UCITS (Undertakings for Collective Investments in Transferable Securities)

From the UCITS I directive to the UCITS V directive

The European UCITS I directive dates back to 1985. It laid the foundations for the harmonization of various European legislations concerning collective investment undertakings such as SICAVs and FCPs. UCITS IV introduced the concept of the "European passport," under which a fund approved in one state can, after notification to the authorities of the host countries, be freely distributed in those countries.

The UCITS III and UCITS IV directives were respectively adopted on January 21, 2002, and January 13, 2009. UCITS II, however, never came into existence.

Finally, a UCITS V directive was adopted in May 2014. It introduces specific rules regarding the safekeeping of fund assets to prevent a recurrence of a Madoff-type affair, as well as provisions concerning the variable remuneration of managers, provisions inspired by those of the CRD IV directive which applies to banks.

Main requirements for UCITS funds

UCITS funds must comply with a number of well-defined requirements set out by the European directive. This regulatory framework is designed primarily to protect investors.

1. Clear investment constraints: UCITS funds are subject to constraints related to the types of assets in which they can invest. They must invest in securities or liquid financial assets that can be easily bought and sold, such as stocks, bonds, and money market instruments. Direct investment in physical precious metals, or in other commodities or non-financial assets, is not permitted. However, they are allowed to invest in financial derivative instruments, such as futures contracts or swaps.

2. Diversification ratios: in order to reduce risks for the investor and avoid "putting all eggs in one basket," the UCITS framework establishes strict rules to promote investment diversification. The best-known rule is the "5/10/40" rule. Under this rule, a maximum of 5% of the fund’s net assets can be invested in securities of a single issuer, but this limit can be increased to 10% per entity provided that the total value of all investments exceeding 5% does not exceed 40% of the fund’s total net asset value.

3. Robust risk management and investment limits: UCITS funds must comply with rules limiting the funds’ exposure to risks, notably counterparty risk. This is generally limited to 10% of the fund’s net asset value. The limit is 10% of the fund’s assets when the counterparty is a credit institution, or 5% of its assets in other cases.

4. Transparency of information: to enable investors to be well informed and facilitate fund comparison, the UCITS directive requires an appropriate and standardized level of information disclosure through the fund’s legal documentation. This information disclosure ensures a high degree of transparency for investors. Various documents must be presented to investors before they invest. These documents must be updated very regularly and be available on the fund management company’s websites. These documents include:

• The Key Information Document (KID), which describes the objectives, main features, a risk indicator (SRI), performance scenarios, costs over time, and the composition of costs, etc. (The PRIIPs KID replaced the UCITS KIID as of 01/01/2023.)
• The prospectus, which provides detailed information on the investment strategy and more generally all aspects related to the fund’s management.
• The annual report, which presents the fund’s financial statements and information related to the fund’s assets.

5. The use of an independent depositary: this arrangement aims to protect investors’ assets by ensuring that these assets are not held directly by the management company but by an external entity: the depositary. The use of an independent depositary thus guarantees that the fund’s assets cannot be seized, for example, to pay the management company’s creditors in the event that it experiences financial difficulties.