8.2.3 Best practices from international regulatory legislation

Thirdly, the UCITS requirements have been compared with best practices from international regulatory standards, as drawn up by the IOSCO and OECD.

The UCITS regulations have been compared with various IOSCO reports. Although the UCITS regulations are in line with most of these reports, there are four topics for which this is not the case. These are valuation, costs, ETFs and liquidations.

ESMA has issued guidelines setting out additional requirements for ETFs. To the extent that national regulators comply with these guidelines, many of the best practices for ETFs have been implemented.

The key IOSCO recommendations on costs that are missing from the UCITS regulations are:

The UCITS Directive currently contains very little provisions on the liquidation of a UCITS. The IOSCO's best practices are fairly detailed. For example, according to the IOSCO, the unitholders must be informed in detail about the intention to liquidate the UCITS and the progress of this process. In addition, a termination plan must be drawn up if the decision has been made to terminate an investment fund. This plan should include the rationale for the liquidation, the estimated period of liquidation, the estimated costs and who will pay the costs, how illiquid assets will be dealt with, and how windfall payments received after the unitholders have withdrawn their investments will be dealt with. In addition, the management company would have to consider closing the fund to prevent deposits and withdrawals during the liquidation process. Finally, the management company would have to approve the termination plan, as would the entity responsible for the independent supervision of the investment fund, such as the board of directors. According to the IOSCO principles, institutional investors should be given the opportunity to exit in kind, valuations should take place at fair value, and conflicts of interest should be addressed wherever possible. I believe that all these requirements would be prudent additions to the UCITS regulations.

The valuation of a UCITS is of great importance to unitholders. It determines the price at which a unitholder can exit and enter, and therefore what the unitholder’s return will be.

In its best practices, the IOSCO emphasizes the importance of detailed and defined procedures and methodologies for valuation. These procedures must be consistent. Measures should also be taken to identify, prevent and correct valuation errors. The valuation procedure must be reviewed each year, both internally and by a third party. The principles attach importance to forward pricing. That means you only calculate the price of the units after the subscription deadline (the ‘cut off’). The prices of the underlying investments must not be fixed before the cut off. Therefore, the cut off must take place before the markets, on which the underlying assets are traded, closes. By forward pricing, one prevents parties from being able to estimate in advance which way the intrinsic value will move based on price movements. This practice can be abused – at the expense of other unitholders. Finally, a management company should compensate unithold­ers if any valuation errors have been made that have had a material impact on unitholders.

The Directive stipulates that the valuation must be accurate, correct and in the interests of the unitholders. These requirements are, however, not fur­ther specified but should be laid down in the applicable national law, the fund rules or the instruments of association. A depositary must ensure that the valuation of units is carried out in accordance with the relevant legislation and fund documentation. However, nothing more is specified in the UCITS Directive. Member states are free to decide how a UCITS should deal with valuation errors and when unitholders should be compensated.

Provisions on valuation, costs and liquidations would, in my view, be valuable additions to the UCITS regulations.