Background

In 2002, changes to the original UCITS regime were introduced which were commonly known as “UCITS III” (an earlier proposal for a UCITS II regime was shelved and the rules went from UCITS I to UCITS III).  These changes took the form of the UCITS III Product Directive and the UCITS III Management Company Directive.  Under the UCITS III Product Directive, the range of investments in which a UCITS could invest was extended to include cash instruments, money market instruments, other open-ended funds and index tracking investments.  Investment in financial derivative instruments was also extended to include investment in such instruments for direct investment purposes (as opposed to for efficient portfolio management (“EPM”) or hedging purposes only).

Building on the enhancements introduced by the UCITS III Product Directive, in 2007 further clarification in relation to the types of assets which were eligible for investment by UCITS, and the criteria which such assets must meet in order for them to be eligible, was introduced with the Eligible Assets Directive.  The Eligible Assets Directive added greater certainty to the types of investment which a UCITS can make.  The changes introduced by the UCITS III Product Directive, together with the clarifications introduced by the Eligible Assets Directive, broadened the number of product types which could be established as a UCITS and was a key catalyst to the growth in, and variety of, UCITS funds since then.

Request by the European Commission

Given the passage of time since the Eligible Assets Directive was first introduced, the Commission is now taking the opportunity to assess market practices to ensure that the UCITS eligibility rules are implemented in a uniform manner in all Member States.  The Commission also wants to consider the impact of market and regulatory developments over the past 16 years.

In that context, the Commission has mandated ESMA to:

• carry out an assessment of the implementation of the Eligible Assets Directive in Member States;
• analyse whether any divergences in implementation have arisen;
• make recommendations as to how the Eligible Assets Directive should be revised to keep it in line with market developments;
• analyse the merits of linking certain definitions and concepts to other pieces of EU legislation (e.g. MIFID II, EMIR, the Benchmark Regulation or MMFR); and
• analyse the consistent application of certain provisions including in relation to “delta-one” instruments, indices, EPM techniques, the definition of money market instruments as well as the liquidity of certain transferable securities.

The Commission has also requested ESMA to:

• propose clarifications on key definitions and the criteria against which the eligibility of an asset is assessed;
• analyse whether and to what extent cross-references to other EU legal frameworks could improve legal clarity and, where appropriate, consistency between these frameworks;
• assess the risks and benefits of UCITS gaining exposures to asset classes that are not directly investable for UCITS (e.g. through delta-one instruments);
• advise, in relation to EPM, on possible legislative clarifications to address shortcomings identified by ESMA in its 2018 ESMA Peer Review on the Guidelines on ETFs and other UCITS issues and its related follow-up work, and the ESMA Common Supervisory Action on costs and fees in 2021;
• gather data from National Competent Authorities, and, where needed, from market participants to gather insights on the manner and the extent to which UCITS have gained direct and indirect exposures to certain asset categories that may give rise to divergent interpretations and/or risk for retail investors (e.g. structured/leveraged loans, catastrophe bonds, emission allowances, commodities, crypto assets, unlisted equities); and
• make a preliminary assessment of the impacts of any proposed regulatory adjustments, taking into account the characteristics of the underlying market (e.g. availability of valuation, liquidity, assets safekeeping, etc).

The Commission has requested ESMA to deliver its technical advice by 31 October 2024, after which a public consultation will take place.  

Comment

Promoters and managers of existing and new UCITS funds will have a keen interest in this review and the technical advice which will issue in due course.  The hope is that the success and appeal of the UCITS product will not be impaired by any proposals arising from this review, and that any changes to the current regime will enhance the attractiveness of the UCITS product which has served investors well over the past 38 years.