The European Securities and Markets Authority (“ESMA”) has published a second discussion paper on the topic of UCITS share classes (the “Discussion Paper”), proposing a number of high-level and operational principles to form the basis of a regulatory framework for all UCITS share classes.
ESMA has used the feedback received from its December 2014 discussion paper, together with input provided through engagement by ESMA with relevant stakeholders, to further develop its proposed framework. While the December 2014 consultation proposed non-exhaustive lists of permissible and prohibited differentiation at share class level, the Discussion Paper proposes a principles-based approach and requests feedback on whether and how share classes could actually work under the principles outlined in the Discussion Paper.
ESMA’s current thinking, as expressed in the Discussion Paper, is that UCITS should follow the following high-level principles when setting up share classes:
- share classes of the same fund should have a common investment objective reflected by a common pool of assets (the common investment objective principle);
- UCITS management companies should implement appropriate procedures to mitigate and monitor the risk that features that are specific to one share class could have a potentially adverse impact on other share classes of the same fund (the non-contagion principle);
- all features of a share class should be pre-determined before it is set up in order to allow the potential investor to gain a full overview of the rights and features attributed to his investment (the pre-determination principle); and
- differences between share classes of the same fund should be disclosed to investors when they have a choice between two or more classes (the transparency principle).
In the Discussion Paper, ESMA focuses on the use of derivatives at share class level to allow for customisation for a sub-set of investors. In the case of the non-contagion principle and the transparency principle, the Discussion Paper proposes further operational principles that UCITS management companies ought to observe. ESMA notes that currency risk hedging at share class level may be compatible with the principles enumerated in the Discussion Paper, but expresses doubt that duration risk hedging (often referred to as interest rate risk hedging) or volatility risk hedging would be compatible.
The Discussion Paper does not propose specific transitional provisions which would apply to existing share classes that are not in compliance with the principles proposed but it appears that both grandfathering and closure of classes remain possible options. ESMA invites stakeholders’ views as to what transitional provisions may be deemed necessary.
Next Steps and Comment
The consultation closes on 6 June 2016. ESMA expects to take further steps, possibly in the form of an ESMA opinion addressed to the EU institutions or national competent authorities, by the end of 2016.
The principles-based approach set out in the Discussion Paper appears to be more considered than an arbitrary prohibition of specified types of share class, as proposed in the December 2014 consultation. However, if the principles-based approach is to be adopted, it is hoped that the principles will be applied in a fair and consistent manner. In this regard, ESMA’s comments regarding duration and volatility share classes may cause concern as potentially indicating that a decision has already been made regarding these share classes in advance of receipt of feedback on the consultation.
ESMA’s suggestion in the context of applying the transparency principle that new and existing investors should be informed about the creation and existence of share classes with a derivative overlay in a timely fashion, including updates in periodic reports, may impose a significant burden on asset managers that operate a large number of share classes and could result in investors being provided with a large volume of information of little relevance to them. It is also hoped that the transitional provisions will be proportionate, so that, given that we expect there to be a relatively small number of non-compliant share classes, the option to grandfather and retain existing classes should remain available.
The partners at Matheson intend to submit a response to the Discussion Paper to ESMA and we will be contributing at an Irish and European level to industry feedback and responses. We would be delighted to speak with you should you have any queries in relation to the proposals, or to discuss your viewpoint regarding any aspect of the Discussion Paper.
We have prepared a briefing note providing further detail on the proposals outlined in the ESMA Discussion Paper.
ESMA’s Discussion Paper may be accessed here.
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