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Irish Investment Funds Update: Central Bank consults on UCITS IV implementation, guidance for money

PRACTICE AREA GROUP: Asset Management and Investment Funds
DATE: 07.03.2011

The Central Bank of Ireland (the “Central Bank”) has published proposed amendments to its notices and guidance notes in order to reflect and implement specific provisions of the UCITS IV Directive as necessary. The proposed revisions have been issued by way of consultation, the purpose of which is to request feedback from interested parties. Updates and guidance on additional matters outside of UCITS IV, including the application of a European definition for money market funds, have also been incorporated within the consultation.

UCITS IV TRANSPOSITION

This short consultative stage, which closes on 15 March 2011, follows a significant period of engagement between the Central Bank and the funds industry on the implementation of UCITS IV. Part of the ongoing dialogue between industry and the Central Bank involved a mapping exercise which was undertaken to consider how the relevant provisions of the UCITS IV Directive and its level 2 implementing legislation would be incorporated within the existing Irish regulatory framework.

The European deadline which the Central Bank is working towards in terms of adopting the domestic rules necessary to transpose UCITS IV is 30 June 2011. Implementation of those measures is required from 1 July 2011.

To refresh, the following are the key areas of change established by the UCITS IV Directive:

  • The introduction of enhanced organisational and conduct of business requirements for UCITS management companies and self managed investment companies (“SMICs”).
  • The introduction of the management company passport.
  • The introduction of the key investor information document (“KII”) as the replacement for the simplified prospectus.
  • Streamlining the cross-border notification procedure for UCITS through the introduction of a regulator to regulator electronic process with tighter timelines.
  • The creation of a harmonised European framework for mergers between UCITS funds.
  • Facilitating the use of UCITS master-feeder structures.
  • The strengthening of supervisory co-operation mechanisms between national regulators.

Within its consultation paper, the Central Bank states that, for the most part, the changes and new requirements imposed under UCITS IV are reflected in the draft notes and guidance notes without amendment. For some obligations however, particularly those relating to the organisational structure of UCITS management companies, the Central Bank has elaborated on the basic UCITS IV provisions in order to provide more clarity on their application. New UCITS notices have been drafted with respect to guidance on master-feeder structures and the KII.

Some of the particular matters of relevance for UCITS - in terms of UCITS IV domestic transition phases and deadline dates - which we would specifically draw to your attention are set out below.


COMPLIANCE WITH UCITS IV MANAGEMENT FUNCTION REQUIREMENTS

In the context of timely adoption by management companies and SMICs of the new UCITS IV rules on organisational matters, conflicts of interest, conduct of business and risk management, the Central Bank has requested that all existing UCITS management companies and SMICs must formulate revised business plans.

In this regard, the Central Bank requires existing UCITS management companies to submit revised business plans for review by Friday, 29 April 2011. This is to facilitate a smooth path to compliance and the Central Bank review framework is designed to support management companies to adapt to the necessary arrangements in good time for 1 July 2011. For existing management companies, action will require a gap analysis under the headings of organisational requirements, conflicts of interest, conduct of business and risk management within the UCITS implementing directive. Where these provisions have necessitated actual changes to the existing Irish rules, these modifications have been reflected within the relevant revised draft UCITS notices and draft guidance note 4/07.

SMICs authorised before 1 July 2011 must comply with level 2 measures relating to Article 14 (rules of conduct) and Article 51 (risk measurement) of the UCITS IV Directive from 1 July 2011. Accordingly, they will be required to confirm that their business plans have been amended to ensure compliance with draft UCITS 10.6 (financial derivative instruments) and UCITS 16.2 (code of conduct in relation to collective portfolio management) before 1 July 2011. The Central Bank has confirmed that these revised business plans do not need to be submitted before 1 July 2011, but may be requested at a later stage for review and approval. SMICs must comply with all UCITS IV management function requirements by 1 July 2013.

With respect to new management companies and SMICs seeking authorisation from 1 July 2011 on, these must comply with all of the UCITS IV requirements from the outset.


Regarding the extent to which policies and procedures must be addressed in business plans, the Central Bank has clarified that, whilst UCITS management companies and SMICs must maintain detailed operating procedures covering the relevant areas identified in the UCITS notices, the business plan is not required to include or incorporate those detailed operating procedures manuals. The business plan should, however, include a description of the policy in relation to those areas, with cross references to the relevant procedures. In addition, the Central Bank has highlighted that the business plan must be sufficiently detailed (and updated as necessary) in order to appropriately demonstrate how the management company/SMIC will:

  • ensure compliance with all applicable regulatory requirements; and
  • take account of the nature, scale and complexity of its business and the types of investment funds under management.

RISK MANAGEMENT PROCESS

A UCITS which uses financial derivative instruments (“FDI”) must employ a risk management process (“RMP”) to monitor, measure and manage the risks attached to the positions and their contribution to the overall risk profile of the portfolio. The Central Bank has confirmed that existing RMPs will need to be updated before 1 July 2011 to reflect the revised requirements as set out in the draft UCITS notices and guidance notes.

The Central Bank has noted that a revised RMP must be submitted to the Central Bank if a UCITS proposes to amend its investment policy in relation to its usage of FDIs but that, in all other cases, revised RMPs do not need to be submitted to the Central Bank before 1 July 2011. The Central Bank may request these RMPs at a later stage for review and approval however.

Finally, the Central Bank has clarified that a UCITS' risk management function should be described in its business plan rather than its RMP. This is on the basis that business plans describe risk management as a whole whereas RMPs specifically address the use of FDIs and risk measurement.

REPLACEMENT OF THE SIMPLIFIED PROSPECTUS WITH THE KII – TRANSITIONAL ARRANGEMENTS

Alongside the steps taken by the Central Bank to refine and clarify their rules and guidance on the mandatory changes for UCITS IV management operations, regarding the replacement of existing simplified prospectuses with the KII, the Central Bank has confirmed that Ireland will apply the full grandfathering option permissible under the UCITS IV Directive for existing UCITS.

This means that the transitional provisions which apply to UCITS established in Ireland are as follows:

  • A stand-alone UCITS or an existing UCITS umbrella authorised prior to 30 June 2011 may continue to publish a simplified prospectus until 30 June 2012.
  • A new stand-alone UCITS or a new UCITS umbrella authorised after 30 June 2011 will be required to publish a KII.
  • An existing UCITS umbrella which launches a new sub-fund after 30 June 2011 may elect to publish a simplified prospectus or a KII for the new sub-fund.
  • Where a new share class of an existing UCITS is approved during the transitional period, the UCITS must treat it in the same way as existing share classes of that UCITS. The UCITS must provide either a simplified prospectus or a KII in respect of all of its share classes.

With respect to the approval of new sub-funds, a UCITS umbrella is permitted to revise the existing consolidated simplified prospectus to include details of the new sub-fund.

The Central Bank has also published a draft policy note which explains and clarifies the various provisions applying to UCITS (including sub-funds of umbrella UCITS) which choose to avail of the transitional arrangements for the KII. This complements draft guidance note 1/11 which the Central Bank has also published in proposed form to provide direction on the publication of the KII generally and the information to be included. The guidance note takes into account the level 1, level 2 and level 3 measures which have been published at EU level regarding the KII.

MONEY MARKET FUNDS

Both UCITS and non-UCITS money market funds must comply with the European Securities and Markets Authority’s guidelines on a common definition of European money market funds by 1 July 2011. The Central Bank has noted that the majority of Irish authorised money market funds comply with these guidelines in respect of investment policies. However, an amendment to the prospectus of each money market fund to indicate whether it is a “short-term money market fund” or a “money market fund” will be necessary before 1 July 2011. In this regard, the Central Bank has requested that prospectuses should be filed for review before Friday, 29 April 2011. The Central Bank has prepared a new UCITS notice 17 and non-UCITS notice 17.7 in order to provide guidance on the content of the harmonised definitions of “short-term money market fund”, “money market fund” and related matters.

ADDITIONAL AMENDMENTS

The Central Bank has identified additional amendments which it intends to make to the UCITS notices, non-UCITS notices and guidance notes and it proposes to use the current review process as an efficient opportunity to introduce these changes. On that basis, the following have been included within the Central Bank’s consultation:

A report on related party transactions must be provided in the annual and half-yearly reports of the fund. This report must include a list of all transactions by type, the name of the related party and, where relevant, fees paid to that party in connection with the transaction.

  • Changes to the format and content of the minimum capital requirement report for management, administration and trustee companies.
  • A reduction in the minimum subscription requirement from €125,000 to €100,000 for professional investor funds.
  • Changes for closed-ended investment schemes relating to voting requirements where there are amendments proposed with respect to fund duration, certain fees or investment objectives and policies. The Central Bank has stated that it also intends to apply the same requirements to limited liquidity funds.
  • The removal of the requirement for an audit of a fund at the date of replacement of a management, administration or trustee company.

COMMENT

Following on from the consultation and feedback period, it is expected that the Central Bank will move to settle the notices and guidance notes. Given the level of Central Bank and industry input and dialogue on earlier drafts of the revised notices and guidance notes, it is not anticipated that this final consultative stage will result in material changes. Finalisation of domestic regulations to be approved by the Minister for Finance formally transposing UCITS IV is also expected.

Partners in the Asset Management and Investment Funds Group have been closely involved in the amendment and review process relating to the Central Bank notices and guidance notes and also in relation to the draft domestic regulations, with James Scanlon heading the industry task force to develop a template KII. This means that we are uniquely positioned to share our insights and knowledge of the steps required to transition to UCITS IV compliance and to work towards the phased timelines for preparation and compliance which have been co-ordinated by the Central Bank.

Please contact a member of the Asset Management and Investment Funds Group if you would like to discuss any aspect of the new opportunities arising under UCITS IV, implementation of UCITS IV in Ireland, the new guidelines for money market funds or if you have any queries regarding the additional matters relating to non-UCITS referred to above.

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