The Classification Of Hedge Fund Indices As Financia lIndices

Author:Ms Karen Jennings
Profession:Dillon Eustace
 
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  1. Introduction

    Pursuant to the new level three guidelines issued by the

    Committee of European Securities Regulators ("CESR")

    on 17th July, 2007, CESR has approved in principle the

    classification of hedge fund indices as financial indices for

    the purposes of the UCITS Directive1 subject to the

    satisfaction of certain criteria.

  2. Background

    Pursuant to Article 19(1)(g) of the UCITS Directive, a UCITS

    fund may invest in liquid financial derivative instruments

    whose underlyings consists of one or more securities in which a

    UCITS fund can invest in directly as well as financial indices,

    interest rates, foreign exchange rates or currencies. Whilst

    CESR has previously issued previous guidelines in relation to

    the nature of "eligible assets" for the purposes of

    UCITS funds (the "original Level 3

    guidelines")2, both the original Level 3

    guidelines and the subsequent implementing directive (the

    "Implementing Directive")3 left open the

    question as to whether or not hedge fund indices could be

    properly classified as "financial indices" for the

    purposes of the UCITS Directive.

  3. New Level Three Guidelines

    The new level three guidelines for eligible hedge fund

    indices builds upon the criteria applicable to all financial

    indices, as set out in Article 9(1) of the Implementing

    Directive. However, the new level three guidelines provide that

    in order for hedge fund indices to be deemed eligible

    underlyings for financial derivatives, such indices must be

    subject to additional requirements regarding publication of

    their selection and construction methodologies as set out

    below:

    The criteria applicable to all financial

    indices as set out in the Implementing

    Directive

    The additional criteria set down by the new

    guidelines in respect of hedge funds

    Sufficient diversification

    the Index must be composed in a way that price

    movements or trading activities regarding one component

    do not unduly influence the performance of the whole

    index;

    If the index is composed of eligible assets, it

    should be at least as diversified as set out under the

    diversification ratios of Article 22a(2) of the UCITS

    Directive;

    If the index is composed of noneligible assets, the

    index should be diversified in a way which is

    equivalent to that provided for in Article

    22a(2) of the UCITS Directive.

    By way of further clarification, the original Level 3

    guidelines clarify that if the index is not at least as

    diversified as under Article 22(a), the fund must combine

    its underlying assets with...

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