Interest rate hedged share classes should be permitted in a UCITS, according to the majority of the published responses to the ESMA Discussion Paper on Share Classes of UCITS. William Fry also responded by arguing against the prohibition of interest rate hedged share classes.
As reported in the January issue of our Funds ezine, ESMA identified the following principles that should be used in assessing the legality of share classes:
- Share classes of the same UCITS should have the same investment strategy.
- Features that are specific to one share class should not have a potential (or actual) adverse impact on other share classes of the same UCITS.
- Differences between share classes of the same UCITS should be disclosed to investors when they have a choice between two or more classes.
The Discussion Paper also set out non-exhaustive lists of the types of share classes that ESMA considered compatible and incompatible with the above principles. While currency hedged share classes were identified as compatible, interest rate hedged share classes were not. ESMA argued that interest rate hedging at share class level modified the investment strategy of the share class and accordingly did not comply with the principle that share classes of the same UCITS should have the same investment strategy.
In our response, we suggested that the objective of establishing a common definition of a UCITS share class would be better served if the first principle on the legality of share classes was articulated by reference to the same pool of underlying assets rather than to investment strategy. The latter approach was, in our view, more likely lead to differences in interpretation. On that basis, we argued that so long as interest rate hedged share classes of a UCITS were exposed to the same pool of assets as other share classes of that UCITS, the creation of such share classes was not conceptually problematic.
Other respondents arguing against the prohibition of interest rate hedged share classes also justified those share classes by reason of their exposure to the same portfolio of assets as other share classes in the same UCITS.
Commenting on the usefulness of developing a common position on share classes of UCITS, some respondents warned that the development of excessively detailed rules in this area and “black-listing” certain types of share classes would hinder innovation aimed at improving investor choice.
ESMA is now due to establish a common position on the use of share classes by UCITS. Whether it will change its stance on interest rate hedged share classes remains to be seen and further developments will, no doubt, be closely watched by the considerable number of stakeholders who responded to the Discussion Paper as well as many others set to be affected by its outcome.