On 6 April 2016, ESMA issued a discussion paper on UCITS share classes (ESMA/2016/570, the "Discussion Paper"). This contains a range of proposals that are now subject to consultation – with a closing date for feedback of 6 June 2016. It follows an earlier discussion paper issued in December 2014 on the subject (ESMA/2014/1577).
The earlier discussion paper proposed prescribing types of permissible share classes and types of prohibited share classes. However, the Discussion Paper now proposes a principles-based approach.
The principles advocated are as follows:
- Common investment objective - Share classes of the same fund should have a common investment objective reflected by a common pool of assets.
- Non-contagion - UCITS management companies should implement appropriate procedures to minimise 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.
- Pre-determination - All features of the share class should be pre-determined before it is set up.
- Transparency - Differences between share classes of the same fund should be disclosed to investors when they have a choice between two or more classes.
- Anti-circumvention - Share classes should never be set up to circumvent the rules of the UCITS Directive on diversification, derivative eligibility and liquidity.
Share Class Hedging
Of key concern for many UCITS managers will be the implications for hedging strategies at share class level – both currency hedging and other mechanisms, including duration risk hedging or volatility risk hedging.
The current proposals would not eliminate any specific techniques, provided they meet the principles (outlined above). Notably, the Discussion Paper states that ESMA "regards currency risk hedging at the level of a share class as compatible with the principle of a common investment objective". Thus currency hedging is implicitly singled-out as a share class level technique that, properly constructed, ESMA foresees as being consistent with its principles. This is most welcome in an Irish context, particularly as the operational principles proposed accord broadly with existing Central Bank of Ireland requirements in this respect.
Within the non-contagion heading, ESMA also sets out a range of operational principles to be applied to any share class with a derivative overlay. These detailed measures (including a prescribed 95-105% exposure range) are such that ESMA casts doubt on whether other share class hedging strategies (such as duration risk hedging or volatility risk hedging) could be compatible with them.
Within the pre-determination heading, ESMA also calls out cases where the hedging is discretionary as potentially conflicting with the principles - whereby it is unclear to investors whether a specific risk is being hedged at any given point in time.
Transitional arrangements and final guidance
ESMA notes that further consideration will need to be given to share classes that fall outside the scope of the principles (once finalised). It states that transitional provisions would be introduced and considers the possibility of an amnesty for existing share classes to remain in place and accept new investment.
ESMA has not confirmed what form its final advice will take, but says it is probable that it would be an opinion addressed to EU institutions or national competent authorities outlining the finalised principles.