On 05 January 2018, the Luxembourg securities regulator, the Commission de Surveillance du Secteur Financier, (CSSF) announced an important change of policy, restricting the ability of Luxembourg UCITS to invest in non-UCITS exchange traded funds (ETFs) and requiring UCITS to disinvest from existing positions as soon as possible.
On 05 January 2018, the CSSF published an updated version (Version 5) of its “Frequently Asked Questions concerning the Luxembourg Law of 17 December 2010 relating to undertakings for collective investment” (the FAQs).
Although the change itself - the deletion of FAQ1(4) - is straightforward, its consequences are noteworthy as they represent a policy shift by the CSSF as to what investments a Luxembourg Undertakings for Collective Investment in Transferable Securities (UCITS) is permitted to make into non-UCITS ETFs (including US ETFs).
The CSSF expects UCITS which have invested in such assets to divest themselves “as soon as possible taking into account the best interests of the investors”.
What has changed?
ESMA’s opinion, “Article 50(2)(a) of Directive 2009/65/EC”, dated 20 November 2012 made it clear that non-UCITS (including non-UCITS ETFs) could no longer be included in the so-called “trash” component of the portfolio (ie, the portion, up to 10%, of the assets which can be invested in otherwise ineligible transferable securities and money market instruments)
Until now, the CSSF’s stance has been that non-UCITS ETFs were eligible investments for a UCITS in the main “non-trash” portfolio so long as that they effectively complied with the criteria of Articles 2(2) and 41(1)(e) of the Luxembourg Law of 17 December 2010 (the 2010 Law), “notwithstanding that the offering documents of non-UCITS ETFs grant possibilities which are not equivalent to requirements applicable to UCITS”.
Under this provision, the UCITS had to ensure that the ETF’s investment rules were equivalent to those applicable to UCITS. To this end, the UCITS was entitled to rely on written confirmation of the ETF or its manager as to equivalence of the investment rules.
However, to come into line with other regulators in their application of the UCITS Directive, the CSSF now considers that, for other Unregulated Collective Investment schemes (UCIs) to be eligible under Article 50(1)(e) of that Directive, those UCIs:
- must not be able to invest in illiquid assets (which the CSSF regards as including commodities and real estate), in line with Article 1(2)(a) of the UCITS Directive
- must be bound by rules on asset segregation, borrowing, lending, and uncovered sales of transferable securities and money market instruments which are equivalent to the requirements of the UCITS Directive in line with Article 50(1)(e)(ii) of the UCITS Directive. The CSSF specifies that “mere compliance in practice shall not be considered sufficient”
- must be subject, through their fund rules or instruments of incorporation, to a restriction by which no more than 10% of the UCI’s assets can be invested in aggregate in units of other UCITS or other UCIs, in line with Article 50(1)(e)(iv) of the UCITS Directive. Again, “mere compliance in practice shall not be considered sufficient”.
What to do if invested in non-eligible UCIs
New investments in such UCIs are no longer permitted if they fail to (or no longer) meet the above criteria.
UCITS subject to the 2010 Law which have invested in a UCI, such as a non-UCITS ETF, following the CSSF’s previous policy set out in FAQ 1.4 must disinvest from these UCIs “as soon as possible taking into account the best interests of the investors”.
The CSSF notes that, from 31 March 2018, it will be contacting UCITS managers which had invested in non-UCITS UCIs to check that they are in compliance with the new policy.
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