Undertakings for Collective Investments in Transferable Securities (‘UCITS’) refers to a set of European Union (EU) Directives that provide a legal framework for the creation, management and marketing of collective investment schemes across EU Member States.
- establish a single regulatory regime across the EU for open-end investment funds
- create wider investment and business opportunities for investors and asset managers
- offer higher levels of investor protection
- allow compliant funds to be freely marketed, under the European passport, throughout the EU
- The Product Directive (2001/108/EC) expanded the type and range of financial instruments that a UCITS fund could invest in, allowing asset managers to offer a more extensive range of investment products.
- The Management Directive (2001/107/EC) introduced a European passport to allow funds to operate freely throughout the EU. It also tightened up risk management frameworks and increased managers’ capitalisation requirements.
- net exposure of derivatives cannot exceed 100% of the fund’s net asset value
- strict process rules regarding the netting and offsetting of exposures to determine a “global exposure” to derivatives
- relative approach uses a ratio of up to 200% between the UCITS fund VaR and the VaR of a reference portfolio
- absolute approach allows the one month VaR to be 20% of the fund’s net asset value
- UCITS funds can only invest in eligible assets – the original UCITS Directive was restrictive in scope and effectively allowed only equity and fixed income assets. This has been changed to allow exposure to derivatives, ETFs and more complex money market instruments.
- UCITS funds must operate on a principle of risk spreading – restrictions exist to limit the spread of investments, leverage and exposure. UCITS IV introduced new rules regarding how derivatives exposure can be measured particularly targeting global, issuer and OTC counterparty exposure.
- A UCITS fund must be open-ended, i.e. units in the fund may be redeemed on demand by investors. A UCITS fund must be liquid, i.e. its underlying investments must be liquid enough to support redemptions in the fund on at least a fortnightly basis.
- Assets must be entrusted to an independent custodian or depositary and held in a segregated account on behalf of the investor
The original Directive was introduced in 1985 with revised amendments being adopted in 2001 and 2009. The current Directive (2009/65/EC), UCITS IV came into force on the 1st July 2011. Further consultations have since taken place with the European Commission publishing a proposed revision (UCITS V) in July 2012. Focusing on depositary functions, regulatory sanctions and remuneration requirements, this is set to come into force in Q3 2014 with Member States having to comply to the new framework within a two-year period.
Consultations have also begun on revisions that will form UCITS VI, with a focus on product rules, liquidity management and eligibility of assets, specifically the use of money market instruments within a UCITS fund.
The key objectives of UCITS are to:
A brief history
UCITS I: The original December 1985 UCITS Directive (85/611/EEC) aimed to offer greater business and investment opportunities by integrating the EU market for investment funds but it suffered from many cross-border marketing restrictions. In addition, the limitation on the range of permitted asset classes that a UCITS fund could invest in made it increasingly difficult to promote as an attractive investment opportunity.
UCITS II: In the early 1990s a draft amendment to the Directive (UCITS II) was an attempt to rectify these issues. However, the proposal was later abandoned as the EU Member States failed to reach a common agreement.
UCITS III: In 2001 the original UCITS I Directive was amended to form UCITS III. Made up of two directives UCITS III introduced significant changes:
UCITS III was widely seen as successful, increasing the flexibility and sophistication of the funds offered. It also extended its global reach, with funds being distributed to over 140 countries.
UCITS IV: UCITS IV (2009/65/EC) was adopted in 2009. The revisions intended to remove some of the regulatory red tape introduced under UCITS III, specifically by simplifying the notification process that enables asset management companies to access a market once the regulator has been notified. Previously it could take up to two months for regulators to complete this process. UCITS IV has enabled promoters of the funds to gain much quicker entry to EU Members States.
UCITS IV also encouraged increased transparency by introducing the concept of Key Investor Information (KII) documents, making it clearer and more understandable for potential investors. This allowed for consistency across EU Member States making it easier to draw direct comparisons between UCITS funds in different EU jurisdictions.
A significant change with UCITS IV was the introduction of rules regarding master-feeder structures. This allows funds to adopt new strategies by pooling assets and achieving economies of scales. This, combined with the management passport, created opportunities for UCITS funds to take advantage of operational rationalisations and cost savings.
UCITS IV introduced several risk management restrictions, in particular allowing two different approaches for calculating exposure:
Funds typically more straightforward in nature, long-equity for example, may adopt this more deterministic method of calculation:
Funds that make extensive use of derivatives tend to opt for the VaR approach, implementing a set of relative or absolute limits:
UCITS V: The key focus of UCITS V is around depository roles, in particular eligibility criteria regarding who can act in this capacity as well as clearer definition with regards to depositary liability. The UCITS V proposal also concentrates on remuneration policies regarding bonus payments and performance fees. The controversial bonus cap that would have seen fund managers limited to 100% of their fixed salary has now been formally removed from the proposed Directive.
The main driver for the revisions is to bring UCITS more in line with the Alternative Investment Fund Managers Directive (AIFMD).
UCITS investment restrictions – key facts
Last updated 11th March 2014