The Committee of European Securities Regulators has rejected the inclusion of hedge fund indices in UCITS in its final advice to the European Commission.
However, all is not yet lost for the inclusion of hedge fund indices in UCITS products. The CESR has also stated that it 'is monitoring the issue and is willing to reconsider its position by October 2006, after gaining sufficient experience.'
Having listened to the comments from market participants during two rounds of consultations and following careful consideration, CESR has published its final advice (Ref. CESR/06-005*, with a feedback statement Ref. CESR/06-013) to the European Commission regarding clarification of definitions concerning eligible assets for investments of UCITS.
CESR has worked to develop the draft advice further, on the basis of the results of the second consultation (Ref. CESR/05-490b, see also the press release Ref. CESR/05-619), on which CESR received almost 50 responses, mostly from asset managers and their associations.
The following three key issues were raised in the second consultation and the progress made is highlighted below:
• The eligibility of derivative instruments on financial indices: The asset management industry, through the comments received to the consultations, expressed a strong interest in allowing derivatives on financial indices based on non-eligible assets. In CESR's view, in addition to indices based on financial derivatives on commodities, as suggested in the 2nd consultation, indices on property may be eligible, provided they comply with the criteria developed, e.g. that the index is sufficiently diversified and represents an adequate benchmark for the market to which it refers. Given the complexities of hedge fund indices and the fact that they are still developing, CESR cannot recommend, at this stage, allowing hedge fund indices to be considered as financial indices for the eligibility of UCITS. CESR is monitoring the issue and is willing to reconsider its position by October 2006, after gaining sufficient experience. CESR members agree not to authorize setting up new UCITS with such investment policies during this period.
• The negotiability of transferable securities: A substantial number of respondents to the second consultation queried the suggested requirement that "the security must be freely negotiable on the capital markets". They pointed out that this requirement appeared to preclude investment in e.g. private placements. CESR has reflected on this, and has deleted the reference to "freely" and to "on the capital markets". In addition, it has been clarified that where a security is listed, a presumption of negotiability applies, but as with the presumption of liquidity, it is not guaranteed.
• The eligibility of money market instruments: Some respondents to the second consultation raised a concern that the wording of CESR's advice could rule out certain types of money market instruments e.g. certificates of deposit, which would not be able to fulfill the draft requirements in Box 6*. The final advice makes a distinction between different types of issuers, and the information requirements have been relaxed for certain types of issuers/ issues, e.g. when the issuer is an establishment subject to prudential supervision.
The Chairman of CESR Expert Group on Investment Management, Mr Lamberto Cardia noted 'I am pleased that CESR members were able to put forward solutions during the second consultation which appeared to have resonated very well with market participants. I believe CESR's final approach strikes a good balance between the need to deliver an approach which provides significant flexibility for product innovation to continue amongst UCITS whilst at the same time, ensuring that the level of investor protection is both adequate and consistent across the EU.'
Cardia added: 'We hope this progress will be welcomed by asset managers who have been beset by significant Single Market barriers since 2002, due to uncertainties related to interpretations of the amending UCITS Directives. Clarification of the eligible assets of UCITS is one on the four priority actions the European Commission has indicated in its Green Paper on investment funds last July. I am very satisfied CESR has now delivered its part in this process and hope that investors will now be able to benefit from the increased choice of products which will become available as a result whilst knowing that adequate safeguards are also in place.'
*The complete final advice CESR/06-005 pdf can be viewed and downloaded here 
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