The CSSF has published on February 18 Circular 13/559 implementing the guidelines published by European Securities and Markets Authority on 18 December 2012 for EU regulators and UCITS management companies on exchange-traded funds and other UCITS issues.
The guidelines set out the information that such funds must publish in their prospectus, key investor information document and annual report, including monitoring of tracking error, the index replication method and leverage policy.
For leveraged funds, the requirements include information on global risk calculation and management. For ETFs that engage in some sort of active management, how the investment policy is implemented must be specified.
The key provisions of ESMA’s guidelines on ETFs and other issues include the requirement that UCITS that are defined as exchange-traded funds must carry the identifier ‘UCITS ETF’ in their name.
ESMA says UCITS ETFs will have to ensure appropriate redemption conditions for secondary market investors by opening the fund for direct redemptions when liquidity in the secondary market is inadequate.
UCITS engaging in efficient portfolio management techniques such as securities lending must inform investors clearly about these activities and the related risks, and all revenues net of operating costs generated by these activities should be returned to the UCITS. UCITS should be able at any time to recall any securities lent or terminate any lending agreement.
The guidelines say UCITS that conclude derivative transactions such as total return swaps must ensure their underlying exposure complies with diversification criteria
UCITS receiving collateral to mitigate counterparty risk from OTC derivative transactions or efficient portfolio management techniques should ensure that the collateral complies with strict qualitative criteria and diversification requirements.
In addition, UCITS investing in financial indices must ensure that investors are provided with the full methodology used to calculate the indices. They may invest only in indices that respect criteria including the frequency of rebalancing and diversification.
The guidelines were finalised following the publication by ESMA of a discussion paper on guidelines for UCITS ETFs and structured UCITS in July 2011 and a consultation paper on ETFs and other UCITS issues in January 2012 (see below under related documents our article, ‘ESMA refines proposed framework to deal with complexity of ETFs and other Ucits’ of February 3, 2012).
The ESMA guidelines came into force on February 18 this year following translation into the EU’s official languages and apply immediately to any new UCITS created after that date, but funds already in existence are subject to transitional arrangements.
Existing UCITS generally have 12 months to comply with the guidelines, with various exceptions: they must comply with the UCITS ETF label requirement if they change their name earlier for another reason; any reinvestment of cash collateral after February 18 should comply with the guidelines immediately; and information requirements apply whenever the documents, prospectus, KIID or other marketing communications are next revised even if before the 12-month deadline. However, existing UCITS ETFs must comply with the provisions related to the treatment of secondary market investors as of the application date.
Structured UCITS that exist before the application date are not required to comply with the guidelines if they do not accept any new subscriptions, but they may actively manage their financial contracts to be able to continue offering the underlying payoff to existing investors.