ESMA Publishes Final Report on UCITS Eligible Assets

What You Need to Know

• ESMA has published its final report advising on significant changes to the UCITS Eligible Assets Directive.
• The proposals aim to harmonise UCITS rules across the EU by moving towards directly applicable regulations and removing national divergences.
• ESMA’s proposals are non-binding and it’s expected the European Commission would launch its own consultation before implementing any changes.

Introduction

On 26 June 2025, the European Securities and Markets Authority (“ESMA”) published its final report providing technical advice to the European Commission on the review of the UCITS Eligible Assets Directive (“EAD”). This report marks a significant milestone in the ongoing evolution of the UCITS framework, aiming to address divergences in national implementation, clarify key definitions and propose legislative amendments to enhance supervisory convergence, investor protection and the overall functioning of UCITS funds.

While the stated aim outlined above is to be welcomed, the scale and prescriptiveness of the proposed changes are significant. The recommendations, most notably the universal look-through approach and the repurposing of the 10% “trash ratio”, go far beyond mere technical adjustments.

If implemented as drafted, the proposed amendments risk materially altering the long-established and accepted aspects of the UCITS regime, potentially limiting product innovation and narrowing the range of investment strategies available to both managers and investors. There is a real concern that, in seeking to protect investors, the proposals may inadvertently erode the flexibility that has made UCITS a world-leading retail investment product.

Background and Rationale for the Review

The UCITS framework has long been a cornerstone of the European and global retail fund market and European cross-border fund distribution, underpinned by robust regulation and a high degree of investor protection.

However, since the adoption of the original UCITS Directive in 1985 (as revamped in 2003) and in 2007 the EAD, the financial markets have evolved considerably, with new asset classes, instruments and investment strategies emerging. ESMA’s view is that this has led to divergent interpretations and practices across Member States, creating an unequal playing field and potential risks for investors.

In June 2023, the European Commission mandated ESMA to review the EAD, with a focus on harmonising the eligibility criteria for UCITS investments, clarifying key concepts and addressing the treatment of exposures to alternative assets (e.g., loans, catastrophe bonds, commodities, crypto-assets, unlisted equities).

Headline Changes

Universal Look-Through Approach

ESMA proposes a fundamental change by requiring a look-through to the underlying asset for all indirect exposures, except for directly held listed securities (e.g., equities and bonds). This means that UCITS may not gain exposure to ineligible assets by using wrappers such as delta-one instruments, ETNs, ETCs, or other means such as financial indices or structured financial instruments, all of which are currently capable of qualifying as eligible assets as permitted by EAD. ESMA considers that this approach would assist in ensuring that the UCITS brand remains distinct from AIFs and to address valuation, risk and transparency concerns.

The 10% “Trash Ratio” (or “Trash Bucket”)

The 10% “trash ratio” would be broadened to include all eligible asset classes, including derivatives and open-ended AIFs. Within this limit it may be permissible for UCITS to gain exposure to certain assets (e.g., loans, catastrophe bonds, CoCo bonds, crypto-assets, commodities, ETCs, ETNs, emission allowances, real estate, SPACs) without the need for a look-through. However, ESMA has emphasised that all other UCITS requirements (liquidity, valuation, risk management) must still be met.

Transitional Arrangements and Grandfathering

ESMA recommends a sufficiently long transitional period for existing funds to come into compliance but is firmly against indefinite or long-term grandfathering. UCITS with non-compliant holdings or strategies must either amend their strategies/portfolios and fund documentation, relaunch as an AIF (noting that direct conversion is prohibited under the UCITS Directive) or possibly even terminate.

Harmonisation and Directly Applicable Regulation

ESMA strongly recommends that the European Commission move towards using directly applicable EU regulations (rather than a directive to be implemented in each member state with national discretions) to ensure maximum harmonisation and eliminate national divergences in the application of UCITS rules.

Additional Key Information

Clarification of Key Definitions and Criteria

• Liquidity: ESMA proposes the removal of the presumption of liquidity for listed instruments. Instead, liquidity must be assessed ex ante and on an ongoing basis, using a minimum common list of criteria (e.g., trading volume, bid-offer spreads, issuance size, volatility).
• Transferable Securities: ESMA proposes to reverse the current ability in EAD to gain indirect exposure to asset classes that cannot be held directly so transferable securities could no longer be “backed by, or linked to, the performance of assets other than those referred to in Article 50(1) of the UCITS Directive”, except within the 10% trash ratio.
• Reliable Valuation: The “reliable valuation” criterion is to be strengthened, requiring valuations at the same frequency as subscriptions / redemptions, supported by adequate liquidity and multiple pricing sources.

Financial Indices and Derivatives

• Indices: The look-through approach will apply to financial indices, meaning that indirect exposure to ineligible assets via indices is only permissible within the 10% trash ratio. ESMA also proposes that, where both the index and provider are on the ESMA register under the Benchmark Regulation, certain index eligibility requirements may be deemed satisfied.
• Derivatives: ESMA clarifies the criteria for determining when a derivative is embedded in a financial instrument and confirms that the look-through approach will apply to all such instruments, except those within the 10% limit.

Investments in AIFs and Non-EU ETFs

• AIFs: The look-through approach will apply to all AIF investments, except within the 10% limit. For closed-ended AIFs to be eligible as transferable securities, they must be subject to equivalent supervision and have a hardwired 10% limit on investment in other CIS.
• Non-EU AIFs: The existing eligibility requirements for non-EU AIFs including non-EU ETFs to be deemed equivalent to a UCITS remain, but the look-through will impose additional due diligence.

Efficient Portfolio Management (EPM) and Collateral

• Fee Splitting: All net revenues from EPM must be returned to the UCITS, with only direct and indirect operational costs deducted. Fee-splitting must be transparent and not result in undue costs.
• Collateral: ESMA supports the use of non-title transfer collateral arrangements (e.g., pledges), provided risks are managed. The rules on reuse of collateral remain unchanged.

Additional Miscellaneous Proposals

• ESMA proposes recalibrating the criteria for money market instruments, requiring both a maturity criterion and a risk profile consistent with money market conditions and clarifying the liquidity assessment.
• Ancillary liquid assets (e.g., short-term deposits) must serve a genuine liquidity need, be held only as long as necessary and be subject to the 20% counterparty limit. No absolute cap is proposed, but the UCITS must be able to justify the holding to its NCA.
• ESMA proposes updating references and ensuring consistency with MiFID II, the DLT Pilot Regime and MiCA. ESMA notes that it may be permissible for crypto-assets to be included in the 10% trash ratio, subject to all other UCITS requirements.

Next Steps

ESMA sets out a clear direction for the future of the UCITS framework and the proposed look-through approach and the recalibration of the 10% limit for indirect exposures to alternative assets are particularly significant, as is the call for directly applicable EU regulations to replace the current minimum harmonisation directives.

However, as the ESMA report is advice requested by the European Commission it is non-binding and forms part of the Commission’s wider considerations to what extent to amend EAD and the UCITS Directive. We expect the Commission will launch its own consultation where industry can submit its views in due course.