UCITS IV - What needs to be done & new opportunities

The UCITS IV Directive (2009/65/EC) will be implemented in Ireland by 1 July 2011. It has now been followed by many implementing measures which give detail of the new requirements. The new framework will present opportunities and will also involve revision of procedures and documentation. 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.

Revision of Documentation

UCITS funds and UCITS managers will need to be UCITS IV compliant by the deadline of 1 July 2011. UCITS funds and UCITS managers are likely to need to;

  • revise the business plan to reflect more detailed and documented operating, administrative and accounting policies and procedures covering 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, compliance function, etc. This update may prove to be relatively straightforward where the investment manager is MiFID compliant as the UCITS IV Directive seeks to align the provisions with the MiFID requirements.
  • revise or adopt a risk management process.
  • issue KIDs in place of the Simplified Prospectus for all new funds from 1 July 2011.
  • issue KIDs in place of the Simplified Prospectus for all existing funds (although the timing of this is not yet clear).
  • revision of the prospectus may be involved and amendment of the fund constitutional document may also be desirable where funds wish to avail of certain provisions of the new framework (such as providing the prospectus on a website rather than in paper or operating as a feeder fund) although this may not be subject to the compliance deadline of 1 July 2011.  

Key changes under the UCITS IV Directive

Revision of the Business Plan

  • UCITS managers and self managed UCITS will need to ensure they have updated, detailed and documented operating, administrative and accounting policies and procedures. 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  

Risk Management

  • Irish Central Bank will update its Derivatives Guidance Note to reflect 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 should present opportunities and simplify processes

  • 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 will be simplified

  • 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- will replace the SP.

  • 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.  

Mergers regime will provide opportunities

  • Pan European merger regime for UCITS.
  • Merger requires prior authorisation by regulator of merging UCITS, 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.  

Master-Feeder structures will now be possible

  • 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.

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  

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 will be tracking developments as they occur.