ESMA DISCUSSION PAPER ON SHARE CLASSES OF UCITS (23 December 2014) (the Discussion Paper )

Transcription

1 European Securities and Markets Authority 12 Throgmorton Avenue 26 March 2015 Dear Sir/Madam ESMA DISCUSSION PAPER ON SHARE CLASSES OF UCITS (23 December 2014) (the Discussion Paper ) Please find enclosed the BlackRock response to the Discussion Paper. About BlackRock BlackRock is a leader in investment management, risk management and advisory services for institutional and retail clients worldwide. As at 31 December 2014, BlackRock s global AUM was 3.83 trillion. BlackRock offers products that span the risk spectrum to meet clients needs, including active, enhanced and index strategies across markets and asset classes. Products are offered in a variety of structures including separate accounts, mutual funds, ishares (exchange-traded funds), and other pooled investment vehicles. BlackRock also offers risk management, advisory and enterprise investment system services to a broad base of institutional investors through BlackRock Solutions. In Europe specifically, BlackRock has a pan-european client base serviced from close to 20 offices across the continent. Public sector and multi-employer pension plans, insurance companies, third-party distributors and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals invest with BlackRock. BlackRock pays due regard to its clients interests and it is from this perspective that we engage on all matters of public policy. BlackRock supports regulatory reform globally where it increases transparency, protects investors, facilitates responsible growth of capital markets and, based on thorough cost-benefit analyses, preserves consumer choice. BlackRock is a member of European Fund and Asset Management Association ( EFAMA ) and a number of national industry associations 1 reflecting our pan-european activities and reach. BlackRock s asset management business incorporates numerous ranges of UCITS funds domiciled across Germany, Ireland, Luxembourg and the UK and we have drawn on experience from these ranges and these jurisdictions in responding to the Discussion Paper. Executive Summary BlackRock supports ESMA s initiative to ensure harmonisation of the UCITS share class regime. The common application of the UCITS Directive in member states is, of course, paramount to the protection of the UCITS brand, but so too we suggest is the flexibility afforded by the Directive to share class regimes. We agree with ESMA s submission that all share classes in a UCITS should share the same investment strategy, however, we find concerning the suggestion that a share class should not be permitted to exist if its features have the potential to adversely impact other share classes in the same UCITS: the legal segregation of UCITS share classes is not currently possible as a matter of member state local law, and 1 Association of British Insurers (ABI), Association Française de Gestion (AFG), Assogestioni, Association française des Sociétés financières (ASF), Association suisse des institutions de prévoyance (ASIP), Bundesverband Investment and Asset Management (BVI), Dutch Fund and Asset Management Association (DUFAS), Eumedion, Financial Reporting Council (FRC), Irish Association of Pension Funds (IAPF), Irish Funds Industry Association (IFIA), Investment Association (IA), Inverco, Alternative Investment Management Association (AIMA) and National Association of Pension Funds (NAPF). 1

2 so the theoretical (but effectively manageable) risk of contagion will continue to exist until local legislation can be changed. This should not therefore be a determining factor of share class existence (provided suitably robust arrangements are in place). Our view is that ESMA should look to maintain flexibility to launch different types of share classes, including those with different hedging strategies, within the general principles of common pooling and furtherance of a common investment objective. Moving investors and assets out of hedged share classes into separate UCITS will have a significant cost impact on investors. The flexibility and breadth of choice the industry is able to offer investors through share classes is key to helping those investors meet their investment objectives, such as planning for their retirement and managing longevity risk. Any limitation on the solutions that can be offered would not be in investors interests, could prove uncompetitive for the European asset management industry and could reduce the ability of the asset management industry to provide products aligned with investors interests which would be counterproductive at a time the Capital Markets Union seeks to reduce barriers to investment in UCITS. Yours faithfully Stuart Corrigall Director Strategic Product Management EMEA Martin Parkes Director Government Relations 2

3 Schedule 12 Throgmorton Avenue Response to Discussion Paper Questions 1. What are the drivers for creating different share classes? The key drivers behind the use of share classes are flexibility and cost. Share classes offer a flexible and cost efficient way for asset managers to provide investors with different investment exposures and operational features to suit their particular needs. Through the use of share classes, asset managers are able to customise features including fund entry points (e.g. eligibility criteria and minimum investment and holding requirements), trading currency, distribution strategies, fee arrangements, investment time horizons (i.e. short, medium, long term periods) and investment exposure, which otherwise could only be achieved through the establishment of separate UCITS. The myriad of investor demands and required outcomes necessitates the existence of share classes and a flexible share class regime. 2. Why do certain UCITS decide to create share classes instead of setting up a new UCITS? Generally speaking, where possible the establishment of a share class will be preferred over a separate UCITS (for the same underlying strategy) because this is quicker and more cost and operationally effective than establishing a new UCITS. Having separate UCITS rather than multiple share classes in the same UCITS detracts from the advantages of pooling assets in a single UCITS (with multiple share classes) such as: economies of scale (service provider costs reduce with AUM scale which benefits investors); fund viability (optimal strategy and experience for investors); fund liquidity (improved liquidity and dealing spreads for investors); tax efficient switching (for some investors in certain circumstances); distribution (quicker and cheaper to market, less onerous process allowing greater choice for investors); performance track record (all classes in same UCITS will benefit from track record unlike in new UCITS, assisting time to market and investor choice); fund management (fund managers can manage more share classes than funds, as share classes tend to be invisible in management terms, additionally, cost and operational efficiencies of pooling assets allocated to the same investment strategy would be lost if assets were moved into separate funds); AUM (the quantum of AUM (and operational) charges required to make a share class viable is much lower than is required for a UCITS launch thus facilitating greater investment choice and keeping costs down); and liquidation (the costs of liquidation (ultimately picked up by investors) are much lower for a share class than they are for a UCITS). 3. What are the costs of creating and operating a new share class compared to the cost of creating and operating a separate UCITS? Both the creation cost, operational cost and legal cost of offering a share class in an existing UCITS is significantly lower than establishing a new UCITS. The ongoing periodic costs/fees are also lower 3

4 for share classes than for a separate UCITS. Lower costs for asset managers, generally means lower costs for investors. The costs vary across providers and jurisdictions but in general terms the cost of launching a new UCITS would be at least three times higher than launching a share class. If ESMA recommends that the industry move assets out of hedged share classes (which account for multiple billions of Euro) into separate UCITS, this would have a significant detrimental impact to investors as it may not be viable to offer the exposure outside the critical mass of a common pool of assets. If investors are forced to switch out of existing share classes they may face significant transaction costs and negative tax consequences. 4. What are the different types of share class that currently exist? It is not possible to give an exhaustive list of share classes that exist since, as ESMA has recognised, there is inconsistency across member states and because this will vary between investment managers, as will the nomenclature of those share classes. The FCA in the UK does provide some helpful guidance in its COLL Sourcebook (section 3.3) regarding acceptable differences between shares classes. At a general level we have seen the following share classes in the UCITS environment: Share class type Retail client Institutional client Investment management agreement only client Example of features/flexibility Daily liquidity Low investment minima Available on fund platforms/supermarkets Fortnightly liquidity High investment minima Performance fees Fee arrangements/rebates can be covered outside the fund in a private agreement 4 Benefit for investors Accessible and liquid investments Fund platforms/supermarkets will often provide investment advice/guidance Limited access to protect retail investors from less liquid/riskier strategies Institutional clients sometimes require a performance fee to align manager and investor interests Allows client requirements to be provided for without impacting UCITS Income Distributing share class Regular income for those investors requiring this Accumulation Accumulating share class Reinvestment of income for those investors requiring this Limited issue Seed investor Performance fee Share class with offer limited to AUM size or date Discounted TER for investors prepared to invest in a fund which has a limited track record and AUM Investor and fund manager benefit from outperformance of Allows client access to a strategy that has a capacity constraint or a discounted TER as part of seeding arrangements or initial offer period Discounted TER for investors Institutional clients sometimes require a performance fee to

5 a fund align manager and investor interests Currency hedged Reduce/eliminate currency risk Allows investor to target required exposure and reduce Interest rate hedged/duration hedged Smoothed income Defined distribution (income and capital payments) Tax efficient wrapper (e.g. UK ISA) Reduce/eliminate interest rate risk Regular, standardised income payments (without capital erosion) Regular, standardised income payments (with capital erosion) Tax efficient wrapper for retail investors impact of currency movements Allows investor to target required exposure and reduce impact of interest rate movements Regular, predictable income for those investors requiring this (e.g. pensioners) Regular, predictable income for those investors requiring this (e.g. pensioners) Tax efficiency 5. How would you define a share class? A share class is a unit of participation in the collective pool of assets of a UCITS which can be customised such that its rights and features can be different to other share classes in the same UCITS. The definition of a UCITS share class is necessarily legalistic since share classes take their legal structure from local companies, contract or trust legislation, not the UCITS Directive. The second principle given by ESMA at paragraph 3(6) states that features that are specific to one share class should not have a potential (or actual) adverse impact on other share classes in the same UCITS. Whilst we agree that an adverse impact should not occur, we do not agree with the statement that there should not be a potential adverse impact, since the segregation of liability between share classes within the same UCITS or UCITS compartment is not possible from a legal structure perspective. There will always therefore be a theoretical risk of contagion between share classes. This has long been acknowledged by the industry and asset managers are well versed in managing this risk (see Q7) and providing adequate investor disclosure of the risk. If this principle were upheld to the letter this may serve to outlaw all hedged share classes (including currency hedged share classes), which we assume is not the intention of ESMA, given the extensive use of such share classes across all main UCITS jurisdictions. We also assume that it is not the intention of ESMA in the Discussion Paper to restrict the flexibility of shares classes beyond hedging, so that the ability to offer share classes with different (non-hedging) features such as those set out in our response to Q4 would be permitted to continue. 6. Do you agree that share classes of the same UCITS should all share the same investment strategy? If not, please justify your position. In our view investors buy funds, not share classes, i.e. an investor s primary consideration when choosing to invest in a UCITS is the investment strategy or asset class rather than whether a particular share class overlay or flexibility exists, which is a secondary consideration. We therefore agree with the principle that share classes of the same UCITS should share the same investment strategy, and be invested pursuant to the same investment objective. This should not, however, in our view prevent the existence of share class specific overlays used to vary an investment exposure (e.g. currency or interest rates) or investor experience within that common investment objective, 5

6 provided of course that those variations and associated risks (if any) are actively managed and clearly disclosed in fund documents and that the costs and liabilities particular to the share class are attributed only to that class. Different share classes can (and do) co-exist within same investment strategy. It is important to remember that risk is an integral part of a UCITS investment strategy and is something that is assessed (from a risk measurement and risk profile perspective) at share class level. Any requirement linked to investment strategy must therefore incorporate risk. We do not agree that share classes within the same UCITS should have the same risk profile. Whilst the differences should not be fundamental we believe that certain tolerances should be acceptable provided those differences do not detract from the common investment objective. One must also consider how the position for an active UCITS may differ from a passive/index UCITS. The following takes currency hedging as an example: Active UCITS An active UCITS will state its investment objective as being to provide a particular return, and all share classes will be invested in pursuit of that objective (e.g. a total return which exceeds the S&P 500). If a GBP currency hedged share class were launched it would invest in the same assets but an FX overlay would be used to hedge out the USD-GBP currency risk. Passive UCITS The investment objective of a passive, index tracking UCITS will generally incorporate reference to a particular benchmark index (e.g. a total return which reflects the performance of the S&P 500). If a GBP currency hedged share class were launched it would invest in the same assets as the unhedged share class plus currency forwards (for the purpose of the hedge) but is likely to track a different GBP currency hedged version of the index (e.g. S&P 500 GBP Hedged) which is published by the index provider as a separate index from the unhedged version of the index. Although the wording of the investment objective of the currency hedged share class would state that it tracks an index that is different from the index tracked by the unhedged share class (e.g. S&P 500 GBP Hedged versus S&P 500) the core investment strategy of the hedged share class and the unhedged share class should be recognised as being the same. We would not therefore regard the fact an index tracking UCITS might use two different (but related) indices as being a different investment strategy, rather it is the operational manner in which index fund hedged share class models are generally operated. On a separate but related note, we would like to highlight to ESMA that the requirements of EMIR alongside central clearing may impact the economics of hedge share class operation since the implication is that costs would be borne by the UCITS rather than the individual share class. 7. Could you explain how the operational segregation between share classes works in practice? The mechanism will be different depending on an asset manager s system capabilities, but in general terms this is a fund accounting exercise and the benefits are operational and economic. The systems used by BlackRock funds are designed to ensure that investors do not bear any cost or liability that is not attributable to their individual share class. Notwithstanding the system used, none can completely eliminate the theoretical risk of contagion between share classes; since from a legal perspective it is not possible to segregate liability between share classes under current legislation (we would support any proposal to change local legislation in this regard). 6

7 A UCITS (or sub-fund thereof) has a single pool of assets, and there is no segregation of these assets between share classes in that UCITS. The value of each share class is determined by an apportionment of the pool of assets. The management of the operational segregation of the common pool of assets in which all share classes have an interest is generally conducted by a fund accounting function, which is (necessarily) separate to the portfolio management team. The portfolio management team invest the assets of a UCITS as a whole without having regard to which share classes have contributed the assets into the common pool of assets. For hedged share classes, the operational segregation arrangements are different. Where a share class is hedged, that hedging strategy is typically implemented separately to the main investment strategy (by the portfolio management or other internal team, or outsourced to a custodian or currency hedging manager) applicable to the UCITS and the associated costs and performance upside and downside (i.e. profit and loss) are applied just to that hedged share class. Some providers will put in place an accounting structure to isolate hedging trades from the other unhedged share classes with the objective of ensuring that the costs linked to the trades as well as the profit and loss on the trades only impact the net asset value of the relevant hedged share class for which the hedge is traded. This is achieved by treating the common pool of assets as a master fund (for accounting convenience rather than de facto legal structure) and each share class as a feeder fund holding a notional number of units in the master fund. This notional number of units in the master fund represents the proportion of the entire UCITS assets that are attributable to the relevant share class. The profit or loss arising from any hedge put in place for a hedged share class should increase or reduce (as the case may be) the notional number of units held by that hedge share class in the master fund. Other providers will use a more common share class model in which they link/book the hedging activity at share class level, once again to achieve the same goal which is the segregation of the costs and profit and loss at the level of the hedged class shareholders. In either case it means that the hedging trades are booked to the assets attributable to the hedged share classes specifically, and not to the UCITS common pool of assets, as the rest of the UCITS trading activity would be. Both methods ensure that the costs and liabilities related to a hedged share class are separated (although of course not legally segregated). 8. Do you agree that the types of share class set out in paragraph 8 are compatible with the principle of having the same investment strategy? In particular do you agree that currency hedging that is described in paragraph 8 complies with that principle? If not, please justify your position. We agree that the examples of share classes, and the example of currency hedging, given by ESMA comply with the principle of having the same investment strategy. However, the example of currency hedging given by ESMA is overly restrictive. There are other methods of currency hedging available (e.g. hedged share classes of passive funds tracking currency hedged versions of indices, which we would consider share the same core investment strategy as unhedged share classes (see Q6 further)). Currency hedging is a varied practice and there are numerous methods available, used across the industry and within individual asset management houses. Any harmonised approach should be principles based and not specific to exact methodologies, in order to allow these different methodologies to continue within general permitted parameters, such as the common investment objective principle already identified by ESMA in the Discussion Paper. 7

8 At a simplistic level it is generally accepted that there are two broad types of currency hedging: base currency hedging (i.e. a single currency hedge covering the whole UCITS, the example given by ESMA in paragraph 8 of the Discussion Paper) and portfolio hedging (i.e. hedging at the currency level of a particular asset). This does mean that with respect to the last example in paragraph 8 of the Discussion Paper Share classes that provide currency hedging when share classes are denominated in different currencies from the base currency that share classes can provide currency hedging when share classes are denominated in different currencies from the base currency, and also share classes can provide currency hedging in the same currency as the base currency. The last example in paragraph 8 should therefore be expanded as follows: Share classes that provide currency hedging when share classes are denominated in different currencies from the base currency, or hedged share classes denominated in the base currency, so as not to inadvertently rule out an existing currency hedging methodology and possible hedged share classes, the restructure of which would not be in investors interests. Regarding the point in paragraph 9 that currency hedging should only be possible if it cannot have an adverse impact on the unit-holders of the other share classes of the UCITS, one method of increasing protection for investors is contractual, i.e. to have separate agreements with counterparties where each would only have limited recourse to the proportion of the UCITS assets attributable to a particular share class. However, the inclusion of such restricted terms may make it unattractive for counterparties to enter into such arrangements. 9. Do you believe that other types of share class that comply with the principle of having the same investment strategy exist (or could exist) and should be allowed? If yes, please give examples. Yes. We believe that there are parallels to be drawn between currency hedging and interest rate/duration hedging and that both should be permitted within a UCITS. Both currency risk and interest rate risks are discrete risks that can be extracted from an investment strategy without impacting the ability to follow a common investment objective. Duration hedged share classes work in a similar way to currency hedged share classes. The objective is that a fixed income fund will have exposure to a number of risks: credit, foreign exchange, interest rates. A duration hedged share class would keep the exposure to the other risk factors but seek to hedge out the interest rate exposure, just for that share class thus allowing an investor to isolate a desired exposure/outcome. They might achieve this using, say, treasury or gilt futures or by using swaps. These derivative exposures would be segregated from the rest of the UCITS so that the instruments only affect the performance of the duration hedged class. This works in much the same way as a currency hedged share class which buys FX forwards to close out its FX risk. As with currency hedging, the cost and liabilities of interest rate hedging (e.g. margin costs on interest rate futures) can be allocated to the duration hedged share class holders to prevent any adverse impact to non-duration hedged class holders. It should be borne in mind in relation to UCITS ETFs (which do not typically have separate share classes) that these will often have multiple listings on different exchanges, often with more than one trading currency, and so any guidelines should be sure not to prevent this, since it is in investors interests to be able to choose their trading venue and have some choice over the currency in which they settle their trades. In summary, we believe that ESMA s proposals should seek to maintain flexibility within wide principles based parameters, rather than seeking to list all permitted methodologies which would be a difficult and non-exact exercise. If flexibility is reduced or limited then this will be to the ultimate 8

9 opportunity and financial cost of investors, investors which have requested such flexibility or following full disclosure have decided to invest in such share classes. Whilst today we are focused principally on currency hedging and interest rate hedging it is possible that in future other discrete elements of hedging would be attractive (e.g. beta hedging) and the regime should therefore remain flexible so that all market risks can be hedged in order to prevent any inadvertent exclusion of future strategies that today are relatively untested or even unknown. 10. Do you agree that the types of share class set out in paragraph 10 above do not comply with the principle of having the same investment strategy? If not, please justify your position. Yes, although the detail provided is too limited to be conclusive in all cases. One clarification that should be made in terms of share classes with different leverage is that this should reference share classes that provide leveraged returns. As an example of what should not be excluded from being set up as share class on the basis of leverage: One common method of currency hedging for passive funds / share classes is to track currency hedged versions of indices which incorporate a static monthly hedging methodology (e.g. S&P 500 GBP Hedged). The static monthly hedging methodology hedges against currency risk by using rolling one-month forward FX contracts that are reset at the end of each month. Whilst a hedged share class would be proportionately adjusted for net subscription and redemptions in the share class, no adjustment is made to the FX hedge intra-month to account for price movements of constituent securities of the index. Also, gains or losses from the FX hedge will not be reinvested or covered intra-month until the hedge is reset at month-end. In the event that there is a loss on the FX hedge intra-month, leverage will result in the relevant hedged share class from such loss. When the FX hedge is reset at month-end, any leverage will be removed. Under normal market conditions, the level of leverage generated in a hedged share class between each monthly hedge reset should be minimal. As the investment strategy of a passive index-tracking hedged share class using a static monthly (or other periodic) hedge is not to provide investors with leveraged returns, such a hedge share class should not be excluded from being set up as a share class just because the level of leverage within the share class could vary between each hedge reset. 11. Please provide information about which existing UCITS do not comply with the criteria laid down in paragraph 6 as well as an indication of the assets under management and the number of investors of these UCITS. As mentioned above in our response to Q8, we presume that the intention of the Discussion Paper is not to prohibit currency hedged share classes. BlackRock does not currently offer interest rate hedged/duration hedged share classes in its UCITS ranges (although the flexibility has been built into the prospectus of one of our Luxembourg fund ranges). We do not believe that the Discussion Paper is targeting other flexibilities availed by share classes, as mentioned in our response to Q4. On this basis BlackRock does not offer any UCITS which does not comply with the criteria. 9

10 12. Do you see merit in ESMA clarifying how regulatory ratios such as the counterparty risk limit should be calculated (e.g. at the level of the UCITS or share classes)? We do not believe any further clarification is needed as part of any guidance issued in relation to this Discussion Paper. Please refer to the BlackRock response to ESMA s Discussion Paper on Calculation of counterparty risk by UCITS for OTC financial derivative transactions subject to clearing obligations. 13. Do potential and current investors get adequate information about the characteristics, risks and return of different classes in the same UCITS? If not, what else should be provided to them? We feel that the current disclosures required in the UCITS prospectus and KIID are adequate and strike a proportionate balance to disclosure by highlighting differences in structure, costs and risk. We do not feel that it is necessary to implement further disclosure requirements which may prove to be counterproductive. 14. Do you agree that ESMA should develop a common position on this issue? If not, please justify your position. We are in favour of harmonisation provided flexibility is maintained within well-defined parameters, so that innovation is not stifled and asset managers are able to offer efficient and effective investment solutions as well as investment choice to investors seeking particular outcomes and seeking to plan for their retirement. Discrepancies in interpretation of fundamental principles of the UCITS directives between member states risk damage to the UCITS brand. 10