ESMA Final Report – UCITS Eligible Assets Update

The European Securities and Markets Authority (“ESMA“) has published its final report advising on significant changes to the UCITS Eligible Assets Directive (the “Report“). The aim is to harmonise UCITS rules across the EU by moving towards directly applicable regulations and removing national divergences. While ESMA’s proposals are non-binding, it signals a potentially significant shift in the UCITS space. It is expected the European Commission will launch its own consultation before any of the following changes are implemented.

Key aspects highlighted by ESMA:

• Look-through Approach: a cornerstone of ESMA’s proposal is a mandatory “look-through” period to determine the eligibility of asset classes for at least 90% of the UCITS portfolio, 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.
• 10% “Trash Ratio“: ESMA has proposed flexibility to permit indirect exposures to alternative assets of up to 10% (subject to regulatory safeguards (e.g. on liquidity and valuation)), aiming to enhance diversification and generating returns from uncorrelated asset classes. The 10% “trash ratio” would 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 without the need for a look-through.
• Presumed Liquidity Removal: currently, there is a presumption that listed securities are liquid and negotiable by default. ESMA recommends revising the Eligible Assets Directive to remove that presumption. Instead, every transferable security or money market instrument should be assessed (before and during its holding) for liquidity and negotiability.
• Harmonisation and Consistency Focus: ESMA’s report addresses divergences across Member States in how the Eligible Assets Directive has been applied and recommends that the Commission move towards using directly applicable EU regulations (rather than a directive to be implemented in each member state with national discretions). ESMA have also proposed 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.

The European Commission is not bound to adopt all of these proposals; however, the Report sets a strong indication of the direction the UCITS space is moving. The Commission will consider these recommendations and may launch its own public consultation before amending the Eligible Assets framework. For UCITS management companies, the recommendations suggest that many existing products may need examination and potentially adjustments to comply with, for example, the stricter look-through regime. The precise shape of the legislative reforms remains to be seen, but firms in the UCITS space should ensure readiness.