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ESMA changes approach on UCITS collateral

UCITS receiving government securities may derogate from the collateral issuer concentration rule

ESMA has revised its position on the new 20% issuer diversification requirement in relation to collateral received by a UCITS. A UCITS may now be fully collateralised in government backed securities, provided it meets alternative diversification and disclosure requirements.

The new exemption

ESMA’s “Guidelines on ETFs and other UCITS issues” include a new 20% issuer diversification rule with respect to collateral received for the purposes of efficient portfolio management (EPM) techniques and OTC derivative transactions. The rule was due come into effect on 18 February 2014 for all pre-existing UCITS that were able to avail of the one year transitional period.

However, the 20% issuer concentration rule would have created significant challenges for some UCITS, and money market funds in particular, which would typically receive large quantities of collateral in the form of high-quality government securities. In response to industry requests and following consultation, ESMA issued a final report on 24 March 2014 which provides an exemption from the 20% collateral diversification rule for government backed securities. 

Under the revised guidelines a UCITS may be fully collateralised in different transferable securities and money market instruments issued or guaranteed by a member state, one or more of its local authorities, a third country, or a public international body to which one or more member states belong. The exemption is available to all UCITS rather than just money market UCITS, as previously proposed. The change of approach represents a positive development for many UCITS since the previous ESMA position on the 20% limit could have adversely impacted liquidity and collateral management practices for these funds.

As usual under the ESMA process, the guidelines have to be translated into all official EU languages and officially published and there will then follow a two month period for national regulators to comply or explain. At the end of this period the guidelines will officially apply with transitional arrangements for the new disclosure requirements (as set out below).

New diversification rule

UCITS availing of the above exemption should instead receive securities from at least six different issues, but securities from any single issue should not account for more than 30 % of the UCITS NAV.

Prospectus disclosure

Where a UCITS intends to be fully collateralised in government backed securities, it must disclose this fact in the prospectus. A UCITS availing of the exemption must also list the government issuers to which it may be exposed to beyond the 20% limit.

The prospectus disclosure should be applied at the first update following official application of the guidelines or at the latest, 12 months after application of the guidelines.

Annual report disclosure

The UCITS’ annual report should contain details of the following in the context of OTC financial derivative transactions and efficient portfolio management techniques:

  • where collateral received from an issuer has exceeded 20% of the NAV of the UCITS, the identity of that issuer; and
  • whether the UCITS has been fully collateralised in securities issued or guaranteed by a member state.

These new annual report disclosure requirements are not valid for year-end 2013 but will apply to any accounting period that ends after the date of application of the new guidelines. 

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Michael Hartwell

Partner - Audit

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Brian Jackson

Partner - Audit

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Deirdre Power

Partner - Tax

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Patrick Rooney

Senior Manager - Investment Management Advisory

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