On December 23rd 2014 the European Securities Markets Authority ("ESMA") issued a discussion paper (the "Discussion Paper") on share classes of UCITS.
Due to diverging national practices as to the types of share class that are permitted in a UCITS, ESMA sees a case for developing a common understanding in this area.
The Discussion Paper sets out ESMA's views on what constitutes share classes, how to distinguish share classes from compartments and provides possible approaches to the extent of differentiation between share classes that should be permitted.
ESMA identified three principles that should be used in assessing the legality of different share classes:
- Share classes of the same UCITS should have the same investment strategy;
- Features that are specific to one share class should not have a potential (or actual) adverse impact on other share classes of the same UCITS; and
- Differences between share classes of the same UCITS should be disclosed to investors when they have a choice between two or more classes.
"ESMA's view is that a UCITS or management company seeking to offer different investment strategies should create a separate sub-fund or UCITS for each strategy."
The Discussion Paper sets out a non-exhaustive list of types of share classes that would be compatible with the above principles, including:
- Share classes that differ according to the maximum or minimum investment amounts, or values of holdings allowed to be retained;
- Share classes that differ in terms of the type of investor (e.g. institutional or retail);
- Share classes that differ according to the currency in which they are denominated;
- Share classes that provide currency hedging when share classes are denominated in different currencies from the base currency.
ESMA points out that currency hedging is compatible with the principle of a common investment strategy as such hedging arrangements are intended to ensure that investors receive as nearly as possible the same results of the investment strategy even though their exposure is through a different currency. However currency hedging should only be possible if it cannot have an adverse impact on the unit-holders of the other share classes of the UCITS and the costs of hedging should only be borne by the unit-holders of the hedged share class.
The Discussion Paper also sets out a non-exhaustive list of types of share classes that do not appear to be compatible with the three principles above, including:
- Share classes that are exposed to different pools of underlying assets;
- Share classes whereby the same underlying portfolio is swapped against different portfolios of assets; and
- Share classes that differ in terms of leverage.
ESMA believes that interest rate hedging performed at the level of share classes does not comply with the principle of having the same investment strategy, because it modifies the investment strategy of the share class.
Via a series of questions ESMA seeks feedback from interested stakeholders. The deadline for responding is March 27th 2015.