The UCITS Directive was adopted to create a common market of undertakings for collective investment in transferable securities (UCITS) within the European Union (EU). UCITS are investment funds that comply with a set of common rules known as coordination rules, such as eligibility criteria, for underlying financial instruments that must meet obligations in terms of liquidity or a strict control of investment limits.
Created in 1985, the UCITS Directive has been amended and enriched several times to adapt the regulatory framework to market developments while ensuring a high level of protection for retail investors.
The UCITS Directive has become a key pillar of the Capital Markets Union. The success of this franchise with retail investors is linked to the reputation of sound and well-regulated investment products.
UCITS I (1985)
UCITS I aimed to harmonise the regulation of retail investment funds to allow the cross-border marketing of these financial products within the EU.
Key points included the type of assets eligible to UCITS (transferable securities and money market instruments) and the possibility for funds complying with the Directive’s rules to be marketed in all the EU Member States via a European passport.
UCITS II (early 1990s – abandoned project)
The objective of this review was to expand the scope of eligible assets, in particular alternative funds and more complex financial products.
However, major divergences among Member States and risk management concerns overcame the project, which was eventually abandoned.
UCITS III (2001)
The Directive, which initially only included a product component, was supplemented by an actor component to introduce harmonised rules for UCITS managers and thus facilitate cross-border management of UCITS.
This version also expanded the range of eligible assets by allowing certain derivatives which enabled more flexibility in portfolio management. The objective was to allow better diversification while maintaining a high level of protection for retail investors.
UCITS IV (July 2009)
This major and structuring revision changed Directive 1985 into the EU Directive 2009/65, which officially entered into application on 1 July 2011.
As the implementation of this Directive was ongoing, negotiations took place to regulate the activity of alternative fund managers (with the Alternative Investment Fund Managers Directive, AIFMD). Asset management is now governed by two sectoral regulations: one for retail funds (UCITS) and another for alternative asset managers for all funds that are not UCITS. It should be noted, however, that AIFMD is an actor Directive and that alternative funds are therefore defined within each Member State.
Key improvements in UCITS IV included:
- Introduction of a real management passport, allowing management companies from one Member State to manage UCITS in another Member State without the need to establish a branch
- Simplification of cross-border fund mergers and master-feeder structures: the aim was to strengthen the competitiveness of European asset management by seeking to increase the average size of funds and thus limit structural costs
- Establishment of a Key Investor Information Document (KIID) summarising the main features of UCITS in a standardised form to allow product comparison. This document replaces the non-standardised simplified prospectus at European level.
- Simplification of the cross-border notification procedure
UCITS V (2012)
The UCITS V review was published in the aftermath of the 2008 financial crisis. The review aimed to strengthen retail investor protection and harmonise certain rules with AIFMD. In particular rules governing asset manager remuneration (to avoid excessive risk-taking), as well as the tasks of the depositary. UCITS V has imposed a stricter depositary regime and introduced a harmonised sanction regime.
Key changes compared to UCITS IV:
- Introduction of stricter criteria for entities allowed to act as a depositary: now restricted to credit institutions, national central banks and other legal entities authorised under the laws of EU Member States to carry out depositary activities and subject to harmonised additional conditions
- The obligation for the depositary and the asset manager/UCITS to enter into an agreement whose content is specified in the level 2 text
- For depositaries, application of a strict liability regime for assets held in custody (obligation to return assets in the event of loss) and introduction of new duties: monitoring of the fund’s cash flows, record keeping for assets not held in custody (no return of assets in the event of loss as opposed to the custody regime) and oversight duties for UCITS funds which have a legal personality
The key changes compared to AIFMD are laid down in the following provisions:
- Independence requirements between the UCITS asset manager and the UCITS depositary (i.e. independence between their respective governance bodies, specified in the level 2 text)
- Liability of the depositary for the improper performance of its supervisory functions in the event of loss of assets (or loss of value) if, for example, the depositary does not react on investments that do not comply with the regulatory or constitutive documents of the UCITS
- Delegation of custody to entities acting as central securities depositaries
- Prohibition of reuse of assets held by the depositary or by any third party to whom custody has been delegated on its own behalf
- Harmonisation in the EU of the effects of insolvency laws on assets held in custody: each Member State must ensure that its insolvency law protects UCITS’ assets in the event of bankruptcy of the depositary holding the assets in custody or its sub-custodian located in the EU
- Delegation conditions: the depositary must verify that its sub-custodian has taken all necessary measures to ensure that, in the event of its insolvency or bankruptcy, UCITS’ assets in custody by the sub-custodian (or its delegates) are not available for distribution or realisation for the benefit of the sub-custodians’ creditors (or its delegates’ creditors). Provision specified in the level 2 text.
- No contractual transfer of depositary’s liabilities to a sub-custodian is possible. Provision of information relating to the list of sub-custodians and their own delegates to investors.
In the context of the sustainable finance action plan, the UCITS Directive has been amended to integrate the obligation of asset managers to take sustainability risks into account in their risk management process (delegated acts of the UCITS Directive published in June 2020 and entry into application of the sustainability-related disclosure regulation from 10 March 2021). If asset managers are in the scope of application of the Non-Financial Reporting Directive, they will have to disclose (i) policies on the consideration of adverse impacts on environmental and social matters resulting from their investment decisions (ii) and associated indicators. More transparency is also required on those topics on the website of asset managers and at the UCITS level.
UCITS VI (2024)
In November 2021, the European Commission published a legislative proposal for an omnibus directive amending AIFMD and, for some developments, the UCITS Directive.
The review of AIFMD and UCITS aimed to address a limited number of areas where further improvements could be introduced while integrating the lessons of recent crises.
The omnibus Directive 2024/927, which amends AIFMD and the UCITS Directive, was published in the Official Journal on 26 March 2024. It must now be transposed into national law before April 2026 and April 2027 for the supervisory reporting provisions.
The main changes made to AIFMD and transposed to the UCITS Directive include:
- The improvement of the availability and use of liquidity management tools
- The improvement of AIFMD regulatory reporting and the introduction of equivalent reporting for UCITS
- Information provided to authorities about asset managers’ delegated activities. The delegation framework under AIFMD remains largely unchanged but it is specified that an AIMF must notify the national competent authority (NCA) of the intra and extra EU delegation of any of the functions listed in the Directive. In particular, the portfolio management or risk management delegation. Asset managers must also control delegated activities.
The legislator also worked on the minimum substance of an asset manager to avoid any “letter box” entity and to ensure that UCITS (and AIFM) managers remain responsible for key functions and decisions.
With the revision of the UCITS Directive and AIFMD, the legislator also brought expected clarification regarding the status of the investor CSD. When an investor CSD intervenes in the asset custody chain, it does not act as a market infrastructure (CSD Issuer) and as such it must be considered as a depositary delegate. This clarification complements the delegated regulation on safe-keeping duties of depositaries adopted in October 2018 and which entered into application from 1 April 2020.
This text clarifies that the depositary must maintain a record in the financial instruments’ account that it must open for each UCITS in its books, even for assets whose custody has been delegated. At the level of depositary’s delegates, the use of omnibus accounts including assets of AIFs, UCITS and other clients are allowed whilst due diligence and verifications by the depositary all along the custody chain are strengthened.
UCITS: ongoing developments
Level 2 (RTS) and 3 (guidelines) measures
Liquidity management tools
The omnibus Directive 2024/927 which amends AIFMD and the UCITS Directive must be complemented by implementing measures clarifying operational details on regulatory technical standards (RTS) and guidelines on liquidity management tools (LMT).
The objective is to improve and homogenise the use of liquidity management tools within the EU to allow better protection for investors in the event of crisis or market tensions. Asset managers shall include two LMTs in the fund/sub funds rules, considering the investment strategy, the liquidity profile, the redemption policy of the fund and the market conditions (except for money market funds, which may set up only one LMT).
Liquidity management tools are divided into three categories:
- Anti-dilution tools (ADTs): their objective is to allocate the cost of liquidity to incoming and outgoing investors and avoid the cost being supported by remaining investors. ADTs include:
- Redemption fees, acquired in the fund
- Swing pricing, by adjusting the net-asset value (NAV)
- Anti-dilution levy (ADL), which refers to adjustable rights acquired in the fund
- Dual pricing by determining two NAVs (bid and ask NAVs)
- Quantitative LMTs:
- Suspension of subscriptions/redemptions
- Gates, cap of redemptions request and redemption payments spread over several NAVs
- Extension of notice period
- Other LMTs:
- Redemption in kind, by transferring securities representing the portfolio to the investor. The final RTS will confirm if this tool should only be allowed for institutional investors
- Side pockets to isolate illiquid asset from healthy assets
The suspension of subscriptions/redemptions and side pockets are tools to be used as of right, in exceptional circumstances and in the interest of investors, knowing that they remain tools to be used as a last resort before a potential liquidation decision.
ESMA’s final report on RTS and guidelines is expected by April 2025 and the RTS will be submitted to the European Commission for endorsement.
Regulatory technical standards and implementing technical standards on supervisory reporting
The current AIFMD regulatory reporting will be extended to UCITS. AIFMD reporting has been providing information on the main lines of the portfolio thus far. In the future, comprehensive information on all instruments, markets, exposures, positions, identifiers, total leverage used by the AIF must be provided in the reporting. The amount and percentage of assets subject to portfolio management delegation should also be provided. The RTS and implementing technical standards (ITS) are expected in 2027 at the latest.
Guidelines on funds’ names using ESG or sustainability-related terms
With the entry into force of AIFM and UCITS Directives in April 2024, ESMA has now a mandate to issue guidelines on the naming of funds which can be unfair, unclear, or misleading.
Published in May 2024, the purpose of the guidelines on fund names using ESG or sustainability-related terms is to fight against greenwashing practices. The name of a fund is often the first point of reference for investors, and it can even guide their investment decisions.
To use ESG or sustainability-related terms in fund names, the asset manager must respect two conditions:
- Asset managers must respect a minimum threshold of 80% of the fund’s investments which should meet environmental or social characteristics, or sustainable investments objectives
- Asset managers should apply exclusion criteria depending on the terms used in the fund’s name:
- The use of “Environmental”, “Impact” and “Sustainability” related terms will require exclusions according to the rules applicable to the Paris Aligned Benchmark (PAB)
- Whereas “Transition”, “Social” or “Governance” related terms will require exclusions according to the rules applicable to the Climate Transition Benchmark (CTB)
- For funds using different related terms in the fund’s name, the rules can be cumulative.
- For example, a fund using ESG terminology will have to comply with both PAB and CTB exclusion.
- The same rationale is applicable to a social sustainable fund.
The guidelines were published on 21 August 2024. National competent authorities will have to notify ESMA of their compliance status, whether they comply with the guidelines, not comply but intend to do so or do not intend to comply and provide an explanation in such case.
The entry into application is 21 November 2024 for funds created from this date. Funds created before this date will have to comply before 21 May 2025.
ESMA’s call for evidence on the Eligible Asset Directive (EAD) review
The EAD 2007/16/EC is a delegated directive which supplements the UCITS Directive. It was published in 2007 to clarify concepts such as transferable securities or Money Market Instruments that were not clear through the 1985 UCITS Directive. The initial objective of the EAD was to help market participants and national competent authorities develop a common understanding of key concepts and have clarity as to whether a given asset class was eligible to a UCITS or not.
Since 2007, the number, type and variety of financial instruments has increased, leading to uncertainty on whether certain categories of assets are eligible to UCITS or not. Therefore, the European Commission asked ESMA for a technical opinion.
ESMA launched a call for evidence in May 2024 with a twofold objective:
- Analyse the application of the criteria set out in the Directive: are these criteria still relevant, complete, and applied uniformly by Member States?
- Assess the current exposure of UCITS with a list of certain asset classes that are not currently directly eligible to a UCITS. ESMA is aware of divergent analyses across the EU with some Member States allowing the eligibility of embedded derivatives, catastrophe bonds or commodities via exchange traded commodities for example. ESMA’s assessment also includes assets such as loans, crypto assets or emission allowances. The aim is to analyse whether these exposures are adequate for UCITS considering the underlying asset’s criteria, such as valuation availability, liquidity or the custody conditions.
The call for evidence closed in August 2024. ESMA is expected to provide its technical opinion by March 2025, before a public consultation in case of a legislative proposal from the European Commission.
Scope of the UCITS Directive
- EU asset managers managing UCITS
- UCITS depositaries and asset servicers
Industry implications (UCITS VI and latest developments)
The introduction of a wide range of LMTs enable AIFMs and management companies to activate a tool according to current market conditions before using, as a last resort, the suspension of subscription/redemption orders or side pockets. However, asset managers are generally calling for rules that should not be too restrictive to facilitate the use of these LMTs. Asset servicers (for instance, transfer agents and fund accountants) are also impacted by the operational implementation of LMTs.
The implementation of comprehensive supervisory reporting, which is moreover extended to UCITS, will require asset managers more time to produce reporting, with additional costs.
Securities Services’ view
The UCITS franchise owes its success to the reputation of sound and well-regulated investment products, invested in assets subject to strict eligibility criteria and risk division rules. The UCITS Directive has evolved to strengthen the protection of assets, the transparency of the information provided to investors and to guarantee a high level of protection for investors.
In this context, we welcome the clarification of the role of investor CSDs, who are considered to be delegates of the depositary when interposed in the custody chain between the depositary and the issuer CSD. It indeed removes the unlevel playing field between stakeholders and allows depositaries to perform their due diligence on investor CSDs.
We also welcome the harmonisation of the use of liquidity management tools across the EU. Their implementation by asset managers will depend on the ability of asset servicers (transfer agents and fund accountants in particular) to develop, when necessary, efficient processing so that these tools can be activated as needed, including in the event of high volume in a crisis or deteriorated market conditions (swing pricing, ADL and gates in particular). The existence and level of use of LMTs are currently very heterogeneous among Member States. Market participants should be allowed enough time before the entry into force of the RTS and guidelines to allow for appropriate operational developments at the level of each Member States to aim for harmonisation and a level-playing field.
Concerning the EAD review, we ask for clear rules and definitions to reduce local interpretations and we call for the homogeneous application of these rules to ensure a level-playing field across the EU. While considering the evolution of market practices since 2007, we support promoting a label that remains consistent and understandable by retail investors as UCITS is a key pilar of the Capital Markets Union.
KEY DATES
December 1985: publication of the UCITS Directive 85/611
July 2009: publication of the UCITS directive 2009/65 which repeals and replaces Directive 85/611 (so-called UCITS IV)
July 2011: transposition of the Directive 2009/65 into national laws
July 2014: publication of the Directive 2014/91 modifying the 200/65 Directive coordinating the laws, regulations and administrative provisions relating to UCITS, regarding depositary functions, remuneration policies and sanctions (so-called UCITS V).
March 2016: UCITS V Directive implementation date
March 2016: ESMA published guidelines on asset managers’ remuneration
October 2018: publication of the delegated regulation (EU) 2018/1619 modifying the delegated regulation 2016/438 complementing the UCITS Directive (amendments on safekeeping duties of depositaries)
April 2020: entry into application of the delegated regulation 2018/1619 on safe-keeping duties of depositary
March 2021: entry into application of the Sustainable Finance Disclosure Regulation (SFDR)
August 2021: publication of the delegated regulation (EU) 2021/1255 amending Directive 2010/43/EU regarding the integration of sustainability risks into the governance, risk management and investment evaluation functions for funds under the UCITS directive
August 2022: entry into application of the delegated regulation (EU) 2021/1255
26 March 2024: publication of the omnibus directive 2024/927 modifying the 2009/65 Directive (UCITS) and the 2011/61 Directive (AIFMD)
16 April 2024: entry into force of the omnibus Directive 2024/927
7 May-7 August 2024: ESMA’s call for evidence on the review of the UCITS Eligible Assets Directive 2007/16/EC (EAD)
21 August 2024: publication of ESMA’s guidelines on funds’ names using ESG or sustainable-related terms
21 November 2024: entry into application of the guidelines on funds’ names using ESG or sustainable-related terms for funds created from 21 November 2024
Avril 2025: deadline for ESMA to issue the RTS on LMT’s characteristics and guidelines on the selection, calibration and activation of LMTs, RTS on requirements for Loan Originated Funds (AIFs) to maintain open-ended structure
21 May 2025: entry into application of guidelines on funds’ names using ESG or sustainable-related terms for funds created before 21 November 2024
16 April 2026: entry into application, except for supervisory reporting provision
16 April 2027: entry into application for supervisory reporting provision; deadline for ESMA to issue RTS on the information to be reported in supervisory report for AIFs/UCITS, frequency and timing
ACRONYMS
ADL: Anti-Dilution Levy
ADT: Anti-Dilution Tool
AIF: Alternative Investment Fund
AIFM: Alternative Investment Fund Manager
CMU: Capital Markets Union
CSD: Central Securities Depositary
CTB: Climate Transition Benchmark
EAD: Eligible Assets Directive (UCITS)
ESMA: European Securities and Markets Authority
KIID: Key Investor Information Document
LMTs: Liquidity Management Tools
NCA: National Competent Authority
PAB: Paris Aligned Benchmark
RTS: Regulatory Technical Standards
UCITS: Undertakings for Collective Investment in Transferable Securities