ESMA Opinion on UCITS Share Classes

The European Securities and Markets Authority (ESMA) issued an opinion on UCITS Share Classes which opines on the extent to which different types of units or shares (share classes) of the same UCITS fund can differ from one another, having found diverging approaches in different EU countries.

UCITS can be sold to retail investors throughout the EU. However, there is currently no common EU framework for share classes, with some Member States prohibiting the set-up of different share classes within a single fund and others permitting it with varying degrees of flexibility. While all investors in a UCITS fund invest in a common pool of assets, share classes attribute different rights or features to sub-sets of investors although there is no legal segregation of assets between the share classes.

In its Opinion, addressed to national regulators, ESMA sets out four high-level principles which UCITS must follow when setting up different share classes in order to ensure a harmonised approach across the EU:

  • Common investment objective: Share classes of the same fund should have a common investment objective reflected by a common pool of assets. ESMA considers that hedging arrangements at share class level – with the exception of currency risk hedging – are not compatible with the requirement for a fund to have a common investment objective;
  • Non-contagion: UCITS management companies should implement appropriate procedures to minimise the risk that features 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 the fund is set up; and
  • Transparency: Differences between share classes of the same fund should be disclosed to investors when they have a choice between two or more classes.

ESMA noted that UCITS share classes with differing dividend policy, differing fees, differing minimum subscription levels and such like are acceptable so non-derivative overlay share classes are not affected by this Opinion.

However the most important aspect of the Opinion relates to derivative overlay share classes (where derivatives are used at a share class level to vary the investment outcome for investors in that class). ESMA is of the opinion that these share classes are not appropriate in a sub-fund of a UCITS save for share class currency hedging (which will continue to be permitted).

ESMA is aware that these principles will have an impact on investment fund markets in Member States where share classes can currently be set up which do not comply with them (including some Irish permitted arrangements). Therefore, to mitigate the impact on investors in share classes established prior to this Opinion which do not comply with these principles, ESMA is of the view that they should be allowed to continue. However, such share classes should be closed for investment by new investors within 6 months of publication of the opinion, and for additional investment by existing investors within 18 months of publication.

PRIIPs Regulation

The PRIIPs Regulation will now apply from 1 January 2018 instead of 31 December 2016. Work and controversy on the draft regulatory technical standards for the PRIIPs Regulation continues.

FSB recommendations to address structural vulnerabilities from asset management activities

Following consultation, the Financial Stability Board (FSB) published a report containing policy recommendations to address structural vulnerabilities from asset management activities giving 14 recommendations on issues such as:

  • Liquidity mismatch between fund investment assets and redemption terms and conditions for fund units (for all open-ended funds).
  • Leverage within funds (for all types of funds that use leverage).
  • Operational risk and challenges in transferring investment mandates or client accounts (for all asset managers depending on the level of risks their activities pose to the financial system).
  • Securities lending activities of asset managers and funds (for asset managers that provide indemnifications to clients).

The recommendations do not apply to money market funds.

ESMA opinion on impact of exclusion of fund managers from scope of MiFIR intervention powers

ESMA published an opinion on the impact of the exclusion of fund management companies from the scope of the Markets in Financial Instruments Regulation (MiFIR). Articles 40 and 42 of MiFIR give ESMA and national competent authorities (NCAs) power to temporarily prohibit or restrict the marketing, distribution or sale of certain financial instruments or shares in UCITS and AIFs. The power to intervene applies only to MiFID firms and credit institutions, and do not apply to AIFMs authorised under the AIFMD or to UCITS management companies authorised under the UCITS Directives.

Moreover, fund management companies may be given permission under the AIFMD or the UCITS Directives to carry out certain MiFID services and activities (such as individual portfolio management, investment advice and, for AIFMs only, reception and transmission of orders) in relation to all MiFID financial instruments and not just units of collective investment undertakings (CIUs). Therefore, if a restriction were applied to MiFID firms in relation to these activities, that restriction, unless allowed under national law, could not be applied to fund management companies carrying out those activities. ESMA warns that the MiFIR intervention powers could create a risk of arbitrage between MiFID firms and fund management companies for the provision of MiFID activities and services in relation to units in CIUs and, in some cases, other financial instruments. It believes that, in addition to the powers available under MiFIR, NCAs and ESMA should have power to apply restrictions directly to fund management companies.

Anti-Money Laundering/Combating the Financing of Terror/ Corruption

Compromise proposals on 5AMLD

On 20 December 2016, the Council of the EU published its fifth Presidency compromise proposal (dated 19 December 2016) on the proposed Fifth Money Laundering Directive (5AMLD), which amends the Fourth Money Laundering Directive (4AMLD). On 20 December 2016, the Council of the EU announced that it has agreed its negotiating stance on 5AMLD. 5AMLD requires a qualified majority for adoption by the Council, in agreement with the Parliament. The Council advises that Member States will have 12 months to transpose 5AMLD into their national laws and regulations, although Member States will have longer periods (24 or 36 months) in which to implement the provisions on beneficial ownership registers.

Delegated Regulation amending list of high-risk third countries under 4AMLD

The European Parliament published a press release stating that it objected to the proposed Delegated Regulation amending the European Commission's list of high-risk third countries under 4AMLD because the proposed list of third countries is too limited and should be expanded, particularly to include countries that facilitate tax crimes and calling on the Commission to submit a new delegated act that takes account of the committees' concerns.

ESA letter confirms delay of 4AMLD regulatory technical standards (RTS)

The European Supervisory Authorities (ESAs) informed the European Commission that RTS required under 4AMLD will be delayed.

Article 45(6) of 4AMLD requires the ESAs to draft RTS on the measures that credit and financial institutions are required to take to manage the risk of money laundering and terrorist financing where they have branches or majority-owned subsidiaries in third countries that prohibit the implementation of anti-money laundering (AML) and counter-terrorist financing (CTF) measures consistent with those required under the Directive.

The RTS have been deprioritised because it appears that there are no third countries that meet the description in Article 45(1). Proposed amendments to Article 45 of 4AMLD (set out in 5AMLD) will extend the scope to third countries that have not been captured to date. Therefore, the ESAs will work on the mandate in 2017 and expect to submit the final draft RTS to the Commission by 31 December 2017.

Central Bank of Ireland

16 new platforms and 80 new funds (including sub-funds) were authorised by the Central Bank in November 2016.