Unit Trusts (Electronic Communications) Order 2009

In moving the Unit Trusts (Electronic Communications) Order 2009, I shall also speak to the Open-Ended Investment Companies (Amendment) Regulations 2009. The Open-Ended Investment Companies (Amendment) Regulations 2009 and the Unit Trusts (Electronic Communications) Order 2009 make provision for the electronic transfer of ownership to units and shares in UK-authorised investment funds. This should permit major efficiency savings and reductions in error rates. I will sketch in some background to these instruments. The Law of Property Act 1925 in England and Wales and the Statute of Frauds Act of 1695 in Northern Ireland require transfers of title to units and shares in United Kingdom-authorised investment funds to be made in writing. In Scotland, the Requirements of Writing (Scotland) Act 1995 has the same effect for assignments of property made in the form of a gift. Authorised investment funds are collective investment vehicles that are authorised by the Financial Services Authority. They can take the form of open-ended investment companies or authorised unit trusts. The two are very similar, the only significant difference being their legal form. About £400 billion is currently held in these funds. Although paper processes remain a necessary part of some aspects of the investment fund administration process, they also tend to be more expensive and to have higher error rates than purely electronic processes. Indeed, the electronic messaging firm SWIFT estimates that, across the European Union, the additional annual costs generated by using manual rather than fully electronic processes could be as high as €1 billion. When the further costs driven by the higher error rates associated with manual processing are taken into account, this figure could rise to between €5 billion and €10 billion. We therefore believe that the requirements that I have described for a paper-based process in the UK impose significant costs on investment fund managers and their investors. We estimate that making provision for electronic transfer could bring annual administrative savings for UK fund managers of between £70 million and £290 million. None the less, improvements in efficiency must not come at the expense of maintaining reliable systems that protect the interests of investors. We believe that investor protection will continue to be assured for a number of reasons. First, electronic systems are already a central and reliable part of the financial services architecture. There is, for example, the CREST system for share and bond trading, which holds about 88 per cent of UK shares or, at the retail level, secure systems for internet and telephone banking that are now used significantly by more than 17 million people in the UK. Experience so far has shown that properly designed electronic systems can be equally reliable or, indeed, more reliable than paper-based processes, and that it is right to extend this provision to the fund management industry. Secondly, under the proposed new rules, the fund manager would retain liability for losses incurred where it acted on instructions that were later shown to have been fraudulent. This mirrors the current position for paper-based instructions and acts to place a strong incentive on fund managers to ensure that they have adequate security procedures in place and to protect investors in the unlikely event of loss through fraud. Finally, we will require fund managers to take reasonable steps to confirm the identity of the sender of an electronic instruction. For open-ended investment companies, this requirement is contained in the draft instrument. Detailed rules on the operation of authorised unit trusts are included in Financial Services Authority rules, and the new requirement for that type of fund will therefore be imposed in FSA rules. The Investment Management Association has produced guidance for firms on meeting this ““reasonable steps”” criterion, which it has asked the FSA to approve. The guidance lists the types of electronic communication which can be considered secure and lists precautions which should be taken to verify investors’ identity in particular types of transaction. The proposals have been the subject of a full consultation. Responses to the consultation supported the principle almost unanimously and included helpful feedback, which we have reflected in the proposals before the Committee today, to ensure the effectiveness in property law of transactions made under the proposed new rules. In line with the feedback from the consultation, we do not propose to make it a requirement for fund managers to accept electronic instructions. Investment funds are distributed by a wide variety of means—via independent financial advisers or other intermediaries, directly by the fund manager or through a platform—and the appropriate means for accepting investor instructions varies accordingly. We therefore want to maintain the flexibility for managers to act only on paper instructions where that is most appropriate. We expect electronic transfer to be taken up quickly for wholesale fund business and to be adopted more gradually in retail markets. In conclusion, the reforms can bring substantial efficiency savings for the UK fund management industry, and the safeguards they include will ensure that investor protection is in no way compromised. Accordingly, I commend the order to the Committee.