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ESMA publishes Discussion Paper on UCITS Share Classes
AUTHOR(S): Anne-Marie Bohan, Dualta Counihan, Elizabeth Grace, Joe Beashel, Liam Collins, Michael Jackson, Philip Lovegrove, Shay Lydon, Tara Doyle
PRACTICE AREA GROUP: Asset Management and Investment Funds
On 23 December 2014, the European Securities and Markets Authority (“ESMA”) published a discussion paper on UCITS share classes (the “Discussion Paper”) in which it has set out its views on what constitutes a UCITS share class; how to distinguish UCITS share classes from sub-funds of UCITS; and possible approaches to share class differentiation.
ESMA notes that, while the UCITS directive recognises the possibility for a UCITS to offer more than one share class to UCITS investors, it does not prescribe whether, and to what extent, share classes within a given UCITS / UCITS sub-fund can differ from eachother. The context for the Discussion Paper is the identification by ESMA of diverging national practices regarding the types of share class differentiation permitted, ranging from, for example, share classes with different levels of fees to share classes with potentially different investment strategies. Arising from this, ESMA states that there is merit in developing a common understanding of what constitutes a UCITS share class and the extent of permissible differentiation at share class level. For the purposes of the Discussion Paper, and this briefing note, ESMA’s reference to share and share class covers units of all UCITS regardless of the legal vehicle used, and references to UCITS include UCITS sub-funds.
Summary of Main Points
A key principle identified by ESMA in the Discussion Paper is that share classes established within UCITS should have the same investment strategy, and that UCITS seeking to offer different investment strategies should create separate UCITS / UCITS sub-funds for each strategy.
ESMA proposes a non-exhaustive list of permissible differentiation at UCITS share class level, as follows:
- Share classes that differ according to the maximum or minimum investment amounts, or values of holdings allowed to be retained.
- Share classes that differ in terms of the type of investor (eg, institutional investors versus retail investors).
- Share classes that differ according to the types of charges and fees that may be levied and their amount (on-going charges, subscription and redemption fees, performance-related fee).
- Share classes that differ according to the currency in which they are denominated.
- Share classes that differ according to the allocation of revenues to investors (by capitalisation or distribution, either subject to or exempt from withholding tax).
- Share classes that differ according to their characteristics: registered or bearer.
- Share classes that differ in terms of voting rights.
- Share classes that provide currency hedging when share classes are denominated in different currencies from the base currency.
Regarding currency hedging at the level of a UCITS share class, ESMA states that this could be considered as compatible with the principle of common investment strategy provided the currency hedging does not adversely impact on the shareholders of the other share classes and that the costs of the hedging are borne only by the shareholders of the hedged share class.
A non-exhaustive list demonstrating differentiation at share class level which would not be regarded as permissible by ESMA is also set out in the Discussion Paper. This comprises share classes:
- which are exposed to different pools of underlying assets;
- which are exposed to the same pool of assets but with different levels of capital protection and / or payoff;
- in which the same underlying portfolio is swapped against different portfolios of assets;
- which offer differing degrees of protection against some market risks such as interest rate risk or volatility risk; and
- which differ in terms of leverage.
With respect to interest rate hedging performed at share class level, ESMA’s view is that this does not comply with the overarching principle identified in the Discussion Paper that share classes within the same UCITS / UCITS sub-fund should have a common investment strategy, on the basis that it modifies investment strategy at share class level.
Comments and Next Steps
The Discussion Paper sets out fourteen questions for stakeholders to consider. These include the basic questions as to whether respondents agree that ESMA should develop a common position on what constitutes a UCITS share class, and how share classes may differ from each other. The deadline for responses is 27 March 2015.
The content and subject of this Discussion Paper will form the basis of Matheson’s Roundtable Event in the New Year. This will take place in London and the US in early 2015.
ESMA’s Discussion Paper may be accessed here.