The Product Directive
The Product Directive broadened the scope of permitted investments of a UCITS and provided that a UCITS III fund is permitted to invest in transferable securities, money market instruments, units of UCITS III funds (or similar funds), deposits and derivatives (together, UCITS-compliant assets). As part of the implementation process, the Financial Regulator has issued revised UCITS Notices covering the Product Directive.
It seems that the Financial Regulator will permit a UCITS III fund established in Ireland to gain exposure to hedge fund indices by means of a derivative, thus facilitating the establishment of a variety of structured products as UCITS. Some Member States of the EU may, however, interpret the Product Directive differently to the Financial Regulator and, accordingly, advice should be sought on the likely view to be adopted by the regulators in the Member States in which the UCITS III fund is to be marketed.
The Management Company Directive
The Management Company Directive introduced the concept of giving a management company a ‘European passport’, which is designed to operate on the basis that once a management company is authorised in its home State, that authorisation extends to all Member States, subject to compliance with host State notifications. The operation of this passport in practice is, however, expected to be limited. The scope of activities that may be undertaken by management companies was also widened under the Management Company Directive to cover, for example, the management of non-UCITS funds and individual portfolios. The Directive also introduced a requirement for a simplified prospectus, which is intended to provide more accessible, comprehensive information to strengthen investor protection.
The Financial Regulator’s revised Notices relating to the Management Company Directive are still in draft form. A number of UCITS III funds have, however, been established in Ireland on the basis of the draft Notices.
The Management Company Directive introduced capital adequacy requirements for the management companies of UCITS. A management company must now have an initial share capital of at least €125,000. Where the management company’s assets under management exceed €250 million, the company must provide additional own funds at a rate of 0.02 per cent of the amount of the excess, subject to a cap.
Non-UCITS
Since non-UCITS funds are established pursuant to domestic law rather than EU law, they do not have a passport for sale in other EU Member States. It follows, therefore, that the Financial Regulator has more flexibility regarding the imposition or relaxation of conditions generally. In developing its regulatory regime for non-UCITS, the Financial Regulator has drawn a distinction between different categories of investors, in terms of level of ‘sophistication’ (i.e. whether retail or professional). In addition, certain specialist funds which are not permitted under the UCITS rules are permitted as non-UCITS. In this regard, the Financial Regulator has issued separate Notices setting out specific requirements applicable to such types of funds, particularly feeder funds, funds of hedge funds, property funds and private equity funds.
For non-UCITS funds which are to be sold to retail investors, the Financial Regulator’s rules are broadly similar to those which apply to UCITS. Borrowing for investment purposes is, however, permitted, which is not the case with UCITS. Total borrowing for investment purposes in a retail non-UCITS must not exceed 25 per cent of net assets. As is the case with a UCITS, a retail non-UCITS must invest at least 90 per cent of its assets in listed or exchange-traded securities. The main differences arise in relation to concentration limits, where greater flexibility is permitted in the case of non-UCITS funds.
By confining the categories of investors to whom a fund will be sold to ‘sophisticated’ investors, it is possible to obtain authorisation for a non-UCITS fund which will have greater freedom, particularly in relation to investment and borrowing restrictions. The two relevant categories of funds are Professional Investor Funds (‘PIF’) and Qualifying Investor Funds (‘QIF’).
Professional Investor Fund
A fund established as a PIF may qualify for a derogation from the investment and borrowing restrictions generally applicable to non-UCITS funds. To qualify for such a derogation, a fund must have a minimum subscription of €125,000, or its equivalent in another currency. Whilst derogations are granted on a case by case basis, the Financial Regulator will generally double the percentage limits in its investment restrictions for retail funds and will permit borrowings of up to 100 per cent of net assets.
Qualifying Investor Fund
All investment and borrowing restrictions which apply to non-UCITS funds are automatically dis-applied in the case of a QIF. In addition, a considerable number of the Financial Regulator’s normal requirements for retail non-UCITS are dis-applied.
A QIF must meet the following tests:
•Minimum Subscription: A minimum subscription of €250,000 (or equivalent) is required
•Qualifying Investors: An investor in a QIF must be either (i) a natural person with a minimum net worth in excess of €1,250,000, or (ii) an institution which owns or invests on a discretionary basis at least €25 million or whose beneficial owners are qualifying investors in their own right.
If authorised, a QIF could seek to:
•Carry on short selling without restriction;
•Enter into borrowing arrangements without restriction
•Enter into derivatives contracts (including the buying and selling of futures and options) and repurchase, reverse repurchase and stock-lending agreements in order to pursue hedge fund strategies.
Whilst many funds will have the option of being constituted as a PIF, most choose to be constituted as a QIF instead. This is because a QIF can benefit from automatic derogations, whereas a PIF can only avail of derogations at the discretion of the Financial Regulator and on a case by case basis.
