ESMA policy opinion on Ucits could prompt further clampdown
ESMA has issued a policy opinion which could prevent Ucits funds investing into hedge funds in what might herald a clampdown on Ucits investing in esoteric or illiquid products.
Ucits, under Rule 50(2)(a) allows its funds to invest up to 10% of their net assets in transferable securities and money market securities which do not meet Ucits criteria on eligible assets.
National regulators including the Central Bank of Ireland and Luxembourg’s CSSF, interpreted this as allowing Ucits to invest in unregulated funds including hedge funds. Luxembourg and Dublin’s liberal interpretation of the rules has, however, been upended by ESMA in what could be a sign of a further tightening up of the asset eligibility criteria within Ucits. ESMA stated Ucits, as of 2013, can only invest in collective investment schemes which are Ucits or products, which are subject to similar supervision and provide equivelent investor protections.
“The ESMA opinion appears to be indicative of its stance on Ucits investing in illiquid or esoteric products. I suspect European regulators are going to clamp down further on Ucits investing into illiquid or esoteric products,” said Barrie Davey, director at Robert Quinn, a regulatory compliance consultancy in London.
According to one chief compliance officer at a multi-billion dollar London hedge fund, Luxembourg’s regulators have issued a notice stating that Ucits funds should not make future investments into hedge funds.
The ESMA opinion comes as regulators have become increasingly concerned with Ucits managers investing into esoteric or illiquid products. Some have warned a Ucits blow-up or suspension of redemptions could irreparably damage the brand.
Ucits VI’s consultation asked an open-ended question about whether the criteria for Ucits-eligible assets be expanded. Some, including AIMA, have urged regulators to allow Ucits to invest in commodity derivatives although senior policymakers at the European Commission have expressed views to the contrary.
Some experts, however, are adopting a “wait and see” approach to ESMA’s policy opinion. “It is hard to gauge at this stage whether the ESMA policy opinion is indicative of a broader initiative that will see Ucits VI clamp down on assets which are (currently) eligible for Ucits, but this remains a distinct possibility,” said Conor Durkin, lawyer at Dechert in Dublin.
The rules could detrimentally impact performance at Ucits funds. “The ability to invest in hedge funds enables managers to offset some of the performance drag associated with the investment restrictions of Ucits and this policy change will, most likely, impact on performance” said Durkin.
However, the number of Ucits funds and funds of Ucits hedge funds actually invested in hedge funds is relatively small. “Not many Ucits managers invest directly in hedge funds although some do for diversification benefits. Other managers achieve hedge fund exposure via investment in specialist indices, although as we saw in July this year, ESMA has also been active in tightening the rules that apply regarding eligibility of such indices for use by Ucits,” said Davey.
The hedge fund CCO agreed the impact will be fairly negligible. “Ucits hedge funds are small allocators into hedge funds, and even then it is just 10% of the NAV,” he said.