Investment services: Undertakings for Collective Investment in Transferable Securities (UCITS)

The European Union wishes to harmonise at Community level the conditions relating to the authorisation of undertakings for collective investment in transferable securities (UCITS), thus promoting cross-border trade and ensuring more effective protection for investors. With this in mind, this Directive is aimed at certain UCITS. It establishes a general system of strict obligations governing investments, capital requirements and disclosure obligations, as well as the safekeeping of assets and supervision of the funds.

ACT

Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) [See amending acts].

SUMMARY

This Directive seeks to harmonise Member State legislation on certain categories of UCITS. It therefore aims to align the conditions for marketing UCITS funds and the management company activities carried out by UCITS. In this way, the Directive aims to make it easier to market UCITS funds in Member States other than the one which granted the initial authorisation, whilst ensuring a high level of protection for investors.

The UCITS concerned, whether constituted under the law of contract (common funds managed by a management company) or under statute (investment companies), must meet the following conditions:

• the collective investment of capital raised from the public in transferable securities and/or other liquid assets is their sole object;
• they operate on the principle of risk-spreading; and
• the units are re-purchased or redeemed out of those undertakings' assets.

Once subject to this directive, UCITS cannot remove themselves from its scope. Furthermore, whereas investment companies may only manage the assets in their portfolios, management companies can carry out other activities which do not fall within the scope of the Directive. In other words, the Directive only applies to activities which fall within its scope throughout the territory of the Community.

On the other hand, the Directive does not cover UCITS of the closed-ended type, those which raise capital without promoting the sale of their units or whose units are not sold for any commercial purpose, and those prescribed by regulations.

The business of UCITS

To carry out its business, UCITS must receive prior official authorisation granted by the competent authorities in the Member State in which they are located, or their home Member State, i.e. the Member State in which their registered office and head office are situated. The authorisation granted is valid in all Member States.

The business and operation of the UCITS are governed by the principles applicable in the home Member State. Thus, the home Member State draws up the prudential rules which govern the operation of the UCITS. Any changes to the status of the UCITS such as a delegation are notified to the competent authorities in the home Member State.

Similarly, the establishment of a branch in a host Member State must be notified to the competent authority in the home Member State whilst the host Member State(s) guarantee(s) freedom of establishment and freedom to provide services. In this context, the competent authority in the home Member State has a period of three months in which to inform the host Member State, which then has two months in which to organise prudential supervision.

The competent authorities in the home Member State must be informed of any irregularities by the authorities in the host Member State, and they are responsible for imposing sanctions. However, if these irregularities persist, the competent authorities in the host Member State are also empowered to take all appropriate measures.

In principle, the authorisation covers both the management company and the fund rules for the unit trust/common fund, and the instruments of incorporation of an investment company that has not designated a management company, as well as their depositaries.

Authorisation and activities of management companies

For the management company, the application for authorisation should include:

• the initial capital of 125 000 for management companies and 300 000 for investment companies. In this respect, management companies may be required to provide an additional amount of own funds according to the value of the portfolios they hold;
• a programme of activity;
• the names of the directors who are also of sufficiently good repute and experience;
• information on the close links which may exist between them and natural or legal persons, provided that these do not prevent the effective exercise of supervisory functions by the competent authorities.

In addition, so as to ensure sound and prudent management, the identities of the shareholders or members of management companies and their holdings should also be provided.

The decision on authorisation is delivered within six months of the submission of the application by the competent authorities in the home Member State. Reasons must be given for refusing an authorisation. The authorisation can also be withdrawn.

Management companies should also present a depositary responsible for safekeeping the common fund/unit trust's assets in their application for authorisation. The depositary must have its registered office in the same Member State as that of the management company, be subject to public control, and be a separate company from the management company. It must provide adequate financial and professional guarantees both in the pursuit of its business and for the unit-holders.

Operation of UCITS

UCITS repurchase or redeem a unit-holder's units at its request, other than by way of derogation.

The rules for the valuation of assets, calculating the sale or issue price and calculating the re-purchase or redemption price of the units of a UCITS are laid down by law, in the fund rules or in the instruments of incorporation. In this context, a UCITS unit may not be issued unless the equivalent of the net issue price is paid into the assets of the UCITS. These texts also determine the authorised remuneration and expenditure.

Neither management and investment companies nor depositaries may borrow, unless the borrowing is on a temporary basis and, in the case of investment companies, for operating loans which are essential for their business. Nor may they grant loans or act as a guarantor on behalf of third parties or carry out uncovered sales of transferable securities, money market instruments or other financial instruments.

UCITS which market their units in Member States other than those in which they are situated are obliged to notify accordingly the competent authorities of the Member State(s) concerned by providing the full and simplified prospectuses and other relevant information. The host country authorities only have the right to scrutinise the provisions set up for the marketing of a UCITS on the host country's territory and those intended to facilitate the subscription and repurchase of units in the UCITS. Marketing may begin within two months of communicating the information to the competent authorities.

The investment policies of UCITS

The investments of a UCITS must consist solely of:

transferable securities and money market instruments admitted to or dealt in on a national regulated market or that of another Member State, or recently issued, provided that admission to the stock exchange or to another regulated market is secured within one year of making the application;

• units of a UCITS authorised according to this Directive or other collective investment undertakings covered by rules which are equivalent to the requirements applicable to a UCITS;
• deposits with credit institutions which are repayable on demand or have the right to be withdrawn, and maturing in no more than 12 months;
• financial derivative instruments dealt in on a regulated market or over-the-counter;
• other money market instruments which meet the requirements for protecting investors and savings and are issued or guaranteed by certain specified categories of issuers.

In principle, investments by a UCITS may not exceed:

• 5 % of its assets in transferable securities or money market instruments issued by the same body;
• 20 % of its assets in deposits made with the same body.

However, the 5% ceiling may be re-assessed depending on the nature of the issuer or the bond.

A UCITS may not acquire any shares carrying voting rights which would have an effect on the independence of the issuer. It may acquire no 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 or other collective investment undertaking. However, the limit can be raised to 20%, or even 35% in exceptional circumstances, for investment in shares or debt securities issued by the same body when the aim of the UCITS' investment policy is to replicate the composition of a certain stock or debt securities index.

In addition, by way of derogation, UCITS may be authorised to invest up to 100% of their assets in different (a maximum of six) transferable securities or money market instruments issued or guaranteed by a public entity. It is assumed here that unit-holders have protection equivalent to that of unit-holders in UCITS complying with the general obligations imposed by the Directive.

Furthermore, a UCITS may, within certain limits, acquire the units of another UCITS or collective investment undertaking.

In this context, the risk management procedure should make it possible to monitor and measure the risk by means of the accurate and independent assessment of risks with respect to the value of the assets. This assessment must be communicated regularly to the competent authorities. In all instances, the global exposure should not exceed the total net value of its portfolio.

Information required for authorisation and regular information

In order to protect unit-holders, management or investment companies must publish information in the form of prospectuses and reports which are transmitted to the competent authorities.

The simplified prospectus and the full prospectus enable investors to assess the company, and make an informed judgement of the investment proposed to them and the risks attached thereto. The information, presented briefly in the simplified prospectus and in detail in the full prospectus, relates to the UCITS, its investment policy, how to buy and sell units, and other tax-related details, etc. The simplified prospectus can be used for commercial purposes.

The annual report for each financial year and the half-yearly report covering the first six months of the financial year take stock of the company's situation and development and its business results. The annual report includes a balance-sheet or a statement of assets and liabilities, a detailed income and expenditure account for the financial year, and a report on activities in the past financial year.

The issue, sale, repurchase or redemption price of their units should also be published at least twice a month.

Competent authorities responsible for authorisation and supervision

The competent authorities responsible for authorisation and supervision must be public authorities or bodies appointed by public authorities responsible for the control and supervision of UCITS. The competent authorities of the Member State in which the UCITS is situated are responsible for checking, supervising and imposing sanctions if the provisions are infringed. The authorities in other Member States become involved when a UCITS markets its units on their territory; if this is the case, they too may apply sanctions.

Where a UCITS operates in several Member States through the provision of services or by the establishment of branches, the competent authorities of the Member States concerned shall cooperate in supplying one another with information on the management company.

However, the competent authorities of the different Member States shall be subject to the conditions of professional secrecy when collaborating closely. This Directive does in fact impose strict rules on the disclosure of information. To be more precise, the disclosure of information which has been transmitted requires the express agreement of the competent authorities which transmitted it.

The Commission shall also be assisted by the European Securities Committee in interpreting and improving this Directive.

RELATED ACTS

Commission Directive 2007/16/EC of 19 March 2007 implementing Council Directive 85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) as regards the clarification of certain definitions [Official Journal L 79 of 20.3.2007]

This Directive clarifies the definition of certain financial instruments with the aim of helping the parties concerned to identify, among the assets appearing on the financial markets following the adoption of Directive 85/611/EEC, those assets still covered by the aforesaid Directive. The relevant instruments include transferable securities, money market instruments and liquid financial assets. Furthermore, the Directive provides basic criteria to help assess whether a given class of financial instrument is, or is not, covered by the various definitions.

Recommendation 85/612/EEC of 20 December 1985 concerning the second subparagraph of Article 25(1) of Directive 85/611/EEC [Official Journal L 375 of 31.12.1985]

This recommendation states that, each time the concept of "significant influence" is represented in another Member State's legislation by a numerical limit, the Member State's competent authorities should ensure that such limits are observed by investment and management companies situated within its territory when they acquire shares carrying voting rights issued by a company established within the territory of a Member State where such limits apply. The Member States which relax these limits should communicate them to the Commission, which in turn will inform the other Member States.

Communication from the Commission to the Council and to the European Parliament of 30 March 2004 - Regulation of UCITS depositaries in the Member States: review and possible developments [COM(2004) 207 - Not published in the Official Journal]

Commission Recommendation 2004/383/EC of 27 April 2004 on the use of financial derivative instruments for undertakings for collective investment in transferable securities (UCITS)(Text with EEA relevance) [OJ L 144 of 30.4.2004] The Commission makes recommendations for the appropriate application of Directive 85/611/EEC with respect to assessing risks, specifying that this should be adapted to the relevant risk profile of the UCITS. These deal in particular with:

• the risk-measurement systems;
• the limits set on the UCITS' risk exposure;
• appropriately calibrated standards to measure market risk;
• appropriately calibrated standards to assess leverage;
• the application of appropriate standards and recognised risk-mitigation techniques to limit counterparty risk;
• the use of adequate methodologies when applying limitations to issuer risk;
• the application of relevant cover rules to transactions with both listed, and OTC, financial derivative instruments.

Commission Recommendation 2004/384/EC of 27 April 2004 on some contents of the simplified prospectus as provided for in Schedule C of Annex I to Council Directive 85/611/EEC (Text with EEA relevance) [OJ L 144 of 30.4.2004] In order to better inform investors and, in particular, make the information fully accessible to the average investor, this recommendation specifies what sort of information is required in the simplified prospectus as provided for in Schedule C of Annex I to Council Directive 85/611/EEC.

Commission Green Paper of 12 July 2005 on the enhancement of the EU framework for investment funds [COM(2005) 314 final - Not published in the Official Journal] The purpose of this Green Paper is to assess the impact of European legislation on UCITS in order to boost their cross-border development. Given the strategic importance of the requirement for integrated and efficient markets for investment funds, the existing legislation needs to be amended and improved in order to bridge the gaps. In this context, further work needs to be carried out on aligning national laws. European legislation should also be able to cope with the rapid developments in financial markets. This process should, finally, take into account the high level of investor protection.

Last updated: 05.06.2008