need to form local partnerships to achieve success. There are also a host of requirements for marketing content, which can be easy to miss without the proper research. 

Finance and tax

European UCITS ETFs have significant compliance requirements, and it can be very easy for U.S. issuers to fail to budget enough time and money to meet these requirements. Failure to properly report foreign tax vehicles can be a costly mistake that results in big penalties.

The possible places for finance and tax mistakes to happen include failing to account for tax withholding differences between two countries, failure to grasp currency hedging costs, and missing key details or deadlines.

Best practices for launching a UCITS ETF

For U.S. issuers seeking to launch a UCITS ETF, there are enormous potential rewards. However, there are also challenges and obstacles. Here are some best practices.

Learn all regulatory obligations and diversification rules

One of the best ways to prepare for a UCITS ETF launch is to do the homework and learn all of the regulatory obligations and the diversification rules. Compliance officers and legal in particular need to understand that as you build the product, building it with its regulatory hurdles in mind and with the appropriate levels of diversification will save time and resources.

Differentiate your ETF from existing products

Being first to market is always an advantage. One of the reasons the European market is compelling for U.S. issuers is that there aren’t nearly as many ETFs to compete with. 

If you are a CIO, portfolio manager, or product specialist then you should know that if you have an innovative product idea and can stand it up relatively quickly, you could end up in the pole position. Note that a white label solution can help mitigate the amount of time it takes to launch your product.

Build a strong distribution network

Sales and business development teams should know that building a distribution network that spans multiple countries and markets can be challenging, which is one reason that U.S. asset managers are well served by being focused when they initially expand into Europe. 

Choosing one or two focus markets and building strong distribution networks there can set you up for expanding in the future, and building out a robust, wide-reaching distribution network.

Target a slightly lower fee structure

As is often the case, keeping fees down and expense ratios low will make a product more attractive to an investor. CIOs and business dev teams should bear in mind that the regulatory landscape of Europe is such that there are often strict requirements around sharing your fees with your potential clients. 

If your fees are on the higher end, especially as a newcomer to the market, you could end up having more of a challenge breaking in and establishing yourself. Aim to make a product that has a lower fee structure.

Closely manage the timeline

Arguably, having an accurate assessment of the time it will take to stand up a product in Europe is one of the easiest places for a U.S. asset manager to fall down. Different time zones between teams can slow down communications and create efficiency issues. 

The most successful expansions happen for asset managers who accurately assess the amount of time it will take to clear regulatory hurdles and efficiently drive forward without missing steps or putting themselves in a situation where time and resources are burned without desired outcomes being achieved. Operations and legal teams need to give themselves extra time and wiggle room to learn on the fly, and make sure you are coordinating with partners who have experience and an understanding of the regulatory pace of Europe.

Understand and budget for launch costs

CIOs should understand that launch costs in Europe are, generally speaking, higher than they are in the U.S. This is because there are additional regulations and considerations asset managers must make. Also, if you are not yet an experienced player on the European markets, there are going to be learning experiences which could result in additional costs and slower timelines. 

Understanding all of the launch costs and erring your budgeting on the side of the product costing more than you think it might will save some sticker shock and smooth over the experience.

Also read: ETF vs. mutual fund: 9 strategic considerations for asset managers

FAQs

Here’s what domestic issuers ask the most about UCITS ETFs.

What are UCITS?

UCITS, also known as the Undertakings for Collective Investment in Transferable Securities, is a regulatory framework established by the European Union (EU) for the management and cross-border sale of mutual funds and ETFs. 

UCITS funds must meet strict diversification, liquidity, and investor protection requirements, which makes them one of the most recognized and trusted fund structures in the world. As of 2024, UCITS funds account for the majority of European retail investment funds.

What are 40-Act funds?

40-Act funds are U.S. pooled investment vehicles that are registered with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940. The Act establishes the regulatory framework governing how these funds are structured, operated, and sold to investors. 40-Act funds are subject to strict SEC oversight, including requirements around disclosure, diversification, and investor protection.

Are UCITS ETFs tax free?

No, UCITS ETFs are not tax free. However, they are generally considered tax efficient for a number of reasons. UCITS ETFs domiciled in Ireland and Luxembourg benefit from favorable tax treaties. For example, Ireland’s Double Tax Treaty with the U.S. reduces withholding tax on U.S. equity dividends from 30% to 15%. 

Additionally, UCITS ETFs that offer accumulating share classes allow investors to reinvest dividends without triggering an immediate tax liability, deferring taxation until shares are sold. Tax treatment will ultimately vary depending on the investor’s country of residence and the fund’s domicile. 

Are 40-Act funds tax free?

No, 40-Act funds are not tax free. All 40-Act funds carry tax obligations, but the degree of tax efficiency varies depending on the fund structure. ETFs registered under the 40-Act are among the most tax efficient options available to U.S. investors, due to their ability to use in-kind creations and redemptions to minimize capital gains distributions.

By comparison, mutual funds are generally less tax efficient because portfolio changes typically trigger taxable events that are passed on to shareholders. As with any investment, tax obligations will vary depending on the investor’s individual circumstances.

Do all EU nations follow the same UCITS regulations?

No, EU nations do not all follow the same UCITS regulations. While the UCITS directive establishes a shared regulatory baseline, each country applies their own rules for marketing materials, language requirements, taxation, and reporting. 

The bottom line

The European Union is expected to see a surge of retail investor and institutional investor interest in ETFs. Issuers have a unique opportunity to bring their products and innovations to a new market and build out their brand equity on the international stage. 

However, it can be challenging to break into a new regulatory environment. Asset managers can overcome those challenges by working with partners that have experience on the global stage, such as VettaFi. 

Contact us today to learn how we can set your product up for success by building your index and connecting you with prospective partners in the European Union.