Index Tracking UCITS

Author:Dillon Eustace's Financial Services Practice Group
Profession:Dillon Eustace

One of the cornerstones of UCITS since the introduction of the original UCITS Directive in 1985 has been the imposition of strict risk spreading requirements. This has been enshrined in what is commonly known as the 5/10/40 rule which is that a UCITS may invest no more than 10% of its net assets in transferable securities or money market instruments issued by the same body, provided that the total value of transferable securities or money market instruments held in issuing bodies in each of which it can invest more than 5% is less than 40%.

Under the original UCITS Directive, this principle created problems for UCITS which wished to track an index where the weighting of a constituent element of the index exceeded the 5% limit or where the relationship between two or more constituent elements of the index meant that they were considered to constitute a single issuer resulting in an aggregation of the exposure. As explained below, these problems were addressed by UCITS III.

(i) 20% and 35% Rule

Since the introduction of UCITS III, a UCITS whose policy is to replicate an index is permitted to invest up to 20% of net assets in shares and/or debt securities issued by the same body, with the 20% limit being raised up to 35% in the case of a single issuer where justified by exceptional market conditions. This flexibility is permitted where the relevant index is recognised by the Central Bank on the basis that it is sufficiently diversified, it represents an adequate benchmark for the market to which it refers and it is published in an appropriate manner.

(ii) Index Replication

The reference to "replication" of the composition of a shares or debt securities index is considered by the Central Bank to mean replication of the...

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