With close to EUR 10 trillion in net assets,1 UCITS are an attractive proposition for managers. The UCITS brand is globally recognised and is firmly established as a product of choice for retail investors and institutions requiring a highly liquid investment. However, UCITS have a large number of moving parts and costs associated with their ongoing operations. As such, it is important to “think it through” before taking the leap to launch a UCITS. This article provides a high-level overview of several common topics for consideration.
◊ Does your strategy fit into the UCITS box?
UCITS are highly regulated, more so than their American mutual fund cousins. It is important to consider what, if any, changes will be required to your strategy before taking any further steps. Private fund strategies generally will require changes – sometimes significant – to meet the UCITS investment and liquidity restrictions, and this may cause a performance lag against your private fund strategy. Key investment restrictions to take into consideration include:
- Issuer concentration limits – It is necessary to comply with the 5/10/40 rule (limit of 5% in any one issuer, which may be extended to 10% provided the aggregate of those issuers in which you hold more than 5% does not represent more than 40% of the net assets of the fund).
- The use of derivatives (including counterparty exposure limits) is very regulated and involves detailed global exposure calculations, as well as back testing and reporting requirements.
- UCITS may only take short positions synthetically through derivatives.
- UCITS may only borrow up to 10% of their net assets for short-term liquidity purposes, which means that long/short strategies must be implemented through derivatives on both the long and short sides to obtain the leverage necessary.
- UCITS are prohibited from investing directly, or through derivatives, in commodities.
If it is not possible to fit your strategy into a UCITS, the strategy may fit into an alternative investment fund structure, which, provided it complies with the requirements of the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFMD), will be able to avail of the marketing passport for sale to professional investors (as defined in the AIFMD) throughout the European Economic Area (EEA).
◊ Where and to whom do you plan to sell?
An old adage is that UCITS are sold, not bought. As such, it is important to think ahead about what types of investors you want to target and potential jurisdictions into which you might sell. Such considerations include:
- Will you be targeting institutional or retail investors?
- Where are you primarily thinking of selling? This may influence your choice of jurisdiction for the UCITS.
- What level of sales do you anticipate in each country? This may influence your choice of countries in which to register the UCITS for local sale.
- What type of sales team will you utilise? It is important to determine whether you require appropriate staff “on the ground” in Europe or if you will go through other distribution channels.
◊ Determine your domicile.
While UCITS are a maximum harmonisation vehicle under European law (i.e., they must all comply with the same minimum set of rules), there are differences between the domiciles in which they are established that should be taken into account. In this regard, you should consider your investor base, required timing, tax matters and service providers.
- Investor Base. Ireland and Luxembourg are the most popular UCITS domiciles for non-European managers and have largely similar offerings. Jurisdictions such as Germany, France or Austria are typically more suited for domestic managers in those countries seeking to sell to domestic investors. Continental Europeans may have a preference for Luxembourg due to similar civil law codes and languages; however, both Ireland and Luxembourg are well-recognised domiciles.
- Timing. Typically, the Central Bank of Ireland is viewed as providing a faster process from first filing to authorisation of a UCITS (six-eight weeks for a stand-alone platform), compared to Luxembourg (which is typically closer to three months). These time frames assume that an existing (i.e., already authorised) management company is part of the structure. If the structure will be self-managed (as discussed below), the authorisation process can be run in parallel with the authorisation of the UCITS itself, but may add a few weeks to the process. If you are seeking to establish your own UCITS management company, this process typically takes three-six months.
- Tax Matters. As is the case with most investment products, tax can impact a structure at every level, and it is important to seek local tax advice as part of your structuring considerations.
- Service Providers. Irish and Luxembourg funds are required to have a locally domiciled depositary to carry out the safekeeping of assets. In addition, although a policy rather than a requirement, the administrator (providing transfer agency and fund accounting) is typically locally domiciled."
◊ Here, there and everywhere! – global sales.
It is important at the outset to consider your future sales plans, as there are a number of regulatory considerations (and possible pitfalls!) to selling on a global stage.
UCITS are able to be “passported” into any EEA country via a regulator-to-regulator process, which takes 10 business days. Once passported, the UCITS (with a few exceptions for countries that allow “institutional” registrations) can be sold to any investor in the host country. UCITS may also be privately placed, or locally registered for sale in non-EEA countries.
Determining where you want to sell and whether you want to avail of the passport, utilise private placement or require a local registration is important to getting your internal team prepared for launch.2
In addition, you should consider how you will address the ongoing compliance requirements of your UCITS (e.g., regulatory filings required) in the home jurisdiction of the UCITS as well as the global jurisdictions in which your UCITS is registered.
◊ Go it alone or join an existing platform?
A UCITS can be a costly undertaking. As such, you should consider whether to jump into the deep end and establish your own stand-alone structure, or dip your toe in the water first by setting up a sub-fund on an existing platform. This determination is largely driven by costs, perceived convenience and distribution capabilities.3
◊ If you choose to go it alone, determine your legal structure.
UCITS can be in corporate or contractual (i.e., no separate legal personality) form in both Ireland and Luxembourg. The vast majority of UCITS are corporate entities and the following would be the usual structure today: ICAV in Ireland4 or société anonyme SICAV in Luxembourg. However, contractual forms are more well-known to Asian investors so your proposed jurisdictions of sales should be factored into this equation.
Contractual funds require a separate UCITS management company, which can be provided by a turn-key provider or through the establishment of a new management company, both of which must have separate authorisation and capitalisation from the UCITS.
As many managers are choosing to establish their own UCITS management company as a solution to issues of the UK leaving the European Union (Brexit), it is worth considering the contractual structures from an efficiency point of view if you have, or are planning to have, your own UCITS management company. The use of contractual structures eliminates the requirement to appoint additional directors or operate the fund as a separate corporate structure, allowing for faster establishment, faster winding up and fewer fees to the fund. Irish unit trusts are able to have UCITS management companies that are established in other countries in the European Union (e.g., Luxembourg). The equivalent in Luxembourg (fonds commun de placement) would require a local UCITS management company, which could then delegate to a non-Luxembourg entity.
◊ Self-managed structure or externally managed?
Self-managed structures (i.e., where the board undertakes the functions of the UCITS management company and delegates all day-to-day functions to external service providers) had previously been the most popular structure in Ireland. However, in light of Brexit, many managers have decided to establish their own management company or to utilise a third-party service provider.
Externally managed structures (i.e., where the board of a corporate UCITS appoints a management company to carry out the day-to-day activities of the UCITS and manages/monitors other service providers to the UCITS) are now more commonly being established, and can be implemented through a proprietary entity or a third-party entity.
◊ Determine your board composition.
Typically, a UCITS board of directors consists of four or five directors, comprised of members from the investment manager and independent directors. Both Ireland and Luxembourg have local requirements in relation to local directors and board composition with regard to skills sets that will need to be considered during the structuring phase.
◊ Self-managed structures – ensuring you have substance.
Self-managed structures in both Ireland and Luxembourg must comply with the UCITS management company requirements, as well as certain oversight functions required by the Central Bank of Ireland and the Luxembourg CSSF, respectively.
There are a number of consultancy companies in both jurisdictions (most of which have offices in both jurisdictions) that are able to assist (including through providing personnel) with management oversight. However, recent developments in both Ireland and Luxembourg have made the time commitment requirements for management functions much greater than was previously the case. This has been a significant factor in the increased use of externally managed structures.
◊ Choose your service providers.
As noted above, a UCITS will need to appoint an administrator (providing transfer agency and fund accounting) and a depositary located in the relevant jurisdiction. While not required, these are typically from the same group of companies (in Luxembourg, they may be the same legal entity with functional and hierarchical separation of functions). Both Ireland and Luxembourg are host to the largest global firms in this space, as well as a number of smaller firms.
You will also have other ancillary local appointments required including: auditors; legal advisers; a corporate secretary/domiciliation agent; and a money laundering reporting officer.
You will need to put in place trading relationships with the UCITS’ derivative counterparty(ies). The documentation required will depend on how the UCITS intends to achieve its short exposure (ETDs / uncleared OTCs and/or cleared OTCs). If the UCITS will trade OTC, it will likely require two-way credit support. Different legal structures can be used to assist the UCITS in reducing its counterparty exposure (e.g., an OTC tri-partite credit support arrangement).5