ESMA recently published a discussion paper on share classes of UCITS.
The UCITS Directive recognises the possibility for UCITS to offer different share classes to investors but it does not prescribe whether, and to what extent, share classes of a given UCITS can differ from each other. ESMA has identified diverging national practices as to the types of share class that are permitted, ranging from very simple share classes (e.g. with different levels of fees) to much more sophisticated share classes (e.g. with potentially different investment strategies). Therefore, ESMA sees merit in developing a common understanding of what constitutes a share class of UCITS and of the ways in which share classes may differ from each other.
In the discussion paper, ESMA identifies the following principles that should be used in assessing the legality of different 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.
ESMA also identifies the following non-exhaustive list of types of share class that would be compatible with the principles set out at numbers 1 – 3 above:
- Share classes that differ according to the maximum or minimum investment amounts, or values of holdings allowed to be retained
- Share classes that differ in terms of the type of investor (e.g. institutional investors vs. retail investors)
- Share classes that differ according to the types of charges and fees that may be levied and their amount (on-going charges, subscription and redemption fees, performance-related fee)
- Share classes that differ according to the currency in which they are denominated
- Share classes that differ according to the allocation of revenues to investors (by capitalisation or distribution, either subject to or exempt from withholding tax)
- Share classes that differ according to their characteristics: registered or bearer
- Share classes that differ in terms of voting rights
- Share classes that provide currency hedging when share classes are denominated in different currencies from the base currency
ESMA is of the view that the following non-exhaustive list of types of share class do not appear to be compatible with the principles set out at numbers 1 – 3 above:
- Share classes that are exposed to different pools of underlying assets. For example, a UCITS that offers two share classes, one tracking the Eurostoxx and one tracking the S&P 500
- Share classes whereby the same underlying portfolio is swapped against different portfolios of assets (i.e. the final exposures of the share classes are different)
- Share classes that offer differing degrees of protection against some market risks such as interest rate risk or volatility risk
- Share classes that are exposed to the same pool of assets but with a different level of capital protection and/or payoff. For example, a UCITS offers two share classes. One share class protects 80% of the initial NAV and delivers 100% of the performance of an index after a fixed term (5 years) and the other share class protects 100% of the initial NAV and delivers 50% of the performance of the same index after the same 5 year term
- Share classes that differ in terms of leverage
Unlike currency hedging referred to above, ESMA believes that interest rate hedging performed at the level of share classes does not comply with the principle of having the same investment strategy, because it modifies the investment strategy of the share class. For example, a share class that reduces the duration of the portfolio should not be considered as compatible with the principle of a unique investment strategy because investors in that class are not exposed to the same interest rate risk as investors in the other classes of the fund.
The discussion paper contains a number of questions which ESMA has asked respondents to consider and respond to, the most significant questions are set out below:
- What are the different types of share class that currently exist?
- How would you define a share class?
- Do you agree that share classes of the same UCITS should all share the same investment strategy? If not, please justify your position.
- Do you agree that the types of share class set out at numbers i. – viii. above are compatible with the principle of having the same investment strategy? In particular do you agree that currency hedging that is described at numbers i. – viii. complies with that principle? If not, please justify your position.
- Do you believe that other types of share class that comply with the principle of having the same investment strategy exist (or could exist) and should be allowed? If yes, please give examples.
- Do you agree that the types of share class set out at points a - e above do not comply with the principle of having the same investment strategy? If not, please justify your position.
- Please provide information about which existing UCITS do not comply with the criteria laid down at numbers 1 – 3 above as well as an indication of the assets under management and the number of investors of these UCITS.
- Do you see merit in ESMA clarifying how regulatory ratios such as the counterparty risk limit should be calculated (e.g. at the level of the UCITS or share classes)?
- Do you agree that ESMA should develop a common position on this issue? If not, please justify your position.
ESMA will take into account the feedback from stakeholders with a view to establishing a common position on the use of share classes by UCITS. ESMA appreciates that national practices on the use of share classes vary significantly. Therefore, ESMA will take into account the possible impact on current market practices when developing its final position on this topic.
ESMA will consider all comments received by Friday 27 March 2015. All contributions should be submitted online at www.esma.europa.eu under the heading ‘Your input - Consultations’. All contributions received will be published following the close of the consultation, unless you request otherwise.