European Commission consultation paper entitled "UCITS Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-Term Investments"
On 26 July 2012, the European Commission launched a public consultation (the "Consultation") on a number of regulatory issues relating to money market funds, eligible assets, the use of derivatives, and depositary passports. At this stage, it appears that the Consultation shall form the basis for "UCITS VI", to build on the recent UCITS IV Directive and the upcoming UCITS V Directive. The Commission has requested responses to the Consultation from interested parties by 18 October 2012.
In the Consultation, the Commission has posed a series of broad, open questions relating to eight different areas of the UCITS regime. It appears from the Consultation that the Commission would like to restrict the use of complex structures in UCITS funds, while at the same time expanding the range of permitted underlying investments. This briefing contains a short summary of the main points of the Consultation.
Eligible Assets and Use of Derivatives
The Commission is aware that an increasing number of sophisticated investment strategies are being used to allow UCITS funds to invest in non-eligible assets. The Consultation is concerned that these strategies are inappropriate for UCITS investors and has asked for feedback in respect of the adoption of further restrictions on the scope of assets and exposures that are deemed eligible. In particular, it is proposed that a 'look through' approach is adopted for transferable securities, investments in financial indices and closed-ended funds.
The Consultation looks at derivative instruments and queries whether it would be appropriate to move away from the value-at-risk methodology and towards the commitment method as the sole calculation of global exposure. This would have a significant impact on many existing UCITS, particularly those employing leverage, which would be unable to comply with the global exposure limit of 100% of NAV applicable if they used the commitment approach.
Efficient Portfolio Management Techniques
The Commission examines efficient portfolio management ("EPM") techniques that are employed by UCITS in respect of transferable securities and money market instruments. It is concerned that investors are not always fully informed of the operation of EPM techniques, the treatment of collateral as part of EPM, and the increased risks associated with borrower default. It queries whether a more detailed regulatory framework for EPM should be adopted in order to address these concerns. The Commission also raises queries relating to liquidity issues in EPM transactions and asks whether it would be appropriate to make all EPM transactions 'recallable' at any time.
Over-the-Counter ("OTC") Derivatives
The Consultation considers whether it is necessary to conduct an assessment of the current regulatory framework for OTC derivatives. In particular, the Commission is concerned about the potential for a UCITS to expose its entire portfolio to a single OTC derivative counterparty in circumstances where the counterparty provides collateral for more than 90% of the exposure of the UCITS. The Commission also asks if it would be appropriate to include an explicit requirement that UCITS funds must calculate counterparty risk exposure and issuer concentration on a daily basis.
Extraordinary Liquidity Management Rules
The Commission raises queries relating to the current liquidity issues observed by some UCITS. In particular, it notes that redemptions in UCITS may be suspended "in exceptional cases where circumstances so require and where temporary suspension is justified having regard to the interests of the unit-holders". The Commission is seeking proposals on a framework that would clarify what is meant by this in practice and how to deal with liquidity bottlenecks in such "exceptional cases".
In respect of exchange-traded funds ("ETFs"), the Commission has asked for feedback on a proposal that ETF providers be directly involved in providing liquidity to investors in the secondary market. Please also see our recent bulletin in respect of guidelines issued by ESMA on ETFs1 . These guidelines provide secondary-market investors with a limited right to sell units directly back to UCITS ETFs, in circumstances where the stock exchange value of the units significantly varies from the net asset value (for example, in cases of market disruption such as the absence of a market maker).
Depositary Passport
The Commission notes that UCITS depositaries currently do not have a European passport. The Consultation has asked general questions in order to get feedback on: the advantages and drawbacks of adopting a depositary passport; whether the passporting depositary ought to be subject to the full authorisation regime in the host Member State; and whether there are any other issues that must be considered in order to bring in a UCITS depositary passport. See also our bulletin on the further significant changes to the regulatory regime applicable to UCITS depositaries under UCITS V2.
Money Market Funds
The Commission is aware of the potential systemic importance of money market funds ("MMFs") in the short-term funding market, and has asked general questions regarding the use of MMFs to manage liquidity. It would appear from the Consultation that the Commission is considering bringing in a detailed regulatory framework to harmonise the regulation of MMFs at a European level, and has requested industry-level information and statistics in order to assist the creation of this framework.
The Consultation addresses MMFs under the following three headings:
- Valuation and Capital: the Consultation refers to constant NAV MMFs ("CNAV MMFs") and variable NAV MMFs, and has requested feedback as to whether CNAV MMFs ought to be subject to further regulation or even phased out completely.
- Liquidity and Redemptions: the Commission would like to ensure the stability of MMFs in the event of large redemption requests and has asked for proposed solutions in this regard.
- Investment Criteria and Rating: the Commission is also concerned about the extent to which MMFs rely on credit ratings. The Consultation proposes to ban the use of ratings for MMFs in order to force investors and UCITS investment managers to assess for themselves the risk / reward profile of MMFs instead of relying on credit rating agencies.
Long Term Investments
The Commission has queried the benefits of creating long-term retail funds to help small investors access relatively illiquid asset classes, such as direct investments in unlisted companies, infrastructure projects and in real estate or other physical assets. Normally the UCITS rules would preclude investment in these areas due to long 'lock-up' periods that breach liquidity rules. The Consultation asks whether a regulatory framework ought to be adopted specifically for 'long-term' investments in the retail sector, and whether this regulation ought to be a standalone initiative or part of the UCITS rules.
Addressing UCITS IV
The Commission acknowledges that there are areas of the UCITS IV Directive that require improvement. In particular: disclosure to investors where a feeder UCITS is converted to an ordinary UCITS; organisational rules for self-managed investment companies; the operation of rules relating to fund mergers; and cross-border notification procedures. In addition, the Commission is aware that the upcoming alternative investment fund managers directive ("AIFMD") introduces a number of more detailed provisions relating to liquidity, risk, valuation and leverage rules. The Consultation asks whether harmonisation of the UCITS rules with the AIFMD rules is necessary.
Conclusion
The Consultation considers a wide range of topics that will influence the development of the UCITS regime. The degree to which the Commission has approached the industry for its input and participation at this early stage is a welcome aspect of this initiative. We shall of course keep our clients informed of industry responses and material developments on this topic.
The Commission has requested responses to the Consultation from interested parties by 18 October 2012. For further information online, please see the following website address for the full text of the Consultation, as well as a description of the ways to deliver a response to the Commission: http://ec.europa.eu/internal_market/consultations/2012/ucits_en.htm
Footnotes
1. http://www.arthurcox.com/whats-new/publications/esma-guidelines-etfs-and-ucits-issues-sept2012.html
2. http://www.arthurcox.com/whats-new/publications/ucits-v-aug2012.html
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