The Continuing Evolution Of UCITS Funds

Author:Mr Brian Higgins
Profession:Dillon Eustace

UCITS (Undertaking for Investment in Transferable Securities) is

the European harmonized fund product which can be sold on a cross

boarder basis within the European Union

("EU") based on its authorization in one

EU member state. Ireland was one of the first EU member states to

transpose the first EU UCITS Directive into Irish law when it did

so in 1989. Ireland is now one of the leading domiciles for UCITS

funds which are frequently promoted by US asset manager and

marketed not just in Europe but globally.

The first EU UCITS Directive allowed for a very basic product

which was permitted to invest in transferable securities and only

use derivatives for the purpose of efficient portfolio management.

Accordingly, under the original UCITS regime, UCITS were

essentially long only equity or bond funds. Nevertheless, it proved

to be a very successful product in this section of the market and

established a strong global brand as a regulated investment

product. In the period since the first UCITS Directive, there has

been significant amending legislation and regulations permitting

UCITS to offer a far broader range of investment strategies while

still maintaining its global brand as a regulated investment

product which enables UCITS to be sold not just in Europe but also

in other significant markets such as Asia and South America.

EU Directive 2001/108 (which is commonly referred to as the

"Product Directive") introduced

significant developments to the UCITS product. It broadened the

range of assets in which a UCITS may invest and the investment

strategies which it may pursue. The Product Directive expanded the

types of instruments in which a UCITS may invest to include money

market instruments, other funds (both UCITS and Non-UCITS) and bank

deposits. It also permits the establishment of index tracking funds

and the use of financial derivative instruments for investment

purposes rather than merely for efficient portfolio management.

In accordance with the Product Directive, a UCITS' maximum

potential exposure relating to derivative instruments should not

exceed its total net asset value. The EU Commission has recommended

that a UCITS which uses financial derivatives instruments in a

nonsophisticated manner (i.e. only use a limited number of simple

derivative instruments for non-complex hedging or investment

strategies) may use either, (i) a commitment approach (where the

derivative positions of the UCITS are converted into the equivalent

position in the underlying assets relating to the derivatives,

which may be netted) or (ii) an advanced risk management approach

such as Value-at-Risk ("VaR") to measure

its potential exposure through the use of derivatives.

A UCITS which is a sophisticated user of derivatives must use...

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