The Undertakings for Collective Investment in Transferable Securities or UCITS (pronounced “yoo-sits”) are a set of European Union directives under which collective investment schemes authorised in a single member state can operate throughout the EU under a common regulatory regime.
- UCITS: Background
- UCITS: What the Regulation Covers
- UCITS: Impact and Global Aacceptance
- UCITS Passport: Hedge Fund Distribution
- UCITS: Future Regulation
In 1985, UCITS I offered the first EU regulations governing financial services in asset management. As a single license regime for selling investment funds in the EU, UCITS I applied general criteria regarding authorisation, legal structure, investment policies and disclosure. Marketing and tax regulation remained governed by individual country regimes.
Although the intention was to pave the way for cross-border sales within the EU, the reality fell somewhat short as divergent marketing rules in EU member states created obstacles to cross-border marketing. In addition, the limited definition of permitted investments for UCITS weakened the marketing possibilities of a UCITS fund. A UCITS II directive was drafted to deal with these limitations, but never reached completion as the Council of Ministers could not reach a common position.
UCITS: What the Regulation Covers
In 2002 the “Product Directive” widened the scope of permissible investments to include derivatives, funds of funds, money market funds, cash funds and index tracker funds as UCITS funds.
UCITS III also introduced standards governing how funds are managed. The standards covered the treatment of assets, as well as investor protection and requirements for fund managers:
- Minimum level of own funds
- Eligibility of assets
- Asset allocation
- Diversification of assets
- Safe keeping of the assets
- Supervision of fund management companies
- Separation of companies
- Risk management
- Counterparty exposure
UCITS: Impact and Global Acceptance
UCITS has been declared the “gold standard” in Asia and other overseas regions, and is promoted for the high level of investor protection it offers and its status as the only Europe-based retail and institutional financial product that has achieved global investor acceptance. In addition, the innovative characteristics of UCITS fundamentally change the way hedge funds conduct business and are actually forcing a convergence between hedge funds and traditional asset managers in the short term.
The introduction of derivatives with UCITS III has changed the landscape of UCITS funds from being purely long-only funds to being used by managers to execute long/short strategies with an absolute return profile. UCITS funds are not allowed to go physically short or borrow money, but through using derivatives they are allowed to achieve both short economic exposure and leverage. The first UCITS long/short funds were in the form of 130/30 funds, mainly used by traditional asset managers. This ability to use leverage and go synthetically short in a UCITS has become a popular “next generation” regulated on-shore structure for hedge funds.
UCITS Passport: Hedge Fund Distribution
The funds used for collective investment must have been collected from the “public” (which may be restricted to a small circle of investors). Provided UCITS-regulated funds can meet the regulatory criteria, they benefit from a “passport” allowing them, subject to notification, to be offered to investors in any jurisdiction of the European Economic Area once registered in one Member State. Though initially aimed at the distribution of pan-European retail funds for the purpose of harmonizing the distribution across Europe, it later also became a vehicle for institutional investors. UCITS is the equivalent of the 1940’s Mutual Fund Act in the United States. UCITS funds however cannot be distributed in the US.
UCITS has also become a recognized brand, attracting considerable inflows from both European and non-European investors. Certain jurisdictions outside of Europe (e.g. Hong Kong, Singapore, Switzerland) recognize the UCITS brand and have introduced expedited authorization procedures allowing UCITS funds to be distributed to local investors.
As a result, in 2007, Asian investors increased their contribution of net inflows into EU regulated funds to 35%. By July 2008, over 17% of UCITS funds originated from Asia and South America and the majority of fund managers believed UCITS funds sourced from Asia and oil producing countries would increase in the future.
UCITS: Future Regulation
Finally, a UCITS IV directive was approved in January 2009. The changes that will be implemented in 2011 govern the following:
- Key Investor Information and Notification Procedures
- Cooperation between Member State Supervisory Authorities
- Adapted Framework for Mergers
- Management Company Passport