The Central Bank of Ireland (the “Central Bank”) has issued the long awaited Central Bank UCITS Regulations1 , together with updated UCITS guidance and the seventh edition of the UCITS Q&A.
The main legislative requirements for UCITS are currently set out in the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011 (the “UCITS Regulations 2011”). These are supplemented by the Central Bank’s UCITS Notices, which explain and clarify various aspects of those Regulations and also impose a number of supplemental requirements.
The Central Bank has also published UCITS Guidance Notes. The Central Bank UCITS Regulations consolidate the requirements currently set out in the Central Bank’s UCITS Notices and Guidance Notes and will replace these requirements from 1 November 2015. In addition, the Central Bank has restructured its UCITS Guidance Notes to reflect the publication of the Central Bank UCITS Regulations and has substantially updated the UCITS Q&A.
On 2 January 2014 the Central Bank issued a consultation on the publication of a UCITS Rule Book (“CP77”) in which it announced its intention to replace the existing series of UCITS Notices and Guidance Notes with a single rulebook and make a number of policy changes to the requirements governing UCITS. For further information on the consultation, see our related briefing here.
Following on from that consultation the Central Bank published, on 5 October 2015, the Central Bank UCITS Regulations. While for the most part, the new Regulations reflect the content of the UCITS Notices, the Central Bank is making a number of key changes, including abolishing the requirement for a promoter, withdrawing the Central Bank’s list of permitted markets for UCITS and imposing a supplemental financial reporting requirement.
The UCITS Regulations also reflect the outcome of the Central Bank’s consultation on the adoption of ESMA’s revised guidelines on ETFs and other UCITS Issues (“CP84”), in which the Central Bank expressed its concerns regarding the scope of the derogation from the general collateral diversification requirements for collateral comprising securities issued or guaranteed by states/state authorities.
The Promoter Requirement
The Central Bank UCITS Regulations dispense with the promoter approval process for Irish UCITS. While to date the Central Bank has emphasised the promoter’s importance in ensuring that only sizeable entities with appropriate levels of regulation and relevant experience can establish UCITS in Ireland, in the future it intends to rely instead on the regulatory regime for UCITS management companies with greater emphasis on the obligations of directors in circumstances where a UCITS fund falls into difficulties.
Under the UCITS Regulations 2011, UCITS are permitted to invest in transferable securities and financial derivative instruments which are listed or traded on stock exchanges or other regulated markets. Guidance Note 1/96 sets out the Central Bank’s approach to determining whether a securities market meets the criteria for permitted markets set out in those Regulations and the Central Bank previously provided a list of markets that it deemed automatically in compliance with the requirements of the UCITS Regulations 2011.
As and from 1 November 2015, the Central Bank will no longer publish a list of permitted markets for UCITS. Instead, the UCITS management company or a self-managed UCITS investment company must itself ensure that the UCITS complies with the relevant requirements set out in Regulation 68(1) of the UCITS Regulations 2011 and Schedule 1 to the Central Bank UCITS Regulations.
Financial Reporting Requirements
UCITS management companies and depositaries will be under a new obligation to submit half-yearly management accounts covering the second six months of the financial year. This is in addition to the existing requirements to submit half-yearly management accounts covering the first six months of the financial year, together with audited annual accounts, to the Central Bank. This new reporting requirement will not apply to self-managed UCITS.
According to the Central Bank, this new reporting requirement is an important and necessary supervisory tool, which will allow it to compare and analyse reports from the first six months with the second six months, as well as providing better quality and more timely key risk indicators and alerts on PRISM, the Central Bank’s supervisory framework.
Collateral Diversification Requirements
As set out above, the Central Bank UCITS Regulations also contain the Central Bank’s implementation of ESMA’s Revised Guidelines on ETFs and other UCITS issues (“ETF Guidelines”).
By way of background, ESMA originally published its ETF Guidelines in December 2012, which included certain requirements to assure the quality and diversification of the collateral received by UCITS. In particular, those Guidelines provided that collateral must be of “high quality” and that UCITS must have an exposure of no more than 20% of their collateral basket to any one issuer.
ESMA subsequently issued a revised version of its ETF Guidelines on 24 March 2014, which, among other things, provide that all UCITS can derogate from the general collateral diversification requirement where the relevant collateral consists of securities issued or guaranteed by a Member State, one or more of its local authorities, a third country or a public international body of which one or more Member States belong.
In CP84 the Central Bank raised a number of concerns regarding the revised ETF Guidelines and specifically the extension of the derogation from the collateral diversification requirements to all UCITS, as opposed to UCITS Money Market Funds (“MMFs”) exclusively (as ESMA had initially proposed). In particular, the Central Bank pointed out that while UCITS MMFs are subject to quite specific requirements with regard to credit quality, there are no equivalent requirements for other types of funds, other than the undefined requirement that the collateral be of “high quality”.
The Central Bank UCITS Regulations address the concerns raised by the Central Bank in CP84 by imposing rules regarding the determination of “high quality” collateral, which are set out in paragraph 3 of Schedule III. According to that paragraph, when assessing the quality of collateral, account must be taken of the issuer’s credit rating, where that rating is attributable to an agency registered and supervised by ESMA. In addition, it will be necessary to immediately conduct a new credit assessment of the issuer, where the issuer is down-graded below the two highest short-term credit ratings by the relevant credit rating agency. The Central Bank has also published guidance on the matters that should be taken into consideration in performing such a credit assessment.
The Central Bank UCITS Regulations also contain a number of other clarifications and/or changes to the existing UCITS Notices and Guidance Notes. These include the following:
- the codification of derogations previously granted by the Central Bank in relation to individual requirements: a UCITS will need to re-apply for any derogation previously obtained but not listed in the Central Bank UCITS Regulations;
- new rules will apply to a depository regarding regulatory breaches committed by UCITS for which it acts as depositary. In addition to the requirement to report material breaches to the Central Bank, a depository must report non-material breaches which remain unresolved for four weeks of the depository becoming aware of the breach;
- a new concept of a “responsible person”, which generally means a management company, or, in the case of a selfmanaged UCITS, the UCITS itself. The Central Bank UCITS Regulations impose a number of obligations directly on the “responsible person”, meaning that it may also be held liable for any breach of those obligations;
- where a responsible person proposes to take a short position on behalf of a UCITS, it must ensure that the UCITS prospectus discloses, in relation to each of the categories of assets in which it may invest, whether the UCITS will take long or short positions or both. It must also disclose the percentage of its assets which it anticipates will be invested in long positions and in short positions. According to the Central Bank, UCITS should include this statement when next updating the prospectus;
- where a UCITS applies a redemption gate, all redemption requests must be dealt with on a pro-rata basis both on the dealing day on which the gate is applied and, if relevant, on following days. In other words, unsatisfied redemption requests will not receive priority as the Central Bank considers that this could materially prejudice small investors; and
- a broadening of the categories of eligible over the counter (OTC) counterparties to include a group company of an entity issued with a bank holding company licence from the Federal Reserve of the United States of America where that group company is subject to bank holding company consolidated supervision by that Federal Reserve.
As mentioned, the Central Bank UCITS Regulations will apply from 1 November 2015. There are transitional provisions in respect of certain requirements dealing with redemption gates so that those requirements will not apply until 2 November 2016.
The Central Bank UCITS Regulations simplify the rules governing Irish UCITS and provide a more accessible and streamlined regulatory framework than that which currently exists. In particular, these Regulations do not repeat legislative requirements set out in the UCITS Regulations 2011. They also promote consistency between the requirements applicable to UCITS and those applicable to Alternative Investment Funds (“AIF”).
This is the first time that the Central Bank has issued its investment fund rules in the form of Central Bank regulations and by doing so it has removed any possible uncertainty regarding the extent to which those rules are legally binding. The Central Bank has indicated that it will shortly commence a review of its AIF Rulebook to see whether it should also be issued as Central Bank regulations.
While the new regulatory framework differs in several respects from the existing framework, several of these changes are to be welcomed. This is particularly the case for the abolition of the promoter regime, which mirrors the earlier abolition of the promoter requirements for AIFs, and removes a significant administrative hurdle to establishing an Irish UCITS.
In addition, the fact that the Central Bank will no longer publish a list of permitted markets means more flexibility for UCITS in their choice of markets. Moreover, they will no longer be required to update their prospectus to trade in a new market not included in the prospectus.
The Central Bank’s decision to follow ESMA’s lead and to permit all UCITS to benefit from the derogation from the collateral diversification requirements is also very welcome. However, the imposition of additional monitoring practices where the quality of collateral is diminishing goes beyond what is required by ESMA’s ETF Guidelines. Moreover, the extent to which the newly issued web guidance has binding effect is somewhat unclear.
While the Central Bank UCITS Regulations undoubtedly signal the end of an era, there is nevertheless a substantial degree of consistency between the requirements set out in the UCITS Notices and Guidance Notes on the one hand and those set out in those Regulations on the other. For the most part therefore, it will be business as usual for UCITS, their management companies and depositories. Nevertheless, UCITS and their service providers should review their existing business practices to ensure compliance with the Central Bank UCITS Regulations and its web-guidance. In particular:
- UCITS will need to verify that any derogation obtained from the Central Bank is included in the derogations set out in the Central Bank UCITS Regulations and re-apply for any derogation not included in those Regulations; and
- UCITS management companies will need to take into account the operational and resourcing requirements associated with preparing a second set of halfyearly accounts, which will become due at the same time as the audited annual accounts.
Finally, further changes to the UCITS legislative framework can be expected shortly, as the deadline of 18 March 2016 approaches for the transposition of Directive 2014/91 (UCITS V) into national law.
The Central Bank UCITS Regulations may be accessed here.