8.2.1 Consistent regulation

First of all, I looked at whether there is consistent regulation. I found very few examples of inconsistent regulation. The only exception involves the investment limits. These are unsubstantiated and partly outdated. The rules consist of a few simple restrictions that are not based on economic risk. The concentration limits do not incorporate correlation. So while a UCITS may not invest more than 5% or sometimes 10% in the shares of a single issuer, it can invest its entire portfolio in shares of companies that are very similar. Moreover, restrictions have been placed on the counterparty risk that a UCITS may incur, but the creditworthiness of the counterparty does not play a role in this. Therefore, it makes no difference whether the counterparty risk is incurred on an insolvent company or a company with a good credit rating.

A few examples illustrate the inconsistencies. A UCITS may invest 100% of its assets in government bonds issued by a member state because such bonds are considered to be 'risk free'. Bonds issued by a company may only represent 10% of the assets of a UCITS. Therefore, a UCITS may invest 100% of its assets in bonds issued by Greece, a member state with an S&P rating of B+ (also referred to as 'junk') in mid-2019, but only 10% may be invested in bonds issued by Rabobank, which in mid-2019 has an S&P rating of A+ (also referred to as ‘low risk’). As a result, these restrictions do not provide consistent protection against counterparty risk.

The requirements are also inconsistent with regard to market risk. No investments may be made in commodities. These are seen as too risky and not sufficiently liquid. This also means that no investments may be made in commodity derivatives. Investments may, however, be made in derivatives on a commodity index. The risk associated with these derivatives is not necessarily more limited but these instruments are for some unclear reason allowed.

In mid-2019, a UCITS that was pushing the limits of the investment re­strictions was discredited for not being able to provide its unitholders with sufficient liquidity. The problems encountered by this UCITS are described in paragraph 4.5.2. The UCITS was unable to meet its redemption obligations for six months and ended up in liquidation. The current rules make such problems inevitable.

What is also striking is the difference in the level of detail in which rules have been drawn up on some topics, while no provisions have been included on other subjects. For example, very detailed provisions have been drawn up for cross-border mergers, the obligations of depositaries and auditors in the case of a master-feeder construction, the instruments in which a UCITS may invest and the risk management process.

However, other highly relevant issues such as asset segregation, limited liability for unitholders, civil-law consequences of breaches of investment limits, costs, the calculation of net asset value and liquidation requirements are barely addressed – if at all. The liability regime of depositaries is laid down but there is no mention of the liability of management companies.

Due to the absence of requirements on these areas, one cannot argue that UCITS regardless of the legal structure or home member state offer the same protection to unitholders. The degree of investor protection depends on the home member state and on the legal structure of the UCITS. Without knowledge of national legislation, one cannot simply assume that a UCITS has adequate asset segregation or limited liability in place. Nor can it be assumed that if rules are breached – for example, with regard to investment requirements – unitholders will be compensated. This depends on the requirements of the home member state of the UCITS.

Unitholders in a UCITS will, however, expect the UCITS to have these characteristics. Member states will usually impose such requirements themselves in national legislation, but since these characteristics are not mandatory at European level, this must first be verified. Having UCITS authorization does not make this is a given.