SHEET 19
Undertakings for Collective Investment in Transferable Securities Directive
19.1 Key Elements
19.1.1 Scope
The purpose of this directives is to establish and regulate Undertakings for Collective Investments in Transferable Securities (UCITs), which are open‐ended, diversified, and lowly‐ or unlevered funds that invest into typically liquid assets. ‘Open‐ended’ indicates that the investors can invest in or redeem units at any time, at close to net asset value. Alternatively, units can be traded on an exchange with a mechanism that ensures that units always trade close to net asset value, as is the case for ETFs. UCITS can have several investment compartments, which for most purposes look like individual UCITS (Art 1).
A number of fund types are specifically excluded from this directive, notably closed‐ended funds—ie funds that don't allow redemption and investment during the lifetime of the fund—as well as funds that are either not marketed to the general public, or only marketed outside the Single Market, and funds that do not qualify either on the basis of the assets they invest in or the leverage they apply (Art 3).
19.1.2 Authorisation and Passporting
A key focus of the UCITS Directive is the passporting regime that allows managers domiciled in one Member State to manage funds domiciled everywhere in the Single Market, and that also allows funds that are domiciled in one Member State to be marketed all across the Single Market. In this respect, whilst Member States have some freedom to establish additional requirements on UCITS funds, those requirements must not be applied in a discriminatory manner (Art 1.6–7).
UCITS’ must be authorised in their home Member State, and authorisation is valid across the entire Single Market. An application to authorise a UCITS shall be decided within two months. UCITS’ can only be authorised if both their management company and the depositary are authorised in their respective home Member States, and the directors of the depositary are of sufficiently good repute, and sufficiently experienced in relation to the type of UCITS to be managed. Both management company and depositary can only be changed if authorised by the relevant regulator (Art 5).
If UCITS’ are intending to merge, a number of rules safeguarding the unit holders apply (Arts 37–48). UCITS can be organised in a master‐feeder structure where the feeder UCITS invests in the master, in which case a number of specific rules apply (Arts 58–67).
19.2 Management Companies
Management companies must be authorised in their home Member State—the state where both their head office and registered office are located—and authorisation is valid across the entire Single Market. An application shall be decided after a maximum of six months. Management companies cannot engage in any other activities, with the exception of managing funds that are not covered by this directive, and a few ancillary services that Member States can allow (Art 6; activities in Annex II). Management companies are subject to capital requirements of 0.02% of their assets under management, with a minimum of €125k and a maximum of €10m, up to half of which can be provided by means of a bank guarantee. The staff must be of sufficiently good repute and are sufficiently experienced to perform their duties (Art 7).
Member States must subject management companies to prudential and conduct rules following certain guidelines (Arts 12, 14). In particular there must be a remuneration policy in place that satisfies certain detailed requirements, including that part of the compensation might have to be paid in units of the managed funds, and deferral requirements (Art 14 a–b[V:2]).
Management companies can only be authorised if their significant shareholder or members are known to the regulator and considered suitable (Arts 8, 11). The main responsibility for supervision rests with the home regulator, but host regulators have a role where specified in the Directive (Art 10). Delegation to third parties—including outside the Single Market—can be allowed, but must be subject to specific safeguards. However, the management company itself must retain a substantive part of the overall responsibilities, and remains ultimately responsible for all delegated work (Art 13). Management companies must have a complaints procedure for investors in place, and it must be accessible in the language of all the Member States in which they are operating (Art 15).
19.2.1 Passporting of Management Companies
Management companies authorised in one Member State have the right to provide services all across the Single Market, either via branches, or as cross‐border services. If they only market UCITS they manage in another Member State there are very few additional requirements. For most other activities they have to notify their home regulator and can only start providing services in the other Member State after about a month (Art 18; notification Arts 17–18). The majority of the supervisory responsibility rests with the home regulator (Arts 19–20). However, host regulators can ask for regular reporting for statistical purposes, and to ensure compliance with host‐country specific rules. Requirements for passported companies shall not be more stringent than those for locally resident companies. Infringement discovered by a host regulator will generally be reported to and dealt with by the home regulator (Art 21).
19.2.2 Third‐country Management Companies
Branches of management companies from third countries cannot be accorded better terms than those from within the Single Market (Art 8.2). Notwithstanding that, management companies authorised in a Member State have the right to delegate the actual investment management task to persons outside the EU, provided that certain conditions are fulfilled (Art 13). In the case of issues with reciprocal access with third parties, the same escalation and retaliation rules as under MiFID apply (Art 9, MiFID1 Art 15).
19.2.3 Investment Companies
Investment companies are one possible vehicle of how investors can hold their investment, the other one being common funds (Art 2). Investment companies must have their registered office in, and be authorised in, a Member State (Art 27).
Their activities are restricted to holding the assets for the UCITS (Art 28).
If an investment company has no dedicated management company, certain more restrictive rules apply that mirror those that would otherwise apply to the management company (Arts 29–30 and Art 30[V:11]).
19.3 Depositaries
Depositaries must either be established in a Member State or have their registered office in one (Art 23) and they must be regulated (Art 23[V:6]). Managers can't be depositaries and vice versa, and depositaries cannot engage in any activities that would create a conflict of interest (Art 25[V:8]). The Commission is providing more detailed guidance on the requirements that depositaries must fulfil (Art 26b[V:10]).
Managers must appoint a single depositary for each of the funds they manage, and this appointment must be evidenced by a written contract. The depositary is inter alia responsible for ensuring that fund transactions (sale, issue, repurchase, redemption and cancellation of units) and valuation is done in accordance with applicable national law and reconciliation of all payments. To the extent that assets can be held at the depositary, they must be held there. Where this is not possible, the depositary must have a specific procedure in place to assert ownership of the assets. The assets under custody must be safe in the event of bankruptcy of the depositary (Art 22[V:4]).
Depositaries are not allowed to reuse the assets (eg use them in securities lending or repo transaction) unless under instructions by the UCITS management company, for benefit of the unit‐holders, and covered by high‐quality and liquid collateral (Art 22[V:5]).
There are restrictions as to what tasks depositaries can delegate, and all delegation has to happen for objective business reasons, and in particular not for avoiding regulatory requirements. For sub‐delegation, similar rules apply (Art 22a[V:5]). Depositaries are directly liable both to UCITS and unit‐holders for damages they cause, and this cannot be limited by agreement. (Art 24[V:7]).
19.4 Investment Policies
UCITS funds and investment companies have to follow certain specific investment rules. In the case of compartmented UCITS, each of the compartments must follow the rules independently (Art 49). UCITS can only invest in the following assets (Art 50):
- transferable securities and money market instruments traded on a regulated market, or some other specified venues, including third‐country stock exchanges
- recently issued securities that will be trading on a market as under point 1 within at most a year
- other UCITS’, provided that no more than 10% of investors in the target UCITS are other UCITS’ (except in the case of feeder‐master structures)
- deposits at banks with a maturity of less than 12 months
- derivatives that are traded on a market as under point 1, or OTC derivatives under some circumstances
- some money market instruments that are issued by a public body, a regulated entity, or an entity that has other securities listed on a market as under point 1
- real estate which is essential for the direct pursuit of its business in the case of investment companies.
Management or investment companies must engage in an adequate risk management process, in particular also with respect to derivatives, and there are certain limits as to the use of derivatives for hedging (Art 51).
There are concentration limits. Notably, not more than 5% of the assets can be invested in securities issued by the same body, not more than 20% in deposits with the same bank, and not more than 10% in investments in any specific other UCITS. Aggregate investment in non‐UCITS collective investment schemes is limited to 30%. Derivative counterparty exposure is limited to 10% against banks, and 5% otherwise. Member States have some discretion to change those limits (Arts 52–55).
There are also rules that are meant to avoid a UCITS—or a management company acting via multiple UCITS’—being in a position to exercise significant influence over the management of an issuing body. In this context, a UCITS cannot acquire more than 10% of either of the non‐voting shares, debt instrument, and money market instruments issued by a single body (Art 56).
Where UCITS’ have substantial investments in other UCITS’, this has some implications with respect to disclosure of fees (Art 55). The above limits do not have to be adhered to if securities are acquired in relation to subscription rights, or for reasons beyond the control of a UCITS (Art 57).
19.5 Investor Information
19.5.1 Prospectus and Reports
Every fund and investment company must produce a prospectus, an annual report, and a half‐yearly report (Art 68). Those must be provided to investors as paper copy on demand and free of charge. They must also be provided in a durable medium or by means of a website.
The prospectus must contain as an annex the rules or instruments of incorporation, possibly by referring to a location from where they can be easily obtained (Art 71). The prospectus must allow investors to be able to make an informed judgement of the investment proposed to them, and, in particular, of the risks attached thereto, including a clear and easily understandable explanation of the fund's risk profile. It also must contain the information specified in Schedule A of Annex I, as amended by UCITS 5 under point 25 (Art 69). It also must include specific information as to the fund's investment policy, especially if higher‐risk strategies are followed (Art 70). It must be kept up to date (Art 72).
The annual report must include a balance sheet, an income statement, and a report on the activities of the financial year, as well as the specific information in Schedule B of Annex I. The information required in the half‐yearly report is slightly less (Art 69). The annual report must be audited, and the auditor's statement must be reproduced in full (Art 73).
19.5.2 Key Investor Information
The central document that must be produced by UCITS is the key investor information document. It must include (Art 78)
appropriate information about the essential characteristics of the UCITS concerned, which is to be provided to investors so that they are reasonably able to understand the nature and the risks of the investment product that is being offered to them and, consequently, to take investment decisions on an informed basis.
It must contain a specified set of information, including (Art 78.3) investment objectives and policy, costs and associated charges, and risk/reward profile.
A fund marketed in multiple jurisdictions must use the same key investor information document across all jurisdictions, the only allowed difference being due to translation. The document must be written in a concise manner and in non‐technical language, and must be comprehensible to the investor without any reference to other documents. It also must clearly specify where and how to obtain additional information. It must follow a common format, the details of which are being defined by the European Commission (Art 78).
The key investor information document must be provided to customers free of charge in good time before they purchase units, regardless of whether they purchase them directly or via an intermediary. It also must be available on the website in an up‐to‐date version (Arts 80–81).
19.5.3 Other Information
UCITS’ must make publicly available the issue, sale, repurchase, or redemption price of its units each time it issues, sells, repurchases, or redeems them, and at least twice a month (Art 76).
Marketing communication must be clearly identifiable as such, and must be fair, clear, and not misleading. In particular it must make no statement that contradicts or diminishes the significance of the information contained in the prospectus and the key investor information, and it must explain in which languages those other documents are available and how to get them (Art 77).
19.6 General Obligations of UCITS’
UCITS funds and investment companies are not generally allowed to borrow, ie they must be unlevered except in the case of foreign currency holdings. However, Member States may allow them to borrow up to 10% of their assets on a temporary basis, plus another 10% for acquiring real estate used for operating their business, up to a grand total of 15% (Art 83).
UCITS’ must repurchase or redeem units at the request of any unit‐holder, except in cases where it—in accordance with local law—temporarily suspends redemptions, or is ordered by their regulator to do so (Art 84). Issue and redemption prices—and more generally valuations—have to be done in accordance with applicable law, fund rules, or instruments of incorporation (Art 85), as do the distribution or reinvestment of income (Art 86) and the calculation of fees that can be charged by the management company (Art 90). Units can only be issued when the adequate cash consideration has been received (Art 87). Funds and investment companies cannot engage in lending activities—including guaranteeing loans—unless those loans are eligible investments under Arts 50–51 (Art 88), and neither can they engage in uncovered sales (Art 89).
19.7 Cross‐border Distribution and Passporting of Funds
UCITS’ that seek to distribute their fund in other than their home Member State must submit a certain set of documents—including a translated copy of the key investor document—to their home regulator, who forwards it to the host regulator within 10 days. From the point where the information has been forwarded the UCITS is free to market the units (Art 93). Member States are not allowed to impose any additional requirements on foreign funds within the field governed by this Directive. The UCITS must however comply with the usual local requirements outside this field, and the KID must be easily accessible from a distance and by electronic means. Information on those requirements must be available in a language customary in the sphere of international finance, is provided in a clear and unambiguous manner and is kept up to date (Art 91).
In all countries where a UCITS is marketed, the key investor information must be available in at least one official local language. The other documents can be provided—at the choice of the UCITS—in one of the official languages, in a language approved by the regulator, or—importantly—in a language customary in the sphere of international finance such as English. The manner in which those documents must be provided is determined by applicable local laws and regulations (Art 94).
19.8 Regulators and Regulatory Powers
The directive establishes a requirement for Member States to appoint a regulator (Art 97), the general powers of the regulator (Art 98), and a requirement for them to cooperate in a specific manner (Arts 101, 109–110). Regulators are bound by professional secrecy rules (Art 102), which can be softened in some specific circumstances, eg in a liquidation event (Art 103). Also, they are allowed to transmit information to the central bank and similar bodies (Art 104, Art 104a[V:18]). Certain persons must report breaches of this regulation if they become aware of them (Art 106). Regulators must generally provide reasons for refusals in writing (Art 107), and the main sanction power lies with the home regulator, even for infringements that happened in another Member State (Art 108).
There must be an out‐of‐court settlement procedure in place for customer disputes, and it must work on a cross‐border basis (Art 100).
19.8.1 Fines
The regulation requires that the maximum amount must be at least the bigger of €5m and twice the benefit derived, and 10% of turnover for legal persons (Art 99[V:16]). The regulation specifies circumstances which must attract penalties, eg running a business without obtaining authorisation (Art 99a[V:17]). Similar to other directives, this one specifies which circumstances should be taken into account when deciding about the size of a penalty (Art 99c[V:17]). The presumption is that penalties should be made public unless specific circumstances warrant keeping it secret (Art 99b[V:17]). In any case, ESMA must be informed (Art 99e[V:17]). Member States should put structures in place that allow whistleblowers to come forward, and ensure that they receive adequate protection (Art 99d[V:17]).
19.9 Other
The European Commission has been given power to make certain technical amendments (Art 111, Art 112a[V:23]). It is supported by the European Securities Committee (ESC) (Art 112[V:22]).
There are a number of derogations, notably for Danish pantebreve, and in relation to bearer certificates (Art 113). Certain investment firms currently regulated under MiFID can choose to be regulated under UCITS instead (Art 114).