UCITS III – Investment & Borrowing Restrictions for UCITS Funds

UCITS Funds

11 Sep 2012 UCITS III – Investment & Borrowing Restrictions for UCITS Funds

The following rules apply to Maltese UCITS funds, as well as their sub-funds, set-up after 1st November 2007 under the Undertakings for Collective Investment in Transferable Securities and Management Companies Regulations, 2004 (the “Regulations”). In order to constitute a Maltese UCITS fund, the registered office and head office of the investment management company (if established as a unit trust or common fund), and the registered office and head office of the company (if established as an investment company (SICAV), must be located in Malta. Furthermore, the UCITS fund must be harmonised in accordance with the UCITS Directive and licensed in terms of the Investment Services Act. 

 

Permissible Investments

 

The investments of a UCITS fund are confined to any or all of the following:

 

  1. transferable securities and money market instruments admitted to or dealt on a regulated market or another recognised regulated market in any EU Member State (“Member State”), which operates regularly and is open to the public;
  2. transferable securities and money market instruments admitted to official listing on a stock exchange in a non-Member State or dealt on another recognised regulated market in a non-Member State, which operates regularly and is open to the public; recently issued transferable securities;
  3. units of other UCITS funds authorised in terms of the UCITS Directive and/or other collective investment schemes, whether situated within the EU or otherwise, which satisfy certain criteria
    and fall within the definition of a UCITS fund;
  4. deposits with banks having their registered office within a Member State, which are repayable on demand or may be withdrawn, maturing within no more than 12 months, or any such deposits held by banks having their registered office in a non-Member State, provided that such banks are subject to prudential rules considered by the Malta Financial Services Authority (MFSA) to be equivalent to those laid down by Community Law;
  5. financial derivative instruments, including equivalent cash-settled instruments, traded on a regulated market (“exchange-traded derivatives”) or over-the-counter (“OTC derivatives”);
  6. money market instruments, other than those dealt on a regulated market, if the issue or issuer of such instruments is itself regulated with the purpose of protecting investors and savings, and provided that such money market instruments are:
  • issued or guaranteed by (i) a central, regional or local authority or central bank of a Member State, (ii) the European Central Bank, (iii) the EU or (iv) the European Investment Bank, (v) a non-Member State or, in the case of a federal state, by one of the members making up the federation, or by (vi) a public international body to which one or more Member States belong;
  • issued by an undertaking the securities of which are dealt on a regulated market;
  • issued or guaranteed by an establishment subject to prudential supervision in accordance with criteria defined by Community law, or by an establishment which is subject to and complies with prudential rules considered by the MFSA to be as stringent as those laid down by Community law; or
  • issued by other bodies falling within the categories which the MFSA may from time to time prescribe;
  1. where a UCITS fund is set up as a company or a limited partnership, movable and immovable property which is essential for the direct pursuit of its business. It may not, however, acquire precious metals or certificates representing them.

 

Investment Restrictions

 

The investments of Maltese UCITS funds are restricted as outlined below. It should be noted that the following restrictions do not apply to UCITS funds when exercising subscription rights attaching to transferable securities or money market instruments which form part of their own assets.

 

Investments in Transferable Securities and Money Market Instruments

 

A UCITS fund cannot invest more than 10% of its own assets in transferable securities and money market instruments, and not more than 5% in transferable securities and money market instruments issued by the same body. This 5% limit does not apply to deposits and OTC-derivative transactions with financial institutions subject to prudential supervision, and may be increased:

 

  • to 10% if the value of securities held in the same body is less than 40% of the UCITS fund’s assets;
  • to 20% (and, subject to MFSA approval, to 35% where it proves to be justified by exceptional market conditions) in the case of investment in shares and/or debt securities issued by the same body, where the investment policy of the UCITS fund, as outlined in its prospectus, is to replicate the composition of a certain stock or debt securities index;
  • to 25% in the case of bonds issued by a bank which has its registered office in a Member State and is, by law, subject to special public supervision designed to protect bond-holders; and
  • to 35% if the transferable securities and money market instruments are issued or guaranteed by a Member State, or by its local authorities, by a non-Member State or by public international bodies to which one or more Member States belong.

 

The above limits are without prejudice to the power of the MFSA to authorise a UCITS fund to invest up to 100% of its assets in transferable securities and money market instruments in accordance with the principle of risk spreading, provided that such securities and instruments are issued or guaranteed by any Member State or its local authorities, a non-Member State or public international bodies of which one or more Member States are members. Furthermore, the MFSA must be satisfied that unit-holders in the UCITS fund have protection equivalent to that of unit-holders in a UCITS fund complying with the above limits. If the MFSA authorises any such increase, the UCITS fund must abide by the following conditions:

 

  • it must hold securities from at least six different issues, provided securities from any one issue may not account for more than 30% of its total assets; and
  • its prospectus and any promotional material of the UCITS fund must clearly disclose the names of the states, local authorities or public international bodies issuing or guaranteeing securities in which it intends to invest more than 35% of its assets.

 

Bank Deposits

 

A UCITS fund cannot deposit more than 20% of its assets with any one bank. However, if the principle of risk-spreading is observed, a UCITS fund may exceed this limit during the first six months from its launch.

 

Trading in Derivates

 

A UCITS fund is permitted to trade in OTC and exchange-traded derivatives as long as:

 

  • the underlying assets consists of financial indices, interest rates, foreign exchange rates or currencies, and this is in accordance with its investment objectives as laid down in its prospectus or instruments of incorporation;
  • the counterparties to OTC-derivative transactions are institutions subject to prudential supervision and approved by the MFSA;
  • the OTC-derivatives are subject to a reliable and verifiable valuation on a daily basis and can be sold, liquidated or closed by an offsetting transaction at any time, at their fair value and upon the UCITS fund’s own initiative; and
  • its maximum exposure (i.e. the maximum potential loss incurred if a counterparty defaults) to one counterparty in an OTC-derivative transaction is not more than 5% of the value of its total assets. This limit may be increased to 10% for OTC-derivative transactions with banks having their registered office within a Member State which are repayable on demand or may be withdrawn, maturing in no more than 12 months, or any such deposits held by banks having their registered office in a non-Member State, provided that such banks are subject to prudential rules considered by MFSA as equivalent to those laid down by Community Law. These limits do not apply during the first six months from launch if the UCITS fund observes the principle of risk-spreading.

 

A UCITS fund must ensure that its global exposure (taking into account the current value of the underlying asset; the counterparty risk; future market movements; and the time available to liquidate positions) to derivatives does not exceed the total net value of its portfolio, and its overall risk exposure must not exceed 200% of its net asset value (NAV).

 

A UCITS fund is only permitted to enter into transactions for direct investment in derivatives or for efficient portfolio management / hedging with counterparties who:

 

  • are not the manager or custodian of the UCITS fund;
  • form part of a group whose head office or parent company is licensed, registered or based in Malta, the EEA or any member of the Organisation for Economic Co-operation and Development (OECD), and is subject to prudential supervision equivalent to that laid down by Community law; and
  • have a credit rating of at least A (Standards & Poor) or A2 (Moody’s) or any other rating, which is acceptable to the MFSA.

 

Uncovered Sales

 

A UCITS fund may not engage in ‘uncovered sales’ of transferable securities, money market instruments, units of other UCITS funds or derivates. ‘Uncovered sales’ refer to all transactions which expose a UCITS fund to the risk of having to buy securities at a higher price than the price at which the securities are delivered, thus suffering a loss, and the risk of not being able to deliver the underlying assets for settlement upon maturity.

 

Single Issuer Exposures

 

A UCITS fund is not allowed to combine more than 20% of its assets in investments in transferable securities and money market instruments issued by a single body. This 20% limit also applies to deposits with the same bank as well as counterparty and other exposures from OTC derivate transactions with the same body. A UCITS fund is permitted to derogate from this 20% limit during the first six months of its launch if it observes the principle of risk-spreading.

 

Investments in other UCITS Funds or Collective Investment Schemes

 

A UCITS fund is permitted to invest up to 20% of its own assets in the units of single UCITS fund or other collective investment schemes. On the other hand, the total investment of a UCITS fund in the units of other collective investment schemes (not being UCITS fund) cannot exceed 30% of its own assets. Whenever a UCITS fund invests a substantial proportion of its assets in other UCITS funds or collective investment schemes, all management fees (i.e., fees chargeable by both investing UCITS funds and those chargeable by the UCITS fund / other collective investment scheme in which the former invests) must be disclosed in its prospectus as well a its annual report.

 

A UCITS fund may not acquire more than 10% of the non-voting shares, debt securities or money market instruments of any single issuing body; or 25% of the units of any single UCITS fund or other collective investment scheme. Furthermore, a UCITS fund or its manager is not allowed to acquire any shares carrying voting rights in another UCITS fund or collective investment scheme which would enable that UCITS fund or its manager to exercise a significant influence over its management. This latter prohibition and the 10% and 25% limits may, however, be disregarded in the case of:

 

  • transferable securities and money market instruments issued or guaranteed by a Member State or its local authorities;
  • transferable securities and money market instruments guaranteed by non-Member States;
  • transferable securities and money market instruments issued by public international bodies of which one or more Member States are members;
  • shares held by a UCITS fund in a company incorporated in a non-Member State which invests its assets mainly in securities of issuing bodies which have their registered office in such non-Member State, and provided this is the only way that a UCITS fund may legally invest in such securities and such investment remains within the limits applicable to EU issuing bodies (as outlined above); and
  • shares held by a UCITS fund in subsidiaries solely engaged in the business of management, giving advice or the marketing of the repurchase of units, provided that such business of management, giving advice or marketing is performed in the country where the subsidiary is located.

 

Borrowing Limits

 

A Maltese UCITS fund is also subject to borrowing restrictions, in that it may only borrow:

 

  • up to a maximum of 10% of its assets, when it is set up as an investment company or a limited partnership, unless the UCITS fund is borrowing in order to acquire immovable property essential for the direct pursuit of its business, in which case it may borrow up to 115% of its assets; or
  • up to a maximum of 10% its value, when it is set up as a unit trust or common contractual fund.

 

This borrowing must be on a temporary basis and such that the overall risk exposure of the UCITS fund does not exceed 200% of its NAV. These borrowing limits do not preclude a UCITS fund from borrowing foreign currency by means of a ‘back to back’ loan, as long as the offsetting deposit is denominated in the base currency of the UCITS fund and such deposit is not less than the value of the foreign currency loan outstanding.

 

Repurchase/Reverse Repurchase and Stock borrowing/Stock lending Agreements

 

A UCITS fund is only permitted to enter into a repurchase/reverse repurchase and stock lending/stock borrowing agreement when this is in the interest of its investors and entails an acceptable level of risk; and such agreement is in accordance with good market practice.  It is also necessary for the counterparty to any such agreement to have a minimum credit rating of A (Standard & Poor’s) or A2 (Moody’s) or such other rating which is acceptable to the MFSA. Any collateral obtained through a repurchase or stock lending agreement must be liquid and consist of one of the following:

 

  • cash;
  • government or other public securities;
  • certificates of deposit issued by banks authorised in the EEA, Switzerland, Canada, Japan and the United States, Jersey, Guernsey, the Isle of Man, Australia or New Zealand (“relevant institutions”);
  • bonds/commercial paper issued by relevant institutions;
  • letters of credit issued by relevant institutions with a residual maturity of 3 months or less, which are unconditional and irrevocable; or
  • equity securities traded on a stock exchange in the EEA, Switzerland, Canada, Japan, the United States, Jersey, Guernsey, the Isle of Man, Australia or New Zealand.

 

Furthermore, any collateral obtained through any such agreement must be:

 

  • marked to market daily;
  • no less than the value of the amount invested or securities loaned;
  • transferred to the custodian, or its agent; and
  • immediately available to the UCITS fund, without recourse to the counterparty, in the event of a default by that entity.

 

There are additional restrictions depending upon whether the collateral consists in cash or not. Cash collateral may only be invested in:

 

  • deposits with or certificates of deposit issued by relevant institutions;
  • government or other public securities;
  • letters of credit with a residual maturity of 3 months or less, issued by relevant institutions, which are unconditional and irrevocable;
  • repurchase agreements; or
  • daily dealing qualifying money market funds having a minimum credit rating of AAA or equivalent.

 

Non-cash collateral, on the other hand, cannot be sold or pledged; must be held at the credit risk of the counterparty; and must be issued by an entity that is independent of the counterparty.

 

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This newsletter is for information purposes only. It does not constitute professional advice or an opinion. Please contact Mr. Dominique Lecocq on *protected email* for any questions.