Class Level Assets Within Irish Funds

Author:Mr Benedicte O'Connor
Profession:Dillon Eustace

The Irish Financial Regulator has issued a Policy Update (February 9, 2010) in relation to class level assets within Irish funds clarifying the circumstances in which:

financial derivative instruments may be used at share class level to provide for standard class level distinctions (currency and interest rate hedging, different distribution policies and fee structures) but, more importantly, to provide different levels of participation in the performance of the underlying portfolio; investment in New Issues can be carried out at share class level; and interest rate hedging can be carried out at share class level. Background

For many years Irish funds have been permitted to issue multiple share classes in respect of a single portfolio of assets, with the differentiating features between the different classes usually being currency hedging at class level and different class level distribution policies, management fees and front end/exit fees.

The core principles underpinning the Financial Regulator's approach to multiple classes in respect of a single portfolio of assets (a "Fund") are that:

each Fund must consist of a single common pool of assets; assets may not be allocated to individual share classes; and the capital gains/losses and income arising from that pool of assets must be distributed and/or must accrue equally to each shareholder, relative to their participation in the Fund. These principles are themselves founded on a general "equality of treatment" principle and legitimate concerns that to allow allocation of assets to individual classes could result in "cherry picking" of assets and other potential abuses.

Over the years some exceptions or variations have been permitted, most notably hedged currency share classes where the costs of and gains/losses on the hedging contract are allocated solely to the hedged class. Similar exceptions have allowed interest rate hedging at class level where derivatives have been used to provide different interest rate exposures on different classes in respect of, for example, a diversified bond portfolio.

More recently, allocation of assets to side pockets has been allowed for non-UCITS as a measure to deal with portfolio illiquidity, subject to quite specific rules set down by the Financial Regulator.

Following a number of industry submissions, the Financial Regulator has now formalised a series of welcome changes to its approach which will facilitate the engineering of different returns...

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