Although the UCITS Directive recognises the possibility for a UCITS to offer more than one share class to investors, ESMA believes that it does not prescribe whether, and to what extent, share classes within a given UCITS/UCITS sub-fund can differ from each other. The context for the Discussion Paper is the identification by ESMA of diverging national practices regarding the types of share class differentiation permitted. ESMA notes that, unlike a UCITS sub-fund which may have its own distinctive investment strategy and be subject to the protected cell regime, share classes are categories of share which belong to the same UCITS and there is no legal segregation of assets between them. As a result, ESMA is considering the benefits of developing a common understanding of what constitutes a UCITS share class and the extent of share class differentiation.
Summary of Key Principles
The key principles identified by ESMA in the Discussion Paper for assessing the legality of different share classes (the “Key Principles”) are as follows:
- share classes established within UCITS should have the same investment strategy;
- specific features to one share class should not have a potential adverse impact on other share classes of the UCITS;
- any differences between share classes of the same UCITS should be disclosed to investors; and
- a UCITS seeking to offer different investment strategies should create separate UCITS/ UCITS sub-funds for each strategy.
Permissible Differentiations at UCITS share class level
ESMA proposes a non-exhaustive list of permissible differentiation at UCITS share class level which would be considered compatible with the Key Principles, as follows:
- share classes that differ according to the maximum or minimum investment amounts, or values of holdings allowed to be retained;
- share classes that differ in terms of the type of investor (e.g. institutional investors versus retail investors);
- share classes that differ according to the types of charges and fees that may be levied and their amount (on-going charges, subscription and redemption fees, performance-related fee);
- share classes that differ according to the currency in which they are denominated;
- share classes that differ according to the allocation of revenues to investors (by capitalisation or distribution, either subject to or exempt from withholding tax);
- share classes that differ according to their characteristics: registered or bearer;
- share classes that differ in terms of voting rights; and
- share classes that provide currency hedging when share classes are denominated in different currencies from the base currency.
In relation to currency hedging at the level of a UCITS share class, ESMA states that this could be regarded as being compatible with the overarching principle identified in the Discussion Paper that share classes within the same UCITS/UCITS sub-fund should have a common investment strategy, provided the currency hedging does not adversely impact on the shareholders of the other share classes and that the costs of the hedging are borne only by the shareholders of the hedged share class.
Impermissible Differentiations at UCITS share class level
ESMA also provides a non-exhaustive list demonstrating differentiation at share class level which would not be regarded as compatible with the Key Principles. This comprises share classes:
- which are exposed to different pools of underlying assets;
- which are exposed to the same pool of assets but with different levels of capital protection and / or payoff;
- in which the same underlying portfolio is swapped against different portfolios of assets;
- which offer differing degrees of protection against some market risks such as interest rate risk or volatility risk; and
- which differ in terms of leverage.
In contrast with ESMA’s opinion on currency hedging, interest rate hedging performed at share class level is not regarded as compatible with the principle of common investment strategy on the basis that it modifies investment strategy at share class level.
Comments and Next Steps
The Discussion Paper sets out fourteen questions for stakeholders to consider. These include whether respondents agree that ESMA should develop a common position on what constitutes a UCITS share class, how share classes may differ from each other and whether current investors receive adequate information about the characteristics and risks of different share classes with the same UCITS. ESMA notes that it will take into account the possible impact on current market practices when developing its final position on the topic.
We would encourage promoters of UCITS with a variety of share class levels to consider this Discussion Paper as it may suggest approaches not consistent with what has, to date, been allowed by home state competent authorities.
The deadline for responses is 27 March 2015. All contributions should be submitted online at www.esma.europa.eu under the heading ‘Your input - Consultations’.
ESMA’s Discussion Paper can be found here.