Matheson Update: Central Bank of Ireland Publishes UCITS Regulations

On 5 October 2015, the Central Bank of Ireland (the “Central Bank”) published new regulations

setting out the Central Bank requirements applicable to undertakings for collective investment in

transferable securities (“UCITS”). The Central Bank (Supervision and Enforcement) Act 2013 (Section

48(1)) (Undertakings for Collective Investment in Transferable Securities) Regulations 2015 (the “CB

UCITS Regulations”) supplement existing legislative requirements (in particular, the European

Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011)

and, together with guidance published on the Central Bank website and the UCITS Q&A, replace the

rules and guidance previously set out in the Central Bank’s UCITS Notices and Guidance Notes. The

publication of the CB UCITS Regulations follows a consultation issued by the Central Bank in January

2014 and is accompanied by a feedback statement summarising the responses received.

Background

Following the introduction of the AIF Rulebook as part of the implementation of the Alternative

Investment Fund Managers Directive (“AIFMD”), the Central Bank indicated that it would adopt a

similar approach in respect of UCITS and would consolidate into one document all of the conditions

which the Central Bank imposes on UCITS, their management companies and depositaries. The

Central Bank consulted on this proposal in its “Consultation on Publication of UCITS Rulebook”

(CP77) which outlined the Central Bank’s approach, included a draft of the new proposed UCITS

Rulebook, and raised specific queries in relation to proposals regarding the promoter regime, Central

Bank approval of regulated markets and semi-annual reporting for UCITS management companies.

The Central Bank has decided to publish the requirements applicable to UCITS in the form of a

statutory instrument rather than a “UCITS Rulebook” under relatively new regulation-making powers

conferred on the Central Bank by the Central Bank Supervision and Enforcement Act 2013. This new

procedure has been adopted for implementation of regulation in other financial sectors and the Central

Bank has indicated that using regulations is its preferred approach, as it is intended to assist fund

providers by bringing additional clarity and certainty to the rules applied by the Central Bank. The

Central Bank has indicated that it will shortly commence a review of the Central Bank’s AIF Rulebook

to see whether it should also be issued as Central Bank regulations.

Amendments to Central Bank Conditions

The CB UCITS Regulations introduce a number of amendments to the conditions previously set out in

the UCITS Notices. The key changes are as follows:

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Codification of Existing Derogations

One of the most significant changes effected by the CB UCITS Regulations is the codification of any

derogations previously granted by the Central Bank in relation to individual requirements. The Central

Bank believes that its review process has allowed it to identify any such derogations and to ensure

that they are included. If a particular derogation has not been included in the CB UCITS Regulations,

the relevant UCITS will need to re-apply for such derogation. The Central Bank has emphasised on a

number of occasions that it retains the authority to grant derogations from the provisions of the CB

UCITS Regulations.

While the Central Bank has endeavoured to ensure that all existing derogations are provided for in the

CB UCITS Regulations, each UCITS will now need to consider its current offering documents and

operating procedures, together with its authorisation file, in order to determine whether any

derogations were obtained which are not provided for in the CB UCITS Regulations and to re-apply for

such derogation if necessary. Matheson are of course happy to assist our clients with this analysis

and any such applications.

Removal of Promoter Approval Requirement

Following the approach adopted in respect of alternative investment funds in the AIF Rulebook, the

requirement for UCITS to have approved promoters has been removed. The Central Bank will instead

place reliance on the regulatory regimes for UCITS management companies and it has elaborated on

the obligations of directors in circumstances where a UCITS gets into difficulties. This is a welcome

development and follows the approach adopted by the Central Bank in implementing the AIFMD.

Guidance on Regulated Markets

The Central Bank has withdrawn Guidance Note 1/96, which set out its approach to the determination

of whether a market met the criteria for “regulated markets” upon which transferable securities or

financial derivative instruments must be listed or traded in order to be an eligible investment for a

UCITS. This withdrawal is on the basis that there is a degree of overlap between that guidance note

and the UCITS eligible assets directive. The Central Bank will no longer review submissions on

proposed regulated markets and will no longer publish a list of permitted markets for UCITS. It will

therefore be for the UCITS to determine whether a particular market meets the relevant criteria set out

in the CB UCITS Regulations, which may provide additional flexibility to UCITS.

Financial Reporting Requirements

The Central Bank has extended the financial reporting requirements by requiring UCITS management

companies and depositaries to submit half-yearly management accounts covering the second six

months of the financial year (in addition to the requirement to submit half yearly management

accounts covering the first six months of the financial year, as applied to date). The Central Bank is of

the view that this change will provide it with more complete and timely information, allowing it to

compare and analyse reports from the first six months of the year with the second six months and

providing more timely key risk indicators and alerts on PRISM, the Central Bank’s risk-based

framework for the supervision of regulated firms.

Collateral Diversification

The CB UCITS Regulations contain provisions which reflect the outcome of the Central Bank’s July

2014 consultation on the adoption of the European Securities and Markets Authority (“ESMA”) revised

guidelines on ETFs and other UCITS issues (“CP84”). ESMA’s revised guidelines provide for a

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derogation from the collateral diversification requirement where collateral consists of securities issued

or guaranteed by a member state, one or more of its local authorities, a third country or public

international body to which one or more member states belong. The derogation applies to all UCITS,

subject to additional disclosure requirements applicable to the prospectus and periodic reports of

UCITS who avail of the derogation.

The CB UCITS Regulations include provisions designed to mitigate the risks the Central Bank

perceives in applying the derogation to all UCITS and builds upon the existing obligation on UCITS

management companies to perform a credit assessment set out in the European Communities

(Undertakings for Collective Investment in Transferable Securities) Regulations 2011 by identifying a

specific credit quality threshold.

The CB UCITS Regulations provide that collateral received should be of “high quality”. In assessing

whether collateral is of high quality, the UCITS management company must ensure that, where the

issuer was subject to a credit rating by an agency registered and supervised by ESMA, that rating

must be taken into account. Where an issuer is downgraded below the two highest short-term credit

ratings by the credit rating agency, the management company must conduct a new credit assessment

of the issuer without delay. This revised rule is based on the formulation set out in ESMA’s opinion on

the review of the ESMA guidelines on a common definition of money market funds, meaning that the

threshold applied by a UCITS in its credit assessment of collateral issuers is the standard which

applies to investments by a UCITS MMF.

Further guidance in relation to the matters which should be taken into consideration in a credit

assessment process and also practice which should be followed when there is a deterioration in credit

quality have been incorporated in the UCITS guidance published on the Central Bank’s website.

US OTC Derivative Counterparties

The UCITS Notices set out a list of entities which are eligible to act as counterparties to a UCITS in

OTC derivative trades. This list includes credit institutions and MiFID firms and goes on to capture

any US entities by referring to an entity subject to regulation as a Consolidated Supervised Entity

(“CSE”) by the Securities and Exchange Commission in the US. However, due to changes in the US

regulatory framework, the CSE test has become inapplicable to broker-dealers in the US.

Accordingly, during the consultation period, industry engaged with the Central Bank to amend this list.

The CB UCITS Regulations refers, in addition to credit institutions and MiFID firms, to a group

company of an entity issued with a bank holding licence from the Federal Reserve, where that group

company is subject to consolidated supervision by the Federal Reserve.

The CB UCITS Regulations address the status of clearing houses, where central clearing is mandated

under the European Market Infrastructure Regulation (“EMIR”), by providing that, where an OTC

derivative is subject to novation, the counterparty after the novation must be one of the three entities

referred to in the preceding paragraph, a central counterparty authorised or recognised under EMIR

or, pending recognition by ESMA under EMIR, an entity classified by the SEC as a clearing agency or

by the Commodities Futures Trading Commission as a derivatives clearing organisation.

It is worth noting that the CB UCITS Regulations do not provide for a higher limit in respect of

counterparty exposure to a clearing house. In this regard, the Central Bank has stated in its feedback

statement on CP77 that ESMA has addressed this point in its Opinion 2015/ESMA/880 dated 22 May

2015 and considered that an amendment to the UCITS Directive may be required in order to raise the

relevant exposure limit.

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Investment in Indices through Financial Derivative Instruments

The Central Bank currently permits a UCITS to hold a financial derivative instrument (“FDI”) in respect

of a financial index comprised of eligible assets with concentration levels in excess of those permitted

under the UCITS Regulations, provided that, by applying a look-through approach, the consolidated

holdings held through the index, together with direct holdings, comply with the risk spreading

requirements of the UCITS Regulations. This position is amended by the CB UCITS Regulations so

that each individual underlying financial index will need to be assessed against UCITS concentration

limits.

Prospectus Requirements

The Central Bank has consolidated in the CB UCITS Regulations all of the rules relating to the

prospectus, which are now located together whereas in the UCITS Notices these rules were located

across a number of different Notices. One change introduced is a new requirement that where a

UCITS proposes to take short positions, it must disclose in its prospectus, in relation to each of the

categories of assets in which it may invest, whether it will take long or short positions or both. It must

also disclose the percentage of its assets which it anticipates will be invested in long positions and

short positions. This disclosure requirement is more detailed than was previously the case and it will

remain to be seen how investment managers will be required to address this level of detail in fund

documents.

Reporting of Non-Material Breaches

The CB UCITS Regulations introduce a new requirement for depositaries to report to the Central Bank

non-material breaches which remain unresolved for four weeks, on the basis that this is a reasonable

period within which to resolve any breach and it would be concerned to be aware of instances where

this is not the case. The Central Bank will keep the operation of this rule under review to ensure that it

is workable and proportionate.

Next Steps and Transitional Provisions

The CB UCITS Regulations will apply from 1 November 2015. There are transitional provisions in

respect of certain requirements dealing with redemption gates so that those requirements will not

apply until 2 November 2016. The prospectus disclosures required where a UCITS enters into short

positions as part of its investment policy should be included in the prospectus when it is next updated.

Comment

The consolidation of the Central Bank requirements applicable to UCITS into a single document is a

practical and welcome development, together with the removal of the promoter approval requirement

and the clarification relating to US OTC counterparties. UCITS managers will need to consider

whether they need to apply for permission to retain existing derogations and to ensure that the current

prospectus disclosures, some of which may be in place for an extended period, meet the updated

disclosure requirements. As part of our continuing engagement with the Central Bank through

industry and directly on behalf of our clients, we will seek further clarity on the timeline for filings, if

any, required as a result of this analysis. We are happy to share relevant feedback with clients as it is

made available.

If you would like any further information on the CB UCITS Regulations please contact your usual

Asset Management Group contact or any of the contacts listed in this publication.

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The CB UCITS Regulations, UCITS guidance, updated UCITS Q&A and CP77 Feedback Statement

may be accessed at the following links: CB UCITS Regulations, UCITS guidance, UCITS Q&A and

CP77 feedback statement.

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Full details of the Asset Management and Investment Funds Group, together with further updates,

articles and briefing notes written by members of the Asset Management and Investment Funds team,

can be accessed at www.matheson.com.

The material is provided for general information purposes only and does not purport to cover every

aspect of the themes and subject matter discussed, nor is it intended to provide, and does not

constitute, legal or any other advice on any particular matter. The information in this document is

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