UCITS: Update of ESMA Q&A - KIID requirements

On 29 March 2019, ESMA updated its Q&A on the application of the UCITS Directive ("Q&A") in order to provide further guidance on the past performance and UCITS benchmark disclosure obligations as provided for in  Regulation (EU) 583/2010 on the UCITS KIID (mainly Articles 7) 1) d) and 18) 1)) relating to the content of the UCITS KIIDs).

This update may have an impact on the content of the KIIDs, i.e. (i) the investment objective and policy section of UCITS KIIDs, and (ii) the past performance section. This is also likely to impact other fund documentation (including the prospectus and marketing materials).

1. Additional information to be included in the KIIDS

1.1. Actively or passively managed UCITS

According to ESMA, a UCITS must provide a clear indication in the objectives and investment policy section of its KIID as to whether it is actively or passively managed.

1. a) In the case where the UCITS is passively managed, the KIID should:
   1. - explicitly use the terms "passive" or "passively managed" and, if considered relevant by the UCITS  management company (“UCITS ManCo”), include additional wording to ensure that the meaning of these terms is clear to investors;
   2. - name the index in the objective and investment policy;
   3. - show the past performance of the index beside the performance of the UCITS.

      b) In the case where the UCITS is actively managed, the KIID should:

1. - explicitly use the terms "active" or "actively managed". In addition, the UCITS ManCo should consider providing additional wording to ensure that the meaning of the terms "active" or "actively managed" are clear;
2. - state whether or not the UCITS is being managed in reference to a benchmark index:
   1. * If not managed in reference to an index, the KIID should:
      • make it clear that the UCITS is not managed in reference to any benchmark;
      • show the past performance of the UCITS only.
   2. * if it is managed in reference to an index (see item 1.2 below which explains when this is the case in ESMA's views), the KIID should:
      • provide information as to how the benchmark index is used;
      • name the benchmark index and show past performance against it, where appropriate; and
      • mention the degree of freedom it has from the benchmark (ESMA provides further guidelines on this under answer 8) c) of its Q&A) (see item 1.3 below).

1.2. Meaning of "managed in reference to a benchmark index" for a UCITS

According to ESMA, "managed in reference to a benchmark index" for a UCITS means that the index plays a role in the management of the UCITS, for example, in the explicit or implicit definition of the portfolio’s composition and/or the UCITS’ performance objectives and measures. It is the responsibility of the UCITS ManCo to identify whether or not a UCITS is in practice managed in reference to a benchmark index. A benchmark index may refer to an individual index or a composite index.

ESMA provides some (non-exhaustive and non-cumulative) examples of where an approach may include or imply references to a benchmark and where this fact should be disclosed (see answer 8b of the Q&A).

1. Explicit or implicit definition of the portfolio composition:
   • the benchmark index is the universe from where securities are selected;
   • the UCITS portfolio holdings are based upon the holdings of the benchmark;
   • the UCITS holds units in other UCITS/AIFs in order to achieve similar performance to a benchmark.
      
2. UCITS performance indicators:
   • the benchmark is used for determining performance fees;
   • over performance of the benchmark is an internal or external target;
   • contracts between the UCITS ManCo and third-parties stipulate benchmark over performance as an objective;
   • the portfolio manager has a remuneration element dependent on relative performance to the benchmark;
   • marketing materials compare fund performance with a benchmark;
   • risk indicators are benchmark-dependent (Tracking Error, VaR).

The interpretation of “managed in reference to a benchmark” by ESMA is very broad and therefore we may expect that most active funds will fall within this category as, for instance, most of the UCITS do disclose, in their marketing materials, their performance alongside the performance of a benchmark at the request of institutional investors. In that case, the disclosure will have to make clear to investors that it is a pure comparison indicator taking into account item 1.3 below.

1.3. Interpretation of "the degree of freedom from the benchmark"

ESMA considers that based on Article 7(1)(d) of Regulation (EU) 583/2010 on the UCITS KIID, an indication of how actively managed the UCITS is, compared to its reference benchmark index, should be provided to investors.

The following elements should at least be taken into account by the UCITS ManCo when indicating in the KIID the degree of freedom from the benchmark index for actively managed UCITS whose investment approach includes or implies a reference to a benchmark index:

• the description of the underlying investment universe of the UCITS should indicate to what extent the target investments are part of the benchmark index or not;
• the KIID should describe the degree or level of deviation of the UCITS in regards to the benchmark index;
• the KIID should strike a balance between providing the level of detail required to sufficiently disclose a UCITS’ degree of freedom from a benchmark index, and the obligation to do so in clear language understandable to a retail investor.

2. Consistency Requirement

The Q&A states that coherence should be ensured  (i) across offering documents and marketing documents (including the prospectus) which may lead to additional amendments to the prospectus and the marketing material in addition to the KIID depending on the regulatory interpretation of this Q&A, (ii) across distribution channels, and (iii) across investor types (for instance, if a comparison with a benchmark is disclosed to institutional investors, it will have to be disclosed to retail investors as well).

3. Timing

The Q&A provides that these changes should be incorporated into KIIDs as soon as practicable or by the next update of the KIID following the publication of the Q&A.

4. CSSF Initiative

In early May 2019, the CSSF sent a letter with a link to a questionnaire to Luxembourg UCITS ManCos. The questionnaire has to be returned duly completed for all UCITS under management by 31 May 2019. It aims to enable the CSSF to assess the impact of the updated ESMA Q&A on the Luxembourg UCITS.