The European Securities and Markets Authority (ESMA) published its advice to the European Commission (EC) on the review of the UCITS Eligible Assets Directive (EAD). The EAD is an implementing directive providing clarification on the assets a UCITS can invest in. In the Technical Advice ESMA provides a comprehensive assessment of the EAD’s implementation across Members States and makes proposals to ensure regulatory clarity and uniformity across jurisdictions.
A central element of the Technical Advice is the application of a look-through approach as a fundamental criterion for determining the eligibility of asset classes for at least 90% of the UCITS portfolio. Allowing a certain degree of flexibility, the advice proposes to permit indirect exposures to alternative assets up to 10% (subject to regulatory safeguards e.g. on liquidity and valuation) with a view to improving risk diversification and generating returns from uncorrelated asset classes.
Verena Ross, ESMA’s chair, said in a statement: “The policy proposals set out by ESMA are based on a comprehensive data collection exercise, and will help foster regulatory harmonization and supervisory convergence for UCITS management companies operating and marketing UCITS on a cross-border basis.”
Also, in the spirit of the EU’s ambitions to create a Savings and Investment Union, ESMA sets out high level considerations for improving retail investor access to EU AIFs, through harmonizing currently divergent national rules on cross-border marketing and the potential creation of a retail AIF product.
“ESMA expects the European Commission to take this Technical Advice into account as it reviews the UCITS EAD,” ESMA wrote in a statement.
The technical advice mentions three topics related to efficient portfolio management (EPM) techniques: costs, collaterals, and alignment with the techniques and instruments defined in the Securities Financing Transactions Regulation (SFTR).
- With regard to costs, the technical advice is not proposing any changes in the EAD, but it recommends the European Commission to address this matter in the context of a systematic review of the UCITS Directive (either in the UCITS Directive or in other legal acts, such as the Retail Investment Strategy). ESMA advises the European Commission to give consideration to the policy proposals included in the 2023 ESMA opinion on undue costs. The benefits of incorporating these cost-related policy proposals are stated in the 2023 ESMA opinion. The costs and other impacts should be assessed further in the context of any such future review.
- With regard to collaterals, the proposal made addresses the question related to the possibility of deploying collateral arrangements that do not envisage a title transfer. The technical advice proposes to the European Commission to clarify wording in the UCITS Directive that would allow UCITS to deploy EPMs whose collateral arrangements do not envisage a title transfer, in line with ESMA guidelines on ETF and other UCITS issues. The benefits are therefore greater legal clarity and convergence. This policy proposal is in line with the flexibility advocated for by majority of respondents to the Call for Evidence. In terms of costs, the proposed changes are rather of a clarificatory nature, confirming what has been already said in the ESMA guidelines on ETFs and other UCITS issues. To that end, ESMA expects the cost implications to be limited.
- With regard to the alignment with SFTR, in line with the feedback received by respondents, the proposal does not envisage a full alignment. However, in order to bring further clarity to the system, only as a matter of clarification, the technical advice explains that the notions and definitions used in the SFTR should be deemed relevant for the UCITS purposes, provided that 1) the notion and definition of the specific technique allows the UCITS to comply with its requirements (e.g. on borrowing and short selling) and 2) these notions and definitions are not intended as exhaustive. ESMA is of the view that these clarifications should not increase costs.
On securities lending fee splits, ESMA hence recommended that the EC consider providing further legal clarity on EPM-related costs and fees including on the fee split models with a view to ensuring investor protection.
In industry consultation, a majority of respondents expressed support for allowing fee splitting arrangements that enable UCITS management companies to deduct fees for initiating, preparing, and executing EPMs, such as securities lending, while ensuring adequate disclosures of the generated and retained fees to investors. These respondents expressed the view that such arrangements help to preserve the competitiveness and the quality of the EPM services provided to UCITS (and, ultimately, to investors), regardless of whether the activity is delegated to a third party or performed internally.
“ESMA is of the view that the policy proposals included in the 2023 ESMA opinion on undue costs of UCITS and AIFs may significantly help to tackle the risk of UCITS investors being charged with undue EPM costs, notably the proposals included therein on related-party transactions, due diligence to ensure that all charged costs are equal or better than market standards and the investor compensation obligations in cases where undue costs have been charged,” ESMA wrote in its advice.