09 February 2007

EU regulators look at extending Ucits to hedge fund indices

The Committee of European Securities Regulators has launched a consultation exercise inviting comment from the investment industry and other interested parties on whether hedge fund indices should be classified as financial indices for the purpose of the Ucits regulatory framework for cross-border investment funds.

CESR has published 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, drawing on the views of market participants regarding the ability of hedge fund indices to fall within the definition of 'financial indices' contained in the Ucits Directive.

CESR says 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 the committee's advice to the European Commission in January 2006 on clarification of definitions concerning eligible assets for Ucits investment, 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 as a so-called level 3 measure. At level 1, the Ucits Directive governs the overall framework for the operation of EU-harmonised investment funds, while a level 2 implementing directive on eligible assets clarifies certain definitions in the Ucits Directive relating to eligible assets, including financial indices. Level 3 measures involve strengthened co-operation between national regulators to ensure consistent and equivalent application of Level 1 and Level 2 legislation.

At this stage, CESR says that 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, it believes 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 of the market to which it refers.

The level 2 implementing directive is expected to be published in March. An open hearing on the proposals is due to be held on April 2, with the deadline for consultation responses set for April 16. CESR expects to publish the final level 3 measures in May.

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