EFAMA Reply to ESMA s Discussion Paper on share classes of UCITS (ESMA/2014/1577)

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1 (ESMA/2014/1577) Preliminary comments EFAMA welcomes ESMA s initiative to consider the development of a common understanding across the European Union of what constitutes a share class under the UCITS Directive. Share classes have become an indispensable feature of modern day collective investment products and undoubtedly of UCITS. As such, the different varieties of share classes reflect not solely the diversity of the UCITS investor audience from retail to institutional to sovereign but also the high degree of specialisation reached by the UCITS asset management industry in customising products responding to investors specific demands. Apart from sharing ESMA s intended objectives to determine a common position around the notion of UCITS share classes, we would also welcome the general standards identified in the Discussion Paper as useful guidelines to assist industry in the further development of certain types of UCITS share classes and particularly those offering to hedge market risks. Questions 1. What are the drivers for creating different share classes? EFAMA would firstly observe that the drivers behind the creation and customisation of separate share classes are fundamentally economic by nature, to better reflect investors preferences, whether they be retail, institutional, sovereign, etc. Important for ESMA to consider is also the fact that different share class offerings and the pace of their innovation are fundamentally demand side driven, reflecting individual investors preferences for a product that is first and foremost intended to suit their needs, and secondly, economically more advantageous compared to the alternative of investing in a separate fund. Share classes, indeed, meet investor demands by customising the UCITS product on the basis of multiple investor preferences, e.g. their location (within or outside the base currency area of the investment strategy), holding periods, investment amounts, management and subscription / redemption fees, revenue distributions, market developments, nominal vs. real returns, etc., without needing to redeem or purchase shares in another fund (or different compartment thereof). Another significant advantage from an investor s perspective derives from the efficiencies that are generated from the economies of scale tied to the management of a larger underlying pool of assets rue Montoyer 47, B 1000 Bruxelles Fax e mail : info@efama.org VAT Nr BE

2 2 and visible in lower administration and transaction costs. This comes as a result of investors simply opting to switch from one share class to another, instead of triggering an additional transaction (in turn resulting in a higher portfolio turnover) every time they subscribe / redeem into / out of a fund. Specifically for a large institutional investor, the larger a fund and broader the share class offering, the lesser the risk from concentration. In certain jurisdictions, for instance, institutional investors are only allowed to invest in a fund that has sufficiently diversified liabilities (i.e. investors), that could better amortise investment losses or the rare event of the fund s closure. Economic benefits accrue to managers as well, especially where economies of scale translate into a larger mutualisation of costs; i.e. rather than launching several and separate individual funds, each customised to meet investor demands albeit all sharing the same investment strategy proliferating a product offer with considerable regulatory approval, set up, and marketing costs far greater efficiencies can be achieved by allowing more investors into one single fund with several customised share classes in turn based on the same engine, i.e. the fund manager s expertise in delivering the same strategy. For a more precise estimate of such efficiencies, please refer to our answer to Question 3 below. In connection with cost mutualisation and in the backdrop of the worldwide competitive landscape, ESMA should bear in mind that the capacity to create different share classes is also an important factor that allows the European asset management industry to therefore i) manage larger funds to more effectively face off competition from non European providers, while helping to resolve the problem of excessive fund fragmentation noticeable in Europe 1 ; and ii) to offer UCITS shares outside the fund s base currency area to meet rising UCITS demand in non EU, third country jurisdictions (particularly Asia). A broader array of available share classes would also prove competitively advantageous in drawing more non European investors towards the UCITS product brand as well. As an example of the degree of fund fragmentation in Europe, the following EFAMA figures are striking: for the fourth quarter of 2014, the average size of a UCITS fund compared to the average of a U.S. mutual fund was of 245 million against 1.8 billion respectively 2. Apart from pure economic considerations, there are clear operational advantages tied to the offer of separate share classes for both investor and manager; i.e. a noticeable reduction in time to market, where the activation of additional pre approved share classes need only be notified to the competent regulator, as opposed to a new fund launch requiring the latter s prior authorisation, new offering materials 3, additional and separate legal documentation (as ISDAs), new contracts with service 1 As was noted in the European Commission s 2006 White Paper on enhancing the single market framework for investment funds, there is still a proliferation of small funds in Europe, where the larger the pool of assets, the more likely is the opportunity to achieve economies of scale. Such economies can in turn lead to a reduction in charges or better performance for the investor as a result of scale savings. Whilst the focus of White Paper (and in turn the updating of the Directive to UCITS IV) was on other methods to achieve larger pools e.g. master feeder arrangements and fund mergers the ability to create share classes within a single UCITS fund also delivers such an outcome via the pooling of assets of investors who all seek exposure to the same underlying portfolio of investments, albeit with a degree of customisation. 2 After a further break down, for equity funds the respective difference is 239 million vs. 1.5 billion; for bond funds 315 million vs. 2 billion, and for money market funds 918 million vs. 4.3 billion. 3 Compared to the necessary updates to UCITS umbrella prospectuses at the launch of a new individual compartment, activating new share classes would only require the preparation of a new KIID that would generally share the same wording of those for other existing share classes.

3 3 providers (as depositary banks), lack of an existing track record to attract inflows from the outset, higher distribution costs (especially at an international level), etc. For these same reasons, a share class is also easier to close or to otherwise deactivate compared to the tasks of closing an entire fund. Finally, from a manager s perspective, EFAMA would note that share classes usually permit a significantly smaller initial asset base (or seed capital) to launch if compared to the opening of new fund vehicles 4 Considering the different varieties of share class types as listed in the ESMA Discussion Paper, EFAMA would consider these to be broad enough for the purpose of elaborating a future common position around the notion of UCITS share class. More generally, we would also include those share classes that provide a systematic hedge against the realisation of one generic market risk, inter alia an equity market drawdown, a risk of sudden interest rate hikes, of widening of credit spreads, inflationary pressures, etc. It is precisely this sort of systematic hedging overlay that provides investors with an additional advantage beyond the rewards generated by the fund manager s specific expertise in terms of alpha generation. The fact that the overlay also allows investors to flexibly adjust their risk profile by switching from one share class to another (or by allocating more to one class over another) without needing to exit the UCITS altogether is an evident demonstration of the advantages from maintaining separate share classes. Among the drivers for UCITS share class differentiation as mentioned above, one that would deserve greater elaboration is the need for efficient hedging. EFAMA would in this regard emphasise that share class hedging is an important functionality for investors, allowing efficient protection against unwanted risks (e.g. currency, interest rate related, equity or other). As such, we believe that share class hedging beyond mere currency and duration should be allowed, provided it complies with the general principles as laid out by ESMA under paragraph 6 of the Discussion Paper. In light of the above considerations around investment products to better respond to demand side pressures, as well as around economic efficiencies, EFAMA would more broadly invite ESMA to consider the link between these considerations and the objectives of the European Commission s recent cornerstone initiative of a European Capital Market Union (CMU). Visibly, there are clear synergies between a diversified UCITS product offer as customised to meet client demands and the need to increase (retail) investors participation by committing more of their savings to capital markets. Worthy of notice is also the fact that the economic efficiencies described above additionally remove the regulatory cost of setting up new funds, while allowing existing funds to grow sufficiently so as to reap the advantages of scale, as well as to boost the European asset management industry s competitiveness abroad though larger vehicles. 4 For instance, one of our corporate Members has noted that clients in certain local markets (e.g. Taiwan and Singapore) are effectively excluded from access to newly launched UCITS until the fund has established a certain minimum size (usually around USD 100 million) and a NAV track record of at least 3 years.

4 4 2. Why do certain UCITS decide to create share classes instead of setting up a new UCITS? As anticipated above, the primary motive for a UCITS to create separate share classes is demand driven to the extent that it meets specific investor requirements and / or profiles. Moreover, ESMA should consider that it is by far more efficient to create new share classes in a large, single investment pool rather than comparatively smaller funds following the same overall investment strategy. As an example, please consider a UCITS portfolio, invested in European securities with the following different sub sets of investors: those who want income paid out; those who want income accumulated; those who pay different charges; those who want different currencies; those who want to hedge specific market risks (e.g. currency, interest rate, volatility, equity risk, etc.). If a UCITS needed to be set up to meet the customised requirements for each sub set of investor, economies of scale would be lost with a replication up to a total of six UCITS funds (or compartments thereof) with almost identical portfolios. 3. What are the costs of creating and operating a new share class compared to the cost of creating and operating a separate UCITS? The costs for creating and operating a share class as opposed to a new fund are clearly lower. From a regulatory perspective, the activation of a new share class would not require for the prospectus to be updated where this already foresees that one share class, but merely the preparation of the relevant KIID 5. By comparison, the creation of a separate UCITS fund (or compartment thereof) will require an additional new prospectus (or a considerable lengthening of the existing umbrella UCITS prospectus in the case of a new compartment), in addition to the class specific KIID. Another inconvenience from the creation of separate UCITS funds derives from the fact that the separation of assets into, for instance, two UCITS fixed income pools would involve the separate management of these pools towards the same core strategy, yet with a different duration result over time. In fact, the composition of each pool of assets will progressively diverge, as fixed income portfolios invest into successive issues and cash flows to and from the fund will consequently differ, with trades no longer occurring at the same time. The costs of pursuing distinct investment management strategies in this way would therefore be significantly greater than managing a single core portfolio, adjusted for duration at the level of the share class. From a liquidity risk management perspective, a larger fund that allows a multitude of share classes is also easier to manage, compared to smaller and less diversified individual funds. 5 If instead a new type of share class is introduced, small updates to the prospectus, together with a separate KIID unique to the new share class would be required.

5 5 Cost differences may also be explained by the fact that for the launch of a fund ex novo higher additional seed capital is required to run the advertised investment strategy in an efficient way, albeit in the absence of a visible track record, while bearing the brunt of additional administration costs (i.e. with separate bank and custody accounts, accompanied by the associated regulatory reporting). From a launch and operating cost perspective, EFAMA believes that a fair estimate of these costs for a share class (within an existing UCITS structure) on the basis of our Members submissions and aside from custody fees is between some 10% to 20% of that to create a separate UCITS for the same purpose. Besides these costs, ESMA should also recall that liquidation costs of a UCITS are higher than deactivating an individual share class, as well as the fact that switching between UCITS funds comes with transaction costs alongside possibly noticeable market impacts, unlike the mere switching between share classes of the same UCITS where assets are pooled and do not require trading. 4. What are the different types of share class that currently exist? A range of different share classes have been created to enable investors to select a commercial outcome of a given investment strategy which is tailored to their needs, or designed to provide a commercial benefit, or incentive, according to the type of investor. Looking at our broad EFAMA membership, in the UCITS fund market, there currently exist multi class share structures with different characteristics. Below is a non exhaustive list of factors on which share class differentiation may be based: systematic hedging (total or partial) against a generic market risk (e.g. currency, risk of equity market drawdown, risk of an interest rate rise, risk of widening credit spreads, risks of higher inflation, risk of a spike in volatility, etc.); minimum investment vs. minimum holding amount; fixed vs. variable service costs; fixed vs. variable management fees; retail vs. institutional vs. employee; dividend accumulating vs. dividend distributing (or accounting for distributions to charities as for instance in Shariah compliant funds); cash or stock dividend; fees or charges (entry vs. exit fees, management fee, performance fee, service fees, retrocession payments, etc.); distribution channels / platforms; use in retirement plans / pension schemes. The essential merits of being in a position to offer a wide range of share classes are the tailoring of investment outcomes to investor needs, providing the broadest choice for investors, ensuring efficient business models for managing collective investment schemes and providing means to avoid the creation of a separate fund vehicle to deliver similar investment outcomes. It remains therefore of key importance that innovation for a broader and investor driven offer of share classes be allowed to develop.

6 6 5. How would you define a share class? Broadly speaking, we consider share classes as separate categories of shares belonging to the same UCITS (or compartment thereof). Although definitions based on objective criteria may differ somewhat under domestic rules and regulations, they allow sub sets of investors in a UCITS to achieve some level of customisation which accommodates their specific needs without detracting from the common underlying investment strategy. EFAMA supports ESMA s idea that a set of general principles should guide the introduction and use of different kinds of share classes, including hedged ones, and broadly agrees with the three principles ESMA has identified in the three bullet points under paragraph 6 of the Discussion Paper. Still, EFAMA would like to make the following few additional observations with respect to the second and third (bullet point) principles. In the second bullet point, EFAMA is aware that there is presently no legal segregation of assets between share classes and agrees with the principle that one (hedged) share class s specific features should not cause material adverse impacts for holders of different share classes. In parallel, however, we have to admit that the potential for this to occur cannot be eliminated altogether (even if it remains highly unlikely)6. In light of this, we would recommend an alternative principle revolving around the need for the UCITS management company to have robust risk control systems in place to quantify and manage potential spill over risks between different share classes, as also verified by the appointed depositary. As we shall explain in our answers to the following questions, accounting techniques may in certain circumstances prove useful to contain such spill over risks, which we agree should be adequately disclosed to investors in the relevant offering materials and regardless of the share class they choose to invest in. Apart from those instances where it is possible to account for share classspecific exposures separately, certain jurisdictions also foresee alternative legal protection in the form of limited recourse provisions (e.g. as part of ISDA agreements used in OTC trades) between a UCITS and a counterparty, whereby the latter would eventually have recourse only to the UCITS asset that are apportioned to that individual share class 7. As to the third and final bullet point, we would note that differences between share classes are already adequately disclosed in the prospectus, with the KIID left to present the features of an individual share class in line with the relevant section UCITS implementing Regulation 583/ In this respect, please see our reply to Question 13 further below. 6 Such a possibility was even acknowledged by the UK FSA (now FCA) in its 2006 Quarterly consultation document (no. 10), where section 6.9 thereof states: For class specific hedging to be permitted, firms would have to provide an appropriate level of protection for all unitholders, and address the risk that the rights conferred by the hedged class might cause prejudice to holders of other classes of units in the same fund. The same understanding has also been reflected in the FSA Rulebook (COLL 3.3.5B). 7 Such agreement where possible would additionally need to consider the specificities of the segregation requirements for centrally cleared OTC contracts that may make forms of limited recourse more arduous. 8 More specifically, please refer to Articles 26 and 27 thereof.

7 7 6. Do you agree that share classes of the same UCITS should all share the same investment strategy? If not, please justify your position. EFAMA fully supports that all share classes share the same investment strategy. We would observe nevertheless that in the absence of a harmonised and more precise EU wide definition of this notion, the common denominator across every Member State is and remains a common pool of assets with which to meet the UCITS s advertised investment strategy. The fact that adegree of protection may be offered as an overlay at a hedged share class level against a specific market risk complies with the underlying strategy. Referring specifically to paragraphs 9 and 11 in the Discussion Paper, EFAMA would for instance question the rationale for drawing a distinction between hedging for currency risk and hedging for interest rate risk, where only the former in ESMA s view would appear to be compatible with the principle of having a common investment strategy. Legally speaking, there is firstly no language in the UCITS Directive, or in any of its implementing measures, that would seem to exclude the admissability of a share class based on an investment outcome, no matter if favourable or adverse to investors. Secondly, EFAMA would recommend that hedged share classes, when expressly designed to reduce those intrinsic risks in an underlying portfolio like interest rate risk for fixed income pools be allowed, as they are definitely compatible with the underlying strategy. Please see our replies to Questions 7 and 8 below for practical examples. 7. Could you explain how the operational segregation between share classes works in practice? Each UCITS compartment has a single pool of assets with no segregation of these assets between share classes. The value of each share class is determined by an apportionment of the change in value of the pool of assets on the basis of a distribution coefficient. Moreover, the management of the common pool of assets in which all share classes have an interest is functionally separated from the management of the individual share class s features. More specifically, the investment manager taking decisions on how the assets of the UCITS will be invested will not look at each share class, but will manage the portfolio as a whole, ensuring subscriptions are invested in the portfolio and assets sold from the portfolio in order to meet redemption requests. For hedged share classes, the hedging strategy will operationally be implemented separately from the investment strategy. It will be applied systematically to hedge the defined risk, with no discretion by the manager in determining whether or not to apply the hedge. For this purpose, the management team will merely purchase the necessary derivative instruments (e.g. forward currency contracts) required to hedge the identified risk. Whereas the invested assets are booked into the general common portfolio, the instruments for hedging purposes (e.g. a forward rate agreement, a futures contract, and interest rate swap, etc.) at the share class level will need to be booked separately. This allows the corresponding P&L to be isolated and to allocate this only to the shareholders of the hedged share class. Trades are routed / booked by the portfolio / hedging manager to the particular share class in order to allow for the isolation of the related costs and benefits and thereby also ensuring that no cross contamination

8 8 occurs between the hedged and un hedge classes 9. From an accounting perspective, therefore, the share classes are operationally segregated. Any eventual margin requirements relating to the hedging instruments depending on whether these are exchage traded or OTC are allocated to the hedged share class for accounting purposes as well and reflected in the relevant share value 10. In this regard, as an example, asystematic hedging strategy sometimes used for duration hedged share classes would for instance use bond futures, with e.g. 1% of the investor s initial outlay being used to cover the initial margin call (according to the exchange rules) from the fund s broker and the remaining 99% invested in the actual underlying pool. In this example, the hedged shareholder s investment is actually diluted compared to that of the un hedged one (who is invested 100%). The cost of the hedge (along with the associated benefits) is borne only by the former in the form of a margin requirement at the very outset of the investment and consequently fluctuates depending on interest rate volatility. The hedged shareholder s exposure would moreover include the potential additional losses to his initial investment should rates move in the opposite direction of the intended hedge, a scenario that would demontrate how in relative terms un hedged investors may actually be better off. On the back of this example, EFAMA maintains that where operational segregation can be effectively applied, eventual spill over risks from hedged to un hedged share classes and consequent dilution of the underlying NAV for all investors should be adequately contained, and ultimately, this allows the UCITS to hedge against other types of market risk beyond currency related ones. Moreover, as mentioned in our reply to Question 5 above, we recognise that in certain jurisdictions, limited recourse by the UCITS counterparty to the sole assets attributed to one individual share class may be legally feasible, thereby serving as an alternative measure to avoid the dilution of the underlying pool s value. Concerning valuation, initially, each asset in the portfolio will be valued, and liabilities relating to the entire UCITS will be deducted, the fund s general P&L will be allocated to each class based on that specific class percentage in the overall AuM (based on the previous day s NAV and accounting for initial margin specific to each share class). This initial valuation will form the basis of a series of second step valuations for each share class, where any hedging instruments specific to that share class will be valued, where hedging costs specific to that share class will be accrued, and the conversion factor for any income previously reinvested in the UCITS for that share class (in the case of accumulation shares) will be applied in order to complete the class s valuation. 9 There may however be a residual risk of contamination that could occur given the time lag between the timing the hedging trades are booked and the time the portfolio s NAV is calculated (in an ideal world, these moments would need to match). More than a contamination of the un hedged share classes, it is rather a risk for hedged shareholders to be over or underhedged during a very brief period (and which may in any case adjusted for afterwards). 10 With OTCs, collateral requirements, including related netting arrangements, will tend to vary depending on commercial discussion and negotiation with the broker. There are various ways to implement a hedge at a share class level, ensuring that spill over risks across share classes are well managed. Moreover, limited recourse clauses as per our reply to Question 5 would provide, where possible, additional legal comfort.

9 9 8. Do you agree that the types of share classes 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. EFAMA agrees that the listed examples under paragraph 8 of the types of share classes should not be exhaustive. For instance, share classes may differ in terms of how they hedge market risk (full or partial) or of how hedging is performed to immunise against specific risk factors (e.g. duration, inflation, volatility, single or multiple currency, equity market risk, etc.), as long as these hedge overlays are compatible with the underlying investment strategy and are reducing exposure to any of abovementioned factors systematically (i.e. not requiring the risk manager s full discretion, but allowing for the hedging instruments choice, strike prices for options, maturities, etc.) 11. Concerning the second part of the above question, as mentioned previously, EFAMA believes that currency hedging is compatible with the relevant principle as formulated in the Discussion Paper. With regard to currency exposure, ESMA should importantly recognise that managers need to provide a currency choice, particularly for funds that have cross border investors. Hence, currency exposures are more a question of currency choice for a broader investor universe and increased unit / shareholder diversification. In practice, currency hedged share classes are designed for investors who want exposure to assets denominated in foreign currencies without the associated currency risk of the base currency of the fund. These specific share types limit investors currency risk by reducing the effect of exchange rate fluctuations between the fund s base currency and the currency to which the investor wishes to be exposed. Broadly speaking, currency hedged classes may not always offer returns that exactly match those of the equivalent base currency (un hedged) share class. Factors responsible for this phenomenon may for instance be the related hedging costs (e.g. transaction costs, currency rate differentials, etc.), as well as the time lag between the booking of the hedging trade and the valuation of the fund s NAV. More importantly, as described in our reply to Question 7 above relative to operational segregation, the hedging process has no impact on the NAV of the underlying portfolio as it is only the NAV of the specific currency share class that is hedged. As for the example relative to duration hedging, non hedged share classes can also profit from currency movements (where FX rates move in the opposite direction of the one predicted by the hedge), with investors in currency hedged share classes actually recording losses through foregone gains in these circumstances. With regard to share class currency hedging, EFAMA welcomes the fact that ESMA considers it compatible with the principles as set out in paragraph 6 of the Discussion Paper. Any harmonised approach should be flexible enough to recognise the various approaches to currency hedging as well. We similarly believe that the same should be true for other types of market hedging such as duration hedging, or equity market hedging, at a share class level. 11 The fact that the reduction of a risk is implemented on a systematic basis is a key element to consider, as it implies that there is little discretionary management performed in the implementation of the hedging strategy. In addition, this option of being able to choose a share class with a systematic risk hedging is disclosed to investors in the fund share class description: it provides to investors a very clear and transparent level of information on the objective risk mitigation. On the basis of such ex ante information, the investor is free to choose whether to invest in the relevant share class.

10 10 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 justify your position. As long as they comply with the general principle of being compatible with the common portfolio s advertised investment strategy and with those others as presented under paragraph 6 of the Discussion Paper, we support other varieties of share classes not expressly mentioned therein. In this respect, what also matters is that the costs related to any use of derivatives are only borne by holders of the relevant share class (who also benefit from the overlay), and that the asset management company maintain a strict risk management policy tailored to the idiosyncratic risks of the relative share class to limit possible spill over effects 12. Differently to ESMA s initial view expressed in paragraph 11 of the Discussion Paper and for the reasons explained above, duration (or interest rate risk hedging) as well as others not expressly cited by ESMA can clearly be compatible with an underlying investment strategy while mitigating the effect of rate changes and without the inconvenience for investors to have to invest into a new fund vehicle for this purpose. In fact, using duration hedging always as an example, this technique is an activity managed in a manner entirely comparable to currency hedging 13. What matters is that the hedging criteria and performance at a class level are clearly described and that the share class is not being managed on a discretionary basis. The core portfolio and its investment management would thus remain unaffected by the hedging activity at a share class level. Clearly, adequate disclosure is necessary covering the risks and implications associated with this or other hedging strategies, regardless of the types of shares investors own. Additionally, there should be clear procedures and robust systems in place to value and allocate the P&L at a share class level, including the effects of the hedging transactions. 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 EFAMA believes that from the summary descriptions of the share class profiles provided for under paragraph 10 of the Discussion Paper there are grounds to exclude certain types of hedges altogether, particularly with regard to the first, second and fifth (last) bullet points. With regard to the fifth bullet point, referencing share classes that differ in terms of leverage, it would be more correct to refer to share classes that differ in terms of exposure (or in terms of leveraged returns ) instead of plain leverage, as the latter would not capture the investment outcome by merely referring to a technique Another distinction that can be made is exchange traded share classes. It is possible to have a compartment, where one or more share classes are admitted to trading on an exchange where the others are not, implying that other rules for the disclosure of information applies to the former only. 13 As explained in our answer to Question 7, the creation of a duration hedged class isolates the delta between the hedged and non hedged class and effectively provides investors with a single distinguishing performance delta on one core portfolio, without the need to consider diverging performances that would otherwise result through the investment management of two separate pools of assets. 14 Technically, however, leveraged share classes comply with the three principles listed in paragraph 6 of the Discussion Paper, although may not be authorised as long as UCITS risk ratios are not monitored at the level of the share class.

11 11 Concerning those share classes that offer protection against other non currency market risk factors, as interest rate and volatility risk in the third bullet point, these should not be excluded for the reasons explained above. The same outcome should also apply for those share classes described in the fourth bullet point, offering varying degrees of capital protection and / or payoff, as they are ultimately still exposed to the same pool of assets. We deem that ESMA s early guidance as worded under paragraph 10 of the Discussion Paper to consider certain types of share class as incompatible be valid only and specifically for UCITS share classes. 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. To the best of our knowledge, the vast majority of UCITS already comply with the aforementioned criteria and are not aware of any specific ones that would contravene them. In general, those UCITS that do not comply with the criteria would be those using derivatives in a way that alters the nature of the investment strategy. For example, when derivatives are used for taking on additional exposures (i.e. taking views on the evolution of instruments not included in the underlying pool and thus subject to different market risks) that are devoid of any hedging intent in the interest of investors, as is the case of certain share classes offering investors additional exposure (and risk) to a third currency, besides plainly hedging the currency risk between the base currency of the fund and that of the share class. 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)? EFAMA would suggest that this not be tackled on the following grounds. Where exposure is intended to come from the same pool of assets, diversification is already attained via the UCITS Directive s diversification ratios on global exposures. We believe that the CESR 2010 Guidelines on global exposure and counterparty risk for UCITS are still relevant and that a separate ratio per share class would give investors the false impression that assets are segregated at the share class level, when they are not, in line with Article 49 et seq. of the UCITS Directive. We believe that valuable and relevant information for the typical average retail investor around general and more specific risks including counterparty ones affecting the entire UCITS (or separate compartment thereof) is already sufficiently disclosed in the prospectus. 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?

12 12 It is EFAMA s and its Members view that adequate information is already available to investors, both under the relevant Level 1 Directive, as well as under its Level 2 implementing measures. More specifically, this appears under the disclosure requirements concerning share classes under Article 78 (7) b) ii) of the Level 1 text (as recast) and Article 25 of the Level 2 Regulation 583/2010. Given the aforementioned requirements, disclosure via the relevant prospectus, a share class specific KIID and annual / semi annual reports, we consider not only adequate, but also relevant, for average retail investors to understand the main characteristics of the different share classes, alongside their relevant risks, return profile and their related costs. For the majority of investors, further disclosure requirements are not likely to be helpful and could beyond a certain extent even prove counterproductive. Therefore we would urge that ESMA not recommend that additional disclosure requirements be considered. The above cited implementing Level 2 Regulation already requires disclosure of key information on share classes to investors in the plain language of the KIID, and where there are examples of failure in this regard, these should rightly be addressed by the relevant NCAs enforcement of the Regulation. 14. Do you agree that ESMA should develop a common position on this issue? If not, please justify your position. EFAMA welcomes the prospect of ESMA developing a common position relating to UCITS share classes to the extent that it may lead to a harmonized definition, or at least a notion, of what constitutes a share class EU wide. We are, however, definitely against any policy measure aimed at restricting the range of available share class specific hedging tools or at stifling further innovation aimed at improving the additional overlay offered by share class differentiation. Apart from avoiding the blacklisting of certain share classes which would lead to less efficiency and the explosion of new fund launches unless proven to significantly alter or corrupt the advertised investment strategy such common position should moreover apply strictly to the UCITS framework. Depending on ESMA s objectives as a follow up to the present Discussion Paper, EFAMA would in any event welcome a proper cost benefit analysis around more concrete options going forward. *** Brussels, 27 March 2015 [ ]