April 2014

FSO Alert: ESMA revises UCITS collateral diversification rules

Luxembourg

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In March 2014, the European Securities and Markets Authority (ESMA) issued its Report entitled Revision of the provisions on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues. The report introduces more flexible rules on the diversification of collateral received in the context of over-the-counter (OTC) financial derivatives transactions and efficient portfolio management (EPM) techniques.

Introduction

ESMA published its final Guidelines on ETFs and other UCITS issues on 18 December 2012. The guidelines lay down detailed requirements to be met by UCITS, inter alia, on management of collateral received in the context of OTC financial derivative transactions and efficient portfolio management (EPM) techniques.

In December 2013, ESMA issued a consultation paper on the Revision of the provision on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues. The Consultation paper reconsidered ESMA’s position on the requirements on collateral diversification on the basis that they have a significant adverse impact on UCITS’s collateral management policies.

ESMA revision of the guidelines introduces more flexible collateral diversification requirements for UCITS receiving high quality transferable securities and money market instruments as collateral, provided that certain conditions are met.

Summary of revision process

The following table summarizes the process of revision of ESMA guidelines:

Summary of process of revision of ESMA guidelines

Title of ESMA document

Guidelines on ETFs and other UCITS issues

Revision of the provision on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues

Revision of the provisions on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues

Summary

The final guidelines lay down detailed requirements to be met by UCITS, inter alia, on collateral received in the context of OTC financial derivative transactions and efficient portfolio management (EPM) techniques.

The consultation paper reconsidered ESMA’s position on the requirements on collateral diversification on the basis that they have a significant adverse impact on UCITS’s collateral management policies. The report proposed to amend the provisions on collateral diversification for money market funds (MMF) and short-term MMF.

The final report introduces a derogation from the general rules on the diversification of collateral if the collateral is received in the context of over-the-counter (OTC) financial derivatives transactions and efficient portfolio management (EPM) techniques and it is issued or guaranteed by sovereign issuers. The derogation is applicable for all types of UCITS.

Main provision on collateral diversification

Maximum exposure to a given issuer of 20% of the UCITS’ net asset value

A derogation from the Final Guidelines was proposed, similar to that in the final report, but limited to MMF and short-term MMF.

As a derogation from the Final Guidelines, UCITS may be fully collateralized, in securities from at least six different sovereign issues, but securities from any single issue should not account for more than 30% of the UCITS’ net asset value.

Date published

December 2012

December 2013

March 2014

Applicability

February 2013
A transitional period applied between February 2013 and February 2014 to certain requirements.

n.a.

Following publication of the translations of the guidelines, Member States competent authorities have two months to notify ESMA of whether they intend to comply with the guidelines.

The amended provisions on collateral diversification

According to ESMA’s Guidelines on ETFs and other UCITS issues, when a UCITS is exposed to different counterparties through financial derivative transactions and/or efficient portfolio management (EPM) techniques, collateral received should be sufficiently diversified in terms of country, markets and issuers. The criterion of sufficient diversification with respect to issuer concentration is considered to be respected if the UCITS receives from a counterparty of EPMs and OTC financial derivative transactions a basket of collateral with a maximum exposure to a given issuer of 20% of the UCITS’ net asset value. When a UCITS is exposed to different counterparties, the different baskets of collateral should be aggregated to calculate the 20% limit of exposure to a single issuer.

According to the derogation introduced by this Revision of the provisions on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues, a UCITS may be fully collateralized in different transferable securities and money market instruments issued or guaranteed by Member States, their local authorities, third countries, or public international bodies. Such a UCITS should receive securities from at least six different issues, but securities from any single issue should not account for more than 30% of the UCITS’ net asset value.

UCITS that intend to be fully collateralized in securities issued or guaranteed by Member States, local authorities, third countries, or public international bodies should disclose this fact in the prospectus of the UCITS.

UCITS should also identify the Member States, their local authorities, third countries, or public international bodies issuing or guaranteeing securities which they are able to accept as collateral for more than 20% of their net asset value.

The UCITS’ annual report should contain details of the following:

  • Where collateral received from an issuer has exceeded 20% of the NAV of the UCITS, the identity of that issuer
  • Whether the UCITS has been fully collateralized in securities issued or guaranteed by a Member State.

UCITS that exist before the application date are not required to comply with the provisions relating to the prospectus transparency on collateral diversification until the earlier of:

  • The first occasion after the application date of these guidelines on which the prospectus, having been revised or replaced for another purpose is published
  • Twelve months after the application date of these guidelines

Requirements to publish information in the report and account of an existing UCITS do not apply in respect of any accounting period that has ended before the application date of these guidelines.

Next steps

The revisions to the Guidelines on ETFs and other UCITS issues will be translated and published by ESMA on its website. Following this publication, Member States competent authorities must notify ESMA within two months of whether they intend to comply with the guidelines.

 

Download the FSO alert (pdf, 2mb).