Introduction

As readers may be aware, certain types of financial instruments have been subject to increased scrutiny by both ESMA and the Central Bank over recent years due to concerns around investor protection.

In a revised Central Bank UCITS Q&A (the “Q&A”) issued earlier this week, the Central Bank reminds stakeholders that the UCITS is a product which is intended to be suitable for retail investors and restates the existing regulatory requirements applicable to UCITS and UCITS management companies when formulating the investment objective and strategy of the UCITS and implementing the risk management framework. The Q&A also confirms that during the authorisation process for a UCITS, the Central Bank may require additional information to be provided in the course of reviewing a specific application.

In what circumstances will the Central Bank request additional information?

The Central Bank notes that one example of where it may request additional information is in circumstances where the Central Bank may subject an application for authorisation of a new UCITS to enhanced scrutiny by reason of the UCITS’ proposal to invest in CFDs, CLOs, CoCos or binary options.

Is the Central Bank prohibiting or imposing any quantitative limits on the extent to which a UCITS can invest in these financial instruments?

No. The Q&A does not prohibit investment in any financial instruments nor does it impose any new quantitative limits on investment by a UCITS in any financial instruments. However, the Central Bank does indicate that the level of scrutiny it applies may depend on the proposed exposure to certain instruments. In particular the Central Bank has indicated that it may apply enhanced scrutiny at the authorisation phase to satisfy itself that the proposed investment is appropriate “taking into account the overall portfolio of assets proposed”.

What type of information will need to be provided to the Central Bank as part of the authorisation process where a UCITS intends to invest in certain instruments?

The Q&A states that enhanced scrutiny may include review by the Central Bank of “(i) model portfolio information, (ii) the due diligence carried out in respect of the proposed underlying portfolio and (iii) evidence to support the view that the proposed investment is suitable taking into account the above-mentioned requirements.”

Therefore, the board of directors of the UCITS and its management company should ensure that appropriate due diligence is carried out on any new UCITS portfolio prior to approving the investment objective and strategy of the relevant fund and that such due diligence can be provided to the Central Bank during the authorisation process if required.

Conclusion

This clarification provided by the Central Bank with respect to its authorisation process is to be welcomed. In particular, the Q&A is instructive for the boards of UCITS and their management companies, when formulating investment objective and policy, as to how to document their consideration of the composition of any proposed portfolio and its suitability for retail investors.