For the first time at European level, some types of share classes that have been permitted by certain national regulators may have to close to new investment and, eventually, convert to separate funds or sub-funds. It is an example of ESMA dedicating time to the objective of consistency of approach by national regulators, despite its heavy workload on Level 2 and Level 3 measures. The responses by the national regulators will be interesting. Will those countries that have allowed such share classes now fall into line with ESMA’s opinion or choose not to follow it? And if they do not, might other national regulators prohibit the cross border distribution of those share classes into their countries?

ESMA confirms that four high-level principles should be followed by national regulators in deciding whether to allow UCITS to set up different share classes or require them to set up a new sub-fund or new UCITS:

• Share classes of the same fund (or sub-fund) should have a common investment objective reflected by a common pool of assets.
• UCITS management companies should implement non-contagion procedures to minimise the risk that features specific to one share class cannot have a potentially adverse impact on other share classes of the same (sub-)fund.
• All features of a share class should be pre-determined before it is set up.
• Transparency: differences between share classes should be disclosed to investors when they have a choice between two or more share classes.

As we predicted two years ago, when ESMA first opened this debate, its view remains that hedging (other than of currency risk) does not generally meet the first principle. It suggests that such share classes be closed for investment by new investors by the end of July 2017 and for additional investment by existing investors by July 2018.

National competent authorities will need to review their national rules and approaches, and firms will need to review their existing share classes. In some jurisdictions, this might result in certain types of share classes being allowed for the first time, but the greater impact will be in those fund domiciles where the approach to date has been more liberal.

If the relevant national regulators follow ESMA’s opinion, some share classes may have to be closed to new investment, change their strategy or be withdrawn. This will require managers to make an assessment of the impact on investors in those share classes and to have a clear communication strategy.

If a national regulator chooses not to follow ESMA’s opinion and allow such share classes to continue to take new investment or managers to set up new ones, the ability to distribute those share classes cross border into other Member States might be frustrated.

For more information on this please see our KPMG FundNews article or contact Julie Patterson.