The final version of the UCITS IV Directive (2009/65/EC) was published on 17 November 2009. The UCITS IV Directive seeks to consolidate and modernise the regulatory framework applicable to UCITS and to make UCITS more market efficient. The Directive will be implemented in Ireland by 1 July 2011. It has now been followed by many implementing measures (set out below) which give detail of the new requirements. The Central Bank consultation on how the UCITS IV regulatory framework will be implemented in Ireland is expected to issue soon. The compliance implications for individual UCITS funds and for UCITS managers will only become clear when the Central Bank consultation has closed and final UCITS notices and guidance notes issue. In the meantime, a significant level of clarity has been achieved by the level 2 and level 3 measures which have issued to date.
UCITS IV involves four implementing measures known as the “level 2 measures”, i.e. two regulations and two directives, which were all adopted on 1 July 2010 and published on 10 July 2010:
- Commission Directive 2010/42/EU – concerning fund mergers, master feeder structures and notification procedures (Structure Directive);
- Commission Directive 2010/43/EU – concerning conflicts of interest, conduct of business and risk management (Organisation Directive);
- Commission Regulation (EU) No. 583/2010 – concerning key investor information (KII Regulation); and
- Commission Regulation (EU) No. 584/2010 – concerning distribution, notification procedures and use of electronic filing (Notification Regulation).
Both Regulations will be automatically applicable in Ireland as of 1 July 2011 without the need for Irish implementing legislation, unlike the Directives which must first be integrated into national law (by way of Irish regulations) by 1 July 2011.
In addition, implementation of UCITS IV involves a variety of “level 3 measures” which currently comprise the following guides and guidelines issued by CESR (which has now evolved into ESMA):
- CESR guidelines on the methodology for calculation of the ongoing charges figure in the Key Investor Information Document
- CESR guidelines on the methodology for the calculation of the synthetic risk and reward indicator in the Key Investor Information Document
- CESR’s guidelines on UCITS risk management and calculation of global exposure and counterparty risk for UCITS.
- Guidelines - Selection and presentation of performance scenarios in the Key Investor Information document (KII) for structured UCITS.
- Guidelines - Transition from the Simplified Prospectus to the Key Investor Information document.
- CESR’s guide to clear language and layout for the Key Investor Information document.
- Guidelines - CESR’s template for the Key Investor Information document.
CESR consulted on guidelines for risk measurement and global exposure measurement for certain types of structured UCITS. When guidelines covering this are adopted, they will be incorporated into the July 2010 guidelines listed above on UCITS risk management and calculation of global exposure and counterparty risk for UCITS.
Of relevance to the new regulatory framework (although not specifically to UCITS IV implementation) are CESR’s Guidelines on a common definition of European money market funds which issued in May 2010 and which are to be implemented by 1 July 2011.
Key changes under the UCITS IV Directive
Organisation & Regulation of Management Companies
- New requirements will apply to management companies and self managed investment companies.
- UCITS IV will mean more detailed and documented operating, administrative and accounting policies and procedures. As detailed above, areas to be addressed include internal control mechanisms, lines of responsibility, internal audit function, conflicts of interest policies, rules of conduct to ensure ongoing fair treatment of investors, best execution, complaints procedures, data protection procedures, and a specific compliance function. Much of this may already be contemplated by existing business plans but it will need amplification. In practice, it is likely that many of these policies and procedures will be in place where funds have a MiFID authorised investment manager, and this will simplify the exercise considerably. For funds which do not have a MiFID compliant investment manager, it is likely that a GAP analysis will be required to ensure compliance with UCITS IV requirements.
- Independent risk management function and documented process is required
- Many of the new requirements are aligned with MiFID.
- Delegation is permitted and must be effectively monitored.
- The principle of proportionality is provided for so that, for example, compliance should be easier for a smaller UCITS company than for a multi-jurisdictional manager with multiple UCITS under management. The detail of which provisions will be disapplied for self managed UCITS is not yet clear.
- Irish Central Bank will update its Derivatives Guidance Note to reflect new CESR Guidelines.
- New regime will be in force from July 2011 and RMP’s will need to be updated.
- Funds also need their own documented internal risk management measures and limits which should encompass market risks, liquidity risks, counterparty risks and operation risks.
- UCITS investing in derivatives must decide whether to use commitment approach, Relative VaR or Absolute VaR.
- Use of Commitment Approach will be more restricted.
- Prospectus and annual accounts must disclose method used to calculate global exposure. If using VaR, prospectus must disclose expected levels of leverage and the risk of higher leverage levels as well as details of reference portfolio in prospectus (for Relative VaR).
- Annual report must also set out method of calculation of global exposure and further details of VaR, if used.
Management Company Passport
- Irish UCITS management companies should be well placed to benefit from the management company passport in view of the suitability of the operating environment for such companies in Ireland. Moreover, the Finance Act, 2010 specifically addressed potential taxation issues which were identified as requiring clarification so as to ensure that the use of Irish UCITS management companies would not affect the tax status of the non-Irish funds to which they are appointed.
- Management company passporting requirements are not activated by simply marketing UCITS in another member state.
- Passporting notifications are made electronically from home regulator to host regulator within tight timelines.
- Management company is subject to prudential supervision of home state as well as UCITS rules in host state. A branch of a management company must comply with the conduct of business rules of the host regulator.
Cross Border Notifications /Registrations
- Fund sends a standard notification to its home regulator that it wishes to market in another member state.
- Fund’s home regulator notifies host regulator electronically within 10 working days and notifies the fund that it has done so. The fund may then commence marketing in the host member state.
- Provided that local inward marketing and/or local distributor provisions do not add additional requirements, only the KID need be translated.
- EU regulators must ensure their inward marketing requirements are available on a website.
- Likely, in our view, that existing local marketing requirements such as the need for local paying agents will continue.
Key Investor Information Document – KID.
- KID will be required for all new funds from 1 July 2011.
- KID will take the place of the Simplified Prospectus.
- Member states may defer adoption for existing UCITS until 1 July 2012.
- KID will be in a prescribed format, plain English, length of 2 sides of A4 page (or 3 sides of A4 page for structured products), may cross refer to prospectus and website of management company or SMIC, legible characters – typeface Arial or Times New Roman, Type size 10 or 11, 50-75 characters per line. CESR have issued a template KID.
- KID will show a SRRI – Synthetic Risk Reward Indicator – prescribed calculation methodology based on previous volatility, 7 bands of risk using a numerical scale of 1 to 7.
- KID will show an ongoing charges figure which will be expressed as a single figure and will include all costs borne by a fund but not performance fees, transaction costs, exit and entry fees.
- Past performance will be shown by bar chart with prescribed warnings.
- Separate KID will be required for each sub-fund in an umbrella structure.
- A fund with separate classes may use a representative class if that is fair, clear and not misleading.
- KID must be kept up to date and be published (at least annually) within prescribed timescales.Pan European merger regime for UCITS.
- Merger requires prior authorisation by regulator of merging UCITS, and and the regulator of the receiving UCITS also has input.
- Regulators may not require more than 75% of votes actually cast to approve a merger.
- Finance Act 2010 specifically addressed certain taxation issued to facilitate the UCITS IV merger procedures.
- A form of pooling within the UCITS framework.
- At least 85% of assets must be invested in the master UCITS.
- Investment by feeder must be in one master fund only.
- Prescribed information sharing between master and feeder and their service providers.
- Prescribed disclosures to investors.
As mentioned above, the Central Bank are due to issue a consultation on how the UCITS IV regulatory framework will be implemented in Ireland soon and this will provide greater clarity on the compliance implications for individual UCITS funds and for UCITS managers. A&L Goodbody shall be tracking developments as they occur.