UCITS VI warned against curbing legitimate hedging activities
Any restrictions on the eligibility of assets, particularly derivatives, through UCITS VI must avoid curtailing legitimate hedging activity at fund managers.
The European Securities and Markets Authority (ESMA) has already stipulated UCITS vehicles managed by Commodity Trading Advisors (CTAs) be sufficiently diversified, fully transparent and easily replicated, as well as being re-balanced periodically rather than daily or intra-daily. Many experts widely believe these restrictions are a precursor to UCIS VI, which could facilitate a clampdown on asset eligibility criteria within UCITS.
“I do not believe the regulators will impose undue burdens on assets permitted in UCITS as it is a structure which carries significant brand-value in the EU. I certainly do not believe the majority of derivatives that are sometimes used in UCITS will be prohibited as much of this is legitimate hedging activity, and barring UCITS from derivatives exposure could result in additional risks to investors,” said Andrew Brown, chief operating officer at Skyline Capital Management in London.
ESMA’s rules on CTAs have had a noticeable impact. Cantab Capital Partners announced in May 2013 it was shutting its $320 million CCP Quantitative fund, a UCITS-compliant CTA vehicle. There have been calls to split UCITS into “complex” and “non-complex”. Some members of the European Parliament had advocated that UCITS transacting heavily in derivatives be deemed “complex” which would require retail investors to obtain financial advice prior to purchasing units in such funds as part of the Markets in Financial Instruments Directive II (MiFID II). This, however, was rejected in January 2014. Many have argued that funds adopting complex investment strategies are not automatically higher-risk, and there would be too much subjectivity in determining what is “complex” versus “non-complex.”
Others believe the introduction of the Alternative Investment Fund Managers Directive (AIFMD) will result in some less-than-vanilla UCITS strategies restructuring their businesses as AIFMs. AIFMs, unlike UCITS, are not subject to leverage and liquidity restrictions, and can therefore transact in more esoteric instruments.
However, UCITS VI appears to be on the regulatory back-burner with much of the attention currently focused on UCITS V, which comes into effect in March 2016. UCITS V imposes remuneration restrictions on fund managers and brings the depositary regime in line with that of AIFMD following a brief period during which institutional investors in AIFMs enjoyed better protections than retail allocators into UCITS products.
UCITS V requires depositaries to provide safe-keeping of assets, cash-flow monitoring and oversight and subjects them to strict liability for loss of assets in the event of fraud and negligence in what is effectively a mirror image of AIFMD. However, UCITS V goes one step further and states the depositary is prohibited from discharging the liability to the sub-custodian.