On 22 July 2011, ESMA issued a discussion paper setting out policy orientations on possible guidelines for structured UCITS. The discussion paper also addresses UCITS exchange traded funds and the Asset Management and Investment Funds Group has produced a separate update in relation to the discussion paper as it applies to exchange traded funds, please click here to access our update.
The rapid development of the UCITS product as a powerful global brand has been accompanied by extensive evolution, post UCITS III and the Eligible Assets Directive (2007/16/EC), in the investment strategies of the UCITS product and the relative complexities of those strategies. The discussion paper is part of ESMA's review of the impact which structured UCITS may have on investor protection and market integrity. Having reviewed the regulatory regime to which structured UCITS are subject, ESMA believes that the existing requirements are not sufficient to take account of the specific risks associated with these products, particularly as UCITS, including structured UCITS, are categorised under MiFID as non-complex products and are generally available to retail investors.
Structured UCITS are UCITS which use financial derivative instruments, in most cases a total return swap, to provide a predefined payout to investors based on the return of the assets underlying the swap. The strategy is generally comprised of a swap with a single counterparty, such counterparty providing collateral to reduce counterparty exposure to permissible levels. As part of the strategy, the UCITS will generally invest in a portfolio of assets and will pass those assets or the return on them to the counterparty in exchange for a return based on an underlying portfolio. The underlying portfolio may be a straightforward basket of assets, but increasingly such portfolios are based on more complex hedge fund type strategies including long/short equity, commodity and absolute return strategies.
In the discussion paper, ESMA identifies the possibility that it may seek to introduce measures to require warnings to be issued to retail investors in relation to investment in such products or even to go as far as limiting the distribution of them to such investors. ESMA raises the issue of whether structured UCITS should be classified as 'complex' and seeks views as to the criteria to be applied to determine complexity. This proposal is consistent with the view expressed by EMSA's predecessor, the...