A Guide To UCITS In Ireland - (Updated January 2012)

Overview of UCITS in Ireland

Over the last 20 years, Ireland has earned a reputation as a leading jurisdiction for regulated investment funds including UCITS. Currently over US$1.4 trillion in fund assets are domiciled in Ireland while the Irish fund industry services close to US$2.75 trillion in assets.

Ireland's growth as a domicile and servicing centre for investment funds is attributed to the successful establishment in 1987 of the International Financial Services Centre ("IFSC") in Dublin and the subsequent implementation of the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations in 1989 (S.I. No. 78 of 1989) (the "1989 UCITS Regulations"). Ireland is now recognised as a centre of excellence for investment funds generally and in particular in relation to the domiciliation, management and administration of UCITS. Approximately 62% of the almost 5,000 funds (including subfunds) domiciled in Ireland are UCITS and these funds hold over US$1.42 trillion in assets, or 75% of the total of all fund assets held in Irish domiciled funds.

Irish funds are now distributed in over 70 countries. The attraction of Ireland as a domicile for investment funds is based on a unique combination of the Irish legal and regulatory system, the specialist skills and expertise of its workforce, the country's pro-business approach, infrastructure, competitive tax environment and government support. These advantages also pertain to UCITS and the firms providing services to them.

In addition, the willingness of the Irish regulatory authority, the Central Bank of Ireland (the "Central Bank"), to implement timely authorisation processes and to adapt and develop its regulation to keep pace with developments in the investment funds industry both in its interpretation of the UCITS framework and more generally has contributed hugely to Ireland's success. As a result, the investment funds industry in Ireland has developed rapidly, with more than 12,000 people now directly employed in investment funds related activities.

Over 40% of global alternative investment funds are serviced in Ireland, which has fostered an expertise in administering hedge funds but also familiarity with the sophisticated risk strategies which UCITS are now permitted to use.

Almost all of the world's major fund service providers, including custodian banks, have a presence in Ireland, ensuring a competitive market and the broadest range of service offerings. Another recent trend has seen the regionalisation of the financial services industry, with major participants establishing additional fund servicing operations outside Dublin. These companies have thus harnessed a larger workforce and lower operating costs - facilitating competition between Ireland and other newer jurisdictions now offering UCITS products.

Ireland is currently ranked in the top ten places in the world in which to do business by the World Bank and Ireland is consistently highly rated in the world's "best places to do business".

To summarise, Ireland presents the international investment funds industry with an unparalleled set of attractions both as a domicile for UCITS and for the enterprises providing services to them. This publication summarises the legal and regulatory structures under which UCITS may be established in Ireland. We also outline the procedure for authorisation, the primary legal and regulatory considerations applicable when establishing UCITS in Ireland and all relevant supplementary matters to be considered.

1. UCITS - General Overview

1.1 Introduction

In Ireland, each regulated collective investment scheme (a "fund") is authorised as either a UCITS or a non-UCITS. The essential difference between the two regulatory frameworks is that UCITS funds are authorised pursuant to European legislation as implemented in Ireland and, once authorised in Ireland, can be marketed cross-border throughout the EU (and increasingly in regions such as the Far East, the Middle East and Latin America) without the need for further authorisation in the target countries. non-UCITS funds are, on the other hand, authorised under indigenous Irish legislation and as such cannot currently avail of the right to "passport" to other countries, but do not need to conform to the restrictions applicable to UCITS (it can be noted that Irish non-UCITS will potentially be able to take advantage of the new passport for alternative funds under the Alternative Investment Managers Directive from 2013).

This guide deals with UCITS only. Further details relating to non- UCITS Irish funds, including Qualifying Investor Funds ("QIFs"), are set out in our separate guide "Investment Funds in Ireland".

1.2 Legal Framework for UCITS

UCITS are currently established in Ireland pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations (S.I. 352/2011), (the "UCITS Regulations"). This legislation implemented "UCITS IV" in Ireland.

The Central Bank is the statutory regulator of all investment funds in Ireland including UCITS. Its duties include the approval of international promoters and investment managers and the authorisation and ongoing supervision of Irish investment funds, including UCITS, and the Irish investment business firms servicing these.

The Central Bank issues UCITS Notices and Guidance Notes (collectively the "UCITS Notices") which deal with various aspects of fund regulation and clarify its approach to, and interpretation of, aspects of the UCITS Regulations. Accordingly, UCITS and their service providers are also authorised and regulated by the Central Bank in accordance with the requirements set out in the UCITS Notices as well as the UCITS Regulations.

Copies of the UCITS Notices are available on the Central Bank's website: www.centralbank.ie

1.3 General Overview

A UCITS, or "Undertaking for Collective Investment in Transferable Securities", may be established in Ireland in any of the following legal forms:

• an open-ended investment company with variable capital;
• an open-ended unit trust; or
• an open-ended common contractual fund ("CCF").

UCITS are regarded as the most highly-regulated funds because of the necessity to comply with a common European standard. UCITS operate on the basis of their potential for availability to the retail investor (although most are, in fact, targeted at institutional investors) and their investment and borrowing restrictions are generally not negotiable. These restrictions are aimed at ensuring an acceptable level of liquidity and risk diversification while limiting leverage.

In general terms, the basic investment requirement for UCITS is that at least 90% of its net asset value ("NAV") must be invested in (i) transferable securities and money market instruments which are either listed on a stock exchange or which are dealt on a market which is regulated, operating regularly, recognised and open to the public; (ii) recently issued transferable securities which will be admitted to official listing on a stock exchange or other market (as described above) within a year; (iii) money market instruments, other than those dealt in on a regulated market; (iv) units of UCITS; (v) units of non-UCITS Collective Investment Schemes ("CIS"); (vi) deposits with credit institutions; and (vii) financial derivative instruments. UCITS can have no more than a 10% exposure to any one issuer (subject to certain exceptions), with the total number of securities held in issuers in which a UCITS invests more than 5% not, in aggregate, exceeding 40% of NAV (this is referred to as the 5/10/40 rule).

Borrowings are restricted to 10% of NAV and may only be made on a temporary basis. A UCITS must be open-ended in nature. See 2.1 Overview of Investment Parameters for further details regarding permitted investments and the principal investment restrictions.

The principal advantage of a UCITS fund is that, once authorised in one EU Member State, it can, through a "passport" regime, be sold in other EU Member States (subject to a registration process in the other relevant Member States) without requiring further authorisation in that target Member State.

UCITS are also having an impact outside Europe. The UCITS brand is now globally recognised and due to its reputation as a regulated product with a strong emphasis on investor protection, with robust risk management procedures, regulators in the Far East, the Middle East and in Latin America, for example, are comfortable to allow UCITS to be sold in their jurisdictions. This is critical for managers seeking global distribution opportunities. See 10. Distribution of UCITS for further details.

It is possible for a fund established as a non-UCITS to later convert to a UCITS. See 5.3 Conversion to UCITS for further details. This may be particularly useful for offshore or hedge fund managers who wish to initially enter the regulated onshore funds world by establishing a (non-UCITS) Qualifying Investor Fund, which is not subject to the same strict investment restrictions as a UCITS and then convert this at a later date when they are more comfortable with the regulated environment.

1.4 Development of UCITS

UCITS were first introduced in 1985 by Directive 85/611/EC of the EEC, which was subsequently implemented in Ireland by means of the 1989 UCITS Regulations. This regime achieved enormous success both in Ireland and elsewhere in Europe. However, with the passage of time and the introduction and popularisation of new techniques in financial engineering to the markets, aspects of this first framework ("UCITS I") began to appear dated and in need of adaptation. Initial attempts to reform this regime in the early 1990s, known as UCITS II, faltered as the proposed changes were considered too ambitious at that time and it was not until the introduction in 2001 of Directive 2001/108/EC (generally known as the "Product Directive") and Directive 2001/107/EC (generally known as the "Management Directive") that substantive change was eventually introduced. The Product Directive and the Management Directive are generally collectively referred to as "UCITS III" and were implemented in Ireland by way of the European Community (Undertakings for Collective Investment in Transferable Securities) Regulations (S.I. 212/2003) as amended.

The Product Directive significantly widened the range of investment possibilities for UCITS. Firstly, it introduced a definition of transferable securities for the first time, stating that the following qualify:

• shares in companies and other securities equivalent to shares in companies;
• bonds and other forms of debt instruments;
• any other negotiable securities which carry the right to acquire any such transferable securities by subscription or exchange (financial derivative instruments are excluded from this definition).

Secondly, it enabled a UCITS to invest in a range of other asset classes such as:

• money market instruments;
• units of other collective investment schemes;
• deposits with credit institutions;
• financial derivative instruments; and
• indices.

Subsequent amendments have been effected to the legislation initially passed in 2003, including: (i) in order to implement the "Eligible Assets Directive" (Directive 2007/16/EC as implemented in Ireland by S.I. 832 of 2007), which clarified the interpretation of the range of investments which UCITS are permitted to make; (ii) to permit the creation of UCITS common contractual funds; and (iii) to provide for segregated liability between cells in umbrella companies (the Investment Funds, Companies and Miscellaneous Provisions Act, 2005).

Due to uncertainty in the interpretation of the range of permitted investments between Member States, the Eligible Assets Directive was adopted in 2007 to set down criteria for assessing whether different types of financial instruments are eligible to be held as investments by UCITS. This measure, which was implemented in Ireland by S.I. No. 832 of 2007, helped to remove uncertainty as to whether UCITS can legitimately invest in financial instruments such as asset backed securities, listed closed-ended funds, Euro commercial paper, index based derivatives and credit derivatives.

Among the key clarifications set out in the Eligible Assets Directive is the fact that closed-ended funds and credit derivatives are both regarded as transferable securities, subject to certain requirements. Financial indices, whether comprised of eligible or ineligible underlying assets, can be considered as eligible financial indices once they are sufficiently diversified, represent an adequate benchmark for the market to which they refer and are published in an appropriate manner. See 2.1 Overview of Investment Parameters for further details.

1.5 New Developments - UCITS IV

Having successfully addressed concerns with the UCITS product itself under UCITS III, the next challenge addressed was to improve the environment in which the product operates. Directive 2009/65/EC (generally known as "UCITS IV") was adopted by the Council of the European Union in mid 2009 and is now in the process of being implemented in each Member State. Full implementation was required by 30 June 2011 and it came into force on 1 July 2011. It was implemented in Ireland on time by means of the "UCTIS Regulations".

The changes set out in UCITS IV are designed to ensure that investors receive appropriate information regarding each UCITS in a more accessible format than was previously the case and to facilitate the industry in achieving cost savings and creating more efficient structures.

Accordingly, UCITS IV provides for the following key areas of change:

A. Key Investor Information Document ("KIID")

UCITS IV aims to ensure that UCITS disclose relevant and meaningful information to investors by requiring the publication of key investor information in a short, concise document, the KIID. The KIID is required to be short, focused, expressed in plain language, and presented in a way that enables comparisons to be easily made between different offerings. It must provide information regarding essential matters including the past performance of the UCITS, its costs and charges and its risk/ reward profile. The KIID may be used without alteration (other than translation) in each Member State where the UCITS is sold. It is anticipated that the KIID will address the shortcomings identified in the (previously required) Simplified Prospectus.

UCITS authorised from July 2011 must produce a KIID but existing UCITS may continue to produce a simpilified prospectus until 30 June 2012.

What strategies can be pursued?

B. Notification Procedure

The cross-border passporting procedure for UCITS has been streamlined to transform it into a straightforward regulator-toregulator filing.

The previous notification process was relatively time-consuming (2 month time period) and could be costly due to local requirements such as requirements for translations, local agents and compliance with marketing requirements. UCITS IV provided for the creation of a streamlined notification process for crossborder fund sales whereby the UCITS notifies its home regulator of its intention to sell in other Member States. The home state regulator reviews the notification documents and transmits these to the host state regulator with a confirmation that the UCITS fulfils its obligations under the amended Directive.

Under UCITS IV the marketing of a fund in host Member States is typically authorised within 10 working days. Where the Member State into which the UCITS wishes to sell has not yet implemented UCITS IV, it may be necessary to comply with pre-existing forms of registration.

C. Fund Mergers

UCITS IV has provided for pan-European mergers of UCITS, regardless of the legal structure used in constituting either of the merging entities. It outlines procedures and requirements for such fund mergers and competent authorities may only refuse merger applications if these have not been observed. This is intended to facilitate the consolidation of European fund products, enabling UCITS to benefit from greater economies of scale.

A decision on whether to approve the merger must be reached by the authorities of the merging UCITS within 20 working days.

D. Asset Pooling

UCITS IV introduced the ability to establish master-feeder structures, again facilitating increased economies of scale and lower operating costs.

Specific provisions include:

• the feeder fund is required to have at least 85% of its assets in a single master fund;
• the master UCITS may not be a feeder UCITS or invest into feeder UCITS; and
• the investment policy of the feeder UCITS must be approved by the competent authorities of the home Member State of the feeder UCITS.

E. Management Company Passport

UCITS IV has provided for a new form of EU passport whereby managers may manage UCITS domiciled in other EU Member States (the "Management Company Passport").

The Management Company Passport enables:

• fund management companies to manage funds (both corporate and contractual) domiciled in Member States other than the Member State in which the management company is established;
• fund managers to sell funds across the EU without having to establish a full suite of administrative functions for every jurisdiction; and
• economies of scale where existing fund management companies are consolidated.

1.6 Summary of the Evolution of UCITS

Following the initial success of the UCITS product, developments in financial engineering and the increasing popularity of new and alternative investment strategies began to render the applicable investment parameters as slightly dated over time. Having successfully addressed these concerns with the product itself under UCITS III, UCITS IV has improved the environment in which that product operates. Facilitating fund mergers, improving the framework for cross-border distribution and introducing the Management Company Passport are all intended to reduce cost, improve economies of scale and facilitate easier distribution.

UCITS IV was a further important step towards a single market in financial services. It is likely to transform the European asset management industry over the coming years, enabling managers to operate freely throughout the EU and facilitating a truly cross border fund distribution framework. It will also facilitate the creation of a more efficient and flexible European fund sector, with lower overall costs. This will, in turn enable the European fund sector to compete more effectively with the US where there are a much smaller number of equivalent funds with much greater asset values. Reducing the overall number of UCITS, through newly permitted fund mergers and master feeder structures, will increase the efficiency of the sector, which will ultimately be to the investors' advantage.

As such, these amendments are enhancing the strength of the UCITS product and confirming its position as the global brand of choice for regulated collective investment schemes.

2. Permitted Investments & Applicable Restrictions

2.1. Overview of Investment Parameters

In order to seek to ensure investor protection, UCITS are subject to specific investment restrictions – relating both to the types of investments which may be made and the extent of such investments.

Investments of a UCITS are generally confined to: (i) transferable securities and money market instruments which are either listed on a stock exchange or which are dealt on a market which is regulated, operating regularly, recognised and open to the public;

(ii) recently issued transferable securities which will be admitted to official listing on a stock exchange or other market (as described above) within a year;

(iii) money market instruments, other than those dealt in on a regulated market;

(iv) units of UCITS;

(v) units of non-UCITS Collective Investment Schemes ("CIS");

(vi) deposits with credit institutions; and

(vii) financial derivative instruments.

The applicable risk spreading rules mean that there are also limitations on the level and extent of investments that may be held in these permitted investments. See Appendix 1 for full details.

2.2. Transferable Securities

In accordance with the definition contained in the Product Directive, the following qualify as transferable securities:

• shares in companies and other securities equivalent to shares in companies;
• bonds and other forms of debt instruments; and
• other negotiable securities which carry the right to acquire any such transferable securities by subscription or exchange.

This is subject to each such instruments meeting the following criteria (the "Criteria"), as set out in the Eligible Assets Directive:

(a) the potential loss which the UCITS may incur with respect to holding such instruments is limited to the amount paid for them;

(b) their liquidity does not compromise the ability of the UCITS to comply with its obligations to redeem units at the request of a unitholder;

(c) reliable valuation is available for them as follows:

(d) appropriate information is available for them as follows:

(e) they are negotiable;

(f) their acquisition is consistent with the investment objectives or the investment policy, or both, of the UCITS; and

(g) their risks and their contribution to the overall risk profile of the portfolio are adequately captured by the risk management process of the UCITS which must be assessed on an ongoing basis.

For the purposes of (b) and (e) above, unless there is contrary information available to the UCITS, financial instruments which are admitted to, or dealt in, on a regulated market will be presumed not to compromise the ability of the UCITS to effect redemptions and will also be presumed to be negotiable.

However, in relation to (b) above, where information is available to the UCITS that leads it to determine that a specific security could compromise its ability to meet redemptions, the UCITS must assess its liquidity risk. The following are examples of the matters a UCITS may need to consider when determining this:

• the volume and turnover in the security;
• if price is determined by supply and demand in the market, the issue size, the portion of the issue that the asset manager plans to buy and an evaluation of the opportunity and timeframe to buy or sell;
• where necessary, an independent analysis of bid and offer prices over a period of time as well as of the comparability of available prices, to indicate the relative liquidity and marketability of the instrument; and
• in assessing the quality of secondary market activity in a transferable security, analysis of the quality and number of intermediaries and market makers dealing in the transferable security concerned should be considered.

In the case of transferable securities which are not admitted to trading on a regulated market, neither liquidity nor negotiability can automatically be presumed and the UCITS will therefore need to assess the liquidity and negotiability of such securities.

If the security is assessed as insufficiently liquid to meet foreseeable redemption requests, the security may only be bought or held if there are sufficiently liquid securities in the portfolio so as to be able to meet the obligation to meet investor redemption requests.

2.2.1 Closed Ended Funds

Transferable securities also include units in closed-ended funds, constituted as investment companies, unit trusts or under the law of contract (e.g.: CCFs or Luxembourg domiciled Fonds Common De Placement), which fulfill the Criteria and meet the following conditions:

(i) they are subject to corporate governance mechanisms applied to companies (or equivalent mechanisms);

(ii) where asset management activity is carried out by another entity on behalf of the closed ended fund, that entity is subject to national regulation for the purpose of investor protection.

In assessing whether the corporate governance mechanisms for closed ended funds in contractual form are equivalent to investment companies, factors including unit holder rights, the scheme's liquidation rules and provisions regarding segregation of fund assets from those of the investment manager will be taken into consideration.

Investments in closed ended funds for the purposes of circumventing the investment limits set out in the UCITS Regulations are prohibited.

2.2.2 Structured Financial Instruments

In accordance with the provisions of the Eligible Assets Directive, transferable securities include financial instruments which:

(a) fulfill the Criteria; and

(b) are backed by, or linked to the performance of, other assets; provided that where a financial instrument contains an embedded derivative component, the general requirements regarding use of derivatives apply to that component. See 2.6 Financial Derivative Instruments for further details regarding this requirement.

2.3 Money Market Instruments

Money market instruments are now specifically included in the list of permitted investments for UCITS. This term is defined as (i) instruments normally dealt in on the money market; (ii) which are liquid; and (iii) have a value which can be accurately determined at any time. Both listed and unlisted instruments can qualify, subject to the conditions set out below.

2.3.1 General Criteria

Money market instruments are those which fulfill one of the following criteria:

(a) they have a maturity at issuance of up to and including 397 days;

(b) they have a residual maturity of up to and including 397 days;

(c) they undergo regular yield adjustments in line with money market conditions at least every 397 days; or

(d) their risk profile, including credit and interest rate risks, corresponds to that of financial instruments which have a maturity as referred to in subparagraphs (a) or (b), or are subject to a yield adjustment as referred to in subparagraph (c).

2.3.2 Liquid

The reference to such instruments as being "liquid" means that they can be sold at limited cost in an adequately short timeframe, taking into account the obligation of the UCITS to repurchase or redeem its units at the request of any unit holder. In determining this, it is necessary to take into account factors at both the level of the instrument and the fund.

Relevant factors at the instrument level include:

(i) frequency of trades and quotes for the instrument in question;

(ii) number of dealers willing to purchase and sell the instrument, willingness of the dealers to make a market in the instrument in question, nature of marketplace trades (times needed to sell the instrument, method for soliciting offers and mechanics of transfer);

(iii) size of issuance/program; and

(iv) possibility to repurchase, redeem or sell the money market instrument in a short period (e.g. seven business days), at limited cost, in terms of low fees and bid/offer prices and with very short settlement delay.

Relevant factors at the fund level include:

(i) unit holder structure and concentration of unit holders of the UCITS;

(ii) purpose of funding of unit holders;

(iii) quality of information on the fund's cash flow patterns; and

(iv) prospectuses' guidelines on limiting withdrawals.

The fact that some of these conditions are not fulfilled does not automatically imply that the financial instruments should be considered as non-liquid. These elements must ensure that UCITS will have sufficient planning in the structuring of the portfolio and in forecasting cash flows in order to match anticipated cash flows with the selling of appropriately liquid instruments in the portfolio to meet those demands.

2.3.3 Accurate Valuation Possible

In order for money market instruments to be deemed to have a value which can be accurately determined at any time it is necessary to have accurate and reliable valuations systems available which:

(a) enable the calculation of a NAV reflecting the value at which the instrument could be exchanged between knowledgeable willing parties in an arm's length transaction; and

(b) are based either on market data or on valuation models. If the amortization method is used for valuations this must not result in a material discrepancy with the realizable value of the instrument.

The liquidity and valuation requirements can be presumed to be fulfilled in the case of financial instruments which are admitted to, or dealt in on, a regulated market unless there is information available that would lead to a different determination.

2.3.4 Off-market Instruments

Money market instruments, other than those dealt in on a regulated market, can constitute valid investments provided they meet the general requirements outlined above (and those regarding liquidity and valuations), are issued or guaranteed by an appropriate body (as discussed below), and:

i) appropriate information is available for them; and

ii) they are freely transferable.

In this context such "appropriate information" depends on the nature and legal status of the issuer of the instrument but includes:

(a) information on both the issue or the issuance programme and the legal and financial situation of the issuer prior to the issue of the money market instrument;

(b) updates of the information referred to above on an annual basis and whenever a significant event occurs;

(c) verification of the above information by appropriately qualified third parties not subject to instructions from the issuer; and

(d) available and reliable statistics on the issue or the issuance program or other data enabling an appropriate assessment of the credit risks related to the investment in such instruments.

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