Unregulated Funds Ruled Ineligible for Investment by UCITS

In an unexpected move, and without any formal consultation, the European Securities and Markets Authority (“ESMA”) issued an opinion last week on the interpretation of Article 50(2)(a) of the UCITS Directive (“Article”) whereby UCITS could invest up to 10% in transferable securities and money market instruments that were not otherwise eligible assets.  This 10% “trash ratio”, as it is known, could be used to facilitate investment into unregulated funds.

ESMA has advised that the Article refers only to investments in transferable securities and money market instruments and does not refer to shares of funds.  Many national regulatory authorities have interpreted this differently and permitted investment into unregulated funds as part of the trash ratio.

ESMA further advised that any UCITS that have invested in unregulated funds will have to redeem or dispose of those holdings by 31 December 2013.  Furthermore, those UCITS may have to amend their investment policies if they have allowed for investment in unregulated funds.

It should be noted that all other fund investment rules for UCITS, such as investment in other UCITS, will remain the same.

The opinion, particularly as it was not formally discussed, is a further example of a wish at European level for a harmonized interpretation of regulations. It should also be seen in the context of a wider discussion under UCITS V1 of the eligibility of certain assets in UCITS and whether the range of assets in which a UCITS can invest will be restricted.