On 31 January 2012, we circulated a brief update referring to the publication by the European Securities and Markets Authority ("ESMA") of a consultation paper setting out draft guidelines on exchange traded funds ("ETFs") and other UCITS issues. The draft guidelines for the most part follow the policy orientations set out in ESMA's earlier discussion paper on ETFs and Structured UCITS of 22 July 2011 ("Discussion Paper") (see our updates dated 26 July 2011 and 3 August 2011), with the notable difference that many of the recommendations now extend to all UCITS, and not just ETFs or structured UCITS. We set out below further detail on the content of the draft guidelines.
"Retailisation" of Complex Products
The Discussion Paper raised concerns in relation to the current treatment of all UCITS as automatically non-complex instruments for the purposes of the appropriateness test for clients under MiFID. The EU Commission's proposals for the review of MiFID suggest removing structured UCITS from the scope of instruments which are automatically non-complex. The Commission's proposal to treat as complex all structured UCITS as defined in the Key Investor Information Document ("KIID") Regulation (Commission Regulation (EU) No 582/2010) would appear to view all such UCITS as intrinsically complex, which may not be correct in all cases. ESMA has decided to await the outcome of the MiFID considerations rather than providing any further input on that point at this stage.
The draft guidelines in relation to index-tracking UCITS focus on disclosure requirements in respect of such funds and, based on responses received to the Discussion Paper, propose that such requirements should be applied to all index-tracking UCITS rather than solely index-tracking ETFs as originally proposed. In particular, ESMA recommends that the prospectus of an index-tracking UCITS should include:
a clear description of the index, including details of the underlying components (the draft guidelines do provide for investors to be directed to a website for details of the exact index composition); information on how the index will be tracked and implications for investors; the UCITS' policy regarding tracking error including its target level; and details of whether the UCITS will follow a full replication model or use, for example, a sampling policy. ESMA also recommends that the annual and half-yearly reports of the index-tracking UCITS state the size of the tracking error as at the end of the period under review, and that any divergence between the target and actual tracking error for the relevant period should be explained in the annual report.
ESMA have asked for responses on whether further guidelines on tracking error should be developed and, if so, views on the criteria to be used.
Index-tracking leveraged UCITS
ESMA's guidelines would also require index-tracking leveraged UCITS to disclose in their prospectus the leverage policy, how it is achieved, the costs of leverage and the risks associated with the policy. The prospectus and KIID should also disclose the impact of any reverse leverage (ie, short exposure). The guidance paper notes that the use of leverage by index-tracking UCITS should not be a means to circumvent the relevant limits on UCITS global exposure and the UCITS should comply with the requirements on global exposure...