On 23 January, 2013 the Central Bank wrote to industry in relation to ESMA’s 20 November 2012 Opinion concerning the so-called UCITS trash ratio.
ESMA’s opinion significantly restricts the scope of possible investment by UCITS funds in the 10% trash ratio (Article 50(2) (a) of the UCITS Directive).
Until recently, there had been a view (supported by the Central Bank following engagement with Industry) that Article 50(2)(a) would permit investment in collective investment schemes of the type not typically envisaged for investment by UCITS (i.e. open-ended unregulated hedge funds).
ESMA’s opinion now means that UCITS can only invest in units or shares of collective investment schemes as defined in Article 50(1)(e) of the UCITS Directive (i.e. UCITS or UCITS equivalent collective investment schemes which invest no more than 10% of their net asset value in other UCITS or other collective investment schemes).
Background / Previous Position
Article 50(2)(a) of the UCITS Directive provides that “a UCITS may invest no more than 10% of its assets in transferable securities or money market instruments other than those referred to in paragraph 1” (i.e. transferable securities and money market instruments traded on regulated markets, UCITS and UCITS equivalents, deposits with credit institutions, FDIs etc.)
Certain jurisdictions permitted UCITS to use Article 50(2) (a) for investment in open-ended funds which did not meet the UCITS / UCITS-equivalent criteria, including hedge funds. The Central Bank had not initially permitted this use of the 10% trash ratio.
Following submissions by and engagement with Industry, the Central Bank confirmed by letter of 7 August 2008 that it interpreted Article 50(2)(a) as permitting a UCITS to invest up to 10% of its net assets in aggregate in unlisted securities and unregulated investment funds, including hedge funds, “provided that the investment complies with the eligibility criteria for UCITS.”
This meant that the 10% trash ratio could effectively be used for a range of investments including open-ended unregulated hedge funds, provided the investment made under Article 50(2) (a):
- Limited the potential loss which the UCITS may incur with respect to holding these instruments to the amount paid for them
- Did not compromise the liquidity requirements of UCITS and their ability to comply with its redemption requirements
- Made reliable valuation available on a periodic basis which was derived from information from the issuer of the security or from competent investment research
- Made appropriate information available in the form of regular and accurate information on the security or where relevant, on the portfolio of the security
- Was negotiable
- Was consistent with the investment objectives or the investment policy or both of the UCITS
- Had its risks adequately captured by the risk management process of the UCITS
Consequence/Transitional Provisions
Investment managers of UCITS funds need to review each UCITS holding of collective investment schemes to ensure that each holding in a collective investment scheme meets the requirements of Article 50(1) (e).
If it does not, then portfolio adjustments will need to be made as expeditiously as possible while “taking into account the best interests of shareholders”. Taking account of shareholders interests means that there is scope for continuing to retain a now non-compliant holding. However, there is a dead-stop date of 31 December 2013 by which time the particular holding will need to be cleansed from the UCITS’ portfolio.
The Central Bank’s letter to industry confirms support of the ESMA opinion and expects UCITS with existing non-compliant investments to make any necessary modifications to their portfolios by 31 December 2013. New investments in open-ended collective investment schemes must meet the relevant criteria immediately.
