According to Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations, and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), as amended (the “UCITS Directive”), the member states of the European Union (“Member States”) may allow their national UCITS to be set up as umbrella funds. However, the UCITS Directive includes only a limited number of references to classes of shares (and only with respect to marketing to investors) but does not indicate how classes of shares within the same UCITS (or sub-funds thereof) can differ from one another. For the purposes of this article, references to UCITS should be construed as references to a UCITS or a sub-fund thereof.
The European Securities and Markets Authority (ESMA) noticed that Member States took different views on the issue of classes of shares; some Members States forbade their national UCITS issuing different classes of shares, while others allowed it.
Therefore, to ensure a harmonised approach across the European Union, ESMA issued, on 30 January 2017, an opinion advocating common principles for setting up classes of shares in UCITS (the “Opinion”). You can find the Opinion at the following address:
Interestingly, ESMA also addresses the segregation of assets between sub-funds of a UCITS. Indeed, ESMA is of the view that while asset segregation between sub-funds is not legally required in some Member States, the UCITS Directive should be interpreted in such a manner that such segregation should be required. The Luxembourg law of 17 December 2010 on undertakings for collective investment, as amended, provides for asset segregation between sub-funds, unless otherwise provided for in the articles of incorporation or management regulations of the UCITS. Although it is extremely uncommon for the assets of different sub-funds not to be segregated, ESMA’s view will, in principle, result in a requirement for asset segregation between sub-funds.
Principles set out in the Opinion
ESMA raised in the Opinion the following four principles to be followed with respect to classes of shares:
1. Common investment objective
According to ESMA, classes of shares of the same UCITS should have a common investment objective, reflected by investment in a common pool of assets.
ESMA was not concerned with UCITS being set up with different classes of shares for different groups of investors (e.g., retail vs. institutional investors) or different means of investment (e.g., with respect to management fees, minimum investment amounts, voting rights, or currency), as these features do not have a great impact on the performance of the investments.
ESMA was more concerned with UCITS being set up with different classes of shares for derivatives-based hedging arrangements, with the aim of mitigating the risks of the common pool of assets for investors belonging to those specific classes of shares. ESMA is of the opinion that a specific class of shares should not protect investors from certain types of risk and that such a strategy should be set up as a separate UCITS or sub-fund, not as a different class of shares.
ESMA is, therefore, of the opinion that hedging arrangements at the share-class level—with the exception of currency risk hedging—are not compatible with the requirement for a UCITS to have a common investment objective.
ESMA was made aware of classes of shares having been set up specifically for derivatives-based hedging arrangements that cause disadvantages to investors in other classes of shares, by spilling over the risks of a specific class to the common pool of assets.
ESMA is of the opinion that appropriate procedures should be implemented to minimise the risk that features specific to one class of shares could potentially adversely impact other classes of shares of the same UCITS.
As a consequence, ESMA advises that such classes of shares be monitored to avoid any spillover. The Opinion includes operational principles that ESMA believes should be viewed as the minimum standard for classes of shares with a derivative overlay.
To tackle the lack of segregation between classes of shares and the contagion risk of derivatives used in hedging arrangements, the Opinion states that all hedging arrangements and their potential effects on the common pool of assets should be pre-determined and provided to all future investors in a UCITS.
As a consequence, all features of the class of shares should be pre-determined before it is set up.
Differences between classes of shares of the same UCITS should be disclosed to investors when they have a choice between two or more classes.
ESMA is of the opinion that the minimum of transparency towards all investors in a UCITS entails observing the following operational principles:
- Information about existing classes of shares should be provided through the UCITS’ prospectus.
- A list of classes of shares in the form of readily available information, which should be kept up-to-date, should be provided.
- The stress test results should be made available to competent national authorities upon request.
In order to limit the impact on the investors in existing UCITS’ share classes, ESMA allows for all the UCITS’ share classes established prior to 30 January 2017, which do not comply with the provisions of the Opinion, to continue to operate. However, such classes of shares should be closed to investment by new investors by 30 July 2017 and should be closed to additional investment by existing investors by 30 July 2018.
As a preliminary note, the Opinion applies only to Luxembourg UCITS. As a consequence, other types of investment funds in Luxembourg, such as the reserved alternative investment fund (RAIF) or the specialized investment fund (SIF), need not comply with these requirements.
The Luxembourg supervisory authority, the Commission de Surveillance Secteur Financier (CSSF), issued, on 13 February 2017, Press Release 17/06 in relation to the Opinion.
Per the press release, the CSSF expects UCITS to take the necessary measures to comply with the transitional provisions set forth in the Opinion.
In addition, new classes of shares of UCITS must, moving forward, comply with the common principles set out in the Opinion.
It should be noted that although the Opinion mainly references the use of derivatives to highlight the impact that the specific characteristics of a class of shares may have on another class of shares, a class of shares may have other characteristics that, although not mentioned in the Opinion, may not comply with the provisions.
As a consequence, UCITS (or their management companies) must review the characteristics of the classes of shares that are offered to ensure that they comply with the requirements of the Opinion.