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CESR publishes today a consultation paper entitled: “Clarification of the definitions concerning eligible assets for investment by UCITS: can hedge fund indices be classified as financial indices for the purpose of UCITS?’”(Ref. CESR/07-045).
This consultation paper follows the publication of an issues paper 1 and elaborates from the views of market participants on questions concerning the ability of hedge fund indices to fall within the definition of "financial indices" contained in the UCITS Directive.
The decision to explore more thoroughly the issues arising from the potential inclusion of hedge fund indices in UCITS, should be seen in the wider context of CESR’s final advice to the European Commission on clarification of definitions concerning eligible assets for investments of UCITS (Ref. CESR/06-005) submitted in January 2006, which set out in detail its views on the criteria that should be met by a financial index for derivatives in order for the index to be an eligible investment.
The measures proposed will be adopted by CESR at "level 3". At level 1, the UCITS Directive governs the overall framework for the operation of EU-harmonised collective investment undertakings. A level 2 implementing Directive on eligible assets 2 clarifies certain definitions in the UCITS Directive that are related to eligible assets, including financial indices. ‘Level 3’ measures concern strengthened co-operation between (national) regulators to ensure consistent and equivalent application of ‘Level 1’ and ‘Level 2’ legislation.
At this stage, CESR’s stance on the eligibility of hedge fund indices comprises some of the following ideas:
- On the issue of hedge fund indices diversification, taking into account that the diversification requirement set out in the UCITS Directive requires the index to have at least five underlyings, CESR considers there is no need for additional level 3 guidelines.
- It is proposed that an hedge fund index will not meet the criterion of "representing an adequate benchmark" if the UCITS does not verify that the index provider: clearly defines and makes publicly available an explanation of what the index is trying to represent, and assesses whether the methodology of the index construction will affect the extent to which it is representative for the market to which it refers.
- It is proposed that the criterion of "publication in an appropriate manner" will not be met unless the UCITS confirms that the index provider makes publicly available the full methodology of the index and the UCITS verifies that the index will be subject to an independent audit at least annually.
CESR considers that index methodology and standards will probably develop over time. In this respect, CESR proposes to monitor the evolution of the market to consider which measures might be necessary to cope with market developments.
Readers are asked to consider the questions in this consultation paper and send their response via CESR's website (www.cesr.eu) under the section "Consultations". The consultation closes on 16 April 2007. A public hearing will take place at CESR on 2nd April 2007.
1 CESR/06-530 (October 2006), available at www.cesr.eu.
2 The level 2 implementing Directive is expected to be published in March 2007.
