The UCITS Directive (2009/65/EC) recognises the possibility for UCITS to offer different share classes to investors, but provides no detail as to the permitted scope of these share classes. As a result, there is no common legal or regulatory framework for establishing share classes throughout the EU. Therefore, to ensure a harmonised approach across the EU, ESMA issued an opinion on 30 January this year to the member state national regulators emphasising the four high-level principles it believes should be followed in setting up different share classes. In addition to these principles, ESMA also believes that share classes should never be set up to circumvent the rules of the UCITS Directive, particularly those on diversification, derivative eligibility and liquidity.
ESMA’s four high-level principles are:
Common investment objective
Share classes of the same sub-fund should have a common investment objective reflected by a common pool of assets. The opinion clearly expresses ESMA’s view that hedging arrangements at share class level, save for currency risk hedging, are not compatible with the requirement for a sub-fund to have a common investment objective. Accordingly, the only hedging that a share class may engage in is currency risk hedging. ESMA characterises such hedging as a means to level the playing field for EU-wide investors, by allowing them to invest in sub-funds while mitigating the currency risk.
UCITS should implement appropriate procedures to minimise the risk of features particular to one share class potentially having an adverse impact on other share classes of the same sub-fund.
Any additional risk introduced to a sub-fund through the use of a derivative overlay for a given share class should be mitigated and monitored appropriately and in the event of its realisation should only be borne by the investors in the relevant share class. At the level of the share class with a derivative overlay, ESMA requires that a UCITS should:
All features of a share class should be pre-determined before the share class is set up, this pre-determination should also apply to the currency risk which is to be hedged out systematically. However, this requirement should not be interpreted as limiting the discretion of the UCITS as to the type of derivative instrument to be used to hedge the currency risk, or its operational implementation.
Differences between share classes of the same sub-fund should be disclosed to investors when they have a choice between two or more classes. The following operational principles, considered to be minimum requirements, should be observed by a sub-fund with share classes to ensure a common level of transparency vis-à-vis all its investors:
ESMA states that share classes established prior to the publication of the opinion and which do not comply with the high-level principles set out above, will be allowed to continue to operate. However, these share classes should be closed for investment by new investors within six months (July 2017) of publication of the opinion, and for additional investment by existing investors within 18 months (July 2018) of publication of the opinion.