ESMA launches call for evidence on UCITS eligible assets (including cat bonds)

The European Securities & Markets Authority (ESMA) has now launched a formal call for evidence to support a review of the Undertakings for Collective Investment in Transferable Securities (UCITS) Eligible Assets Directive (EAD), including what assets should be eligible, with catastrophe bonds one class of assets named.

It comes as little surprise, given the review process began almost a year ago and we first discussed European regulator’s desire to look at cat bonds through the lens of eligibility for UCITS fund strategies well over a year ago.

When we last wrote about this topic, back in June 2023, we reported that the European Commission had directed financial regulator the European Securities & Markets Authority (ESMA) to study eligible assets for UCITS investment fund strategies, to ensure their suitability, with catastrophe bonds one asset class explicitly mentioned.

This review has been ongoing, but yesterday, ESMA published a formal call for evidence and input, saying that, “The objective of this call is to gather information from stakeholders to assess possible risk and benefits of UCITS gaining exposure to various asset classes.”

ESMA further explained, “Investors and consumer groups interested in retail investment products, management companies of UCITS, self-managed UCITS investment companies, depositaries of UCITS and trade associations are invited to provide their feedback on market practices and interpretation or practical application issues with respect to the eligibility criteria and other provisions set out in the UCITS EAD.

“ESMA is additionally interested in gathering insights on some key notions and definitions used in the UCITS EAD and their transversal consistency with other pieces of legislation in the EU Single Rulebook.”

With UCITS investment fund strategies accounting for roughly 75% of all collective investments by smaller investors, by ESMA’s numbers, that adds up to more than €9 trillion of assets under management.

In the catastrophe bond fund space, we track UCITS cat bond fund assets under management in this chart, with the latest total at the end of Q1 2024 having reached almost $11.4 billion.

So, cat bonds are a tiny component of the UCITS investment universe. But UCITS funds are a significant component of the overall cat bond space, with some $47 billion of cat bond and related risk capital outstanding at the moment.

ESMA continued to explain, “The acclaimed success of UCITS as a global brand is based on their established reputation of being well-regulated and supervised investment products. Most notably, UCITS shall be invested in assets subject to stringent eligibility criteria with a view to ensuring adherence to the investor protection principles underlying the UCITS Directive.

“Since the adoption of the UCITS EAD almost two decades ago, the number and variety of financial instruments traded on financial markets has increased considerably, leading to uncertainty in determining whether some categories of assets are eligible for investment, in turn giving rise to divergent interpretations and market practices in terms of the application of the UCITS Directive.

“ESMA’s technical advice on the review of the UCITS EAD therefore aims to preserve and strengthen the well-functioning of the UCITS framework and the operation of UCITS in the best interest of investors, as well as the quality of investment products offered to retail investors.”

A paper has been published, on the call for evidence in relation to the review of the UCITS Eligible Assets Directive, which you can download and provide a response to here.

Catastrophe bonds have been cited as an example of an asset class that ESMA wants to understand more about, through this call for evidence.

The paper states, “ESMA seeks stakeholders input on a number of questions, inter alia, to gather insights on the manner and the extent to which UCITS have gained direct and indirect exposures to certain asset classes that may give rise to divergent interpretations and/or risk for retail investors (e.g. structured/leveraged loans, catastrophe bonds, emission allowances, commodities, crypto assets, unlisted equities).”

At the foot of that document is a copy of the formal request to ESMA from the European Commission to begin this study, from last June which is when we had covered that news.

Questions that ESMA wants to answer are related to liquidity, risk diversification and the ability of a UCITS fund to ensure it can allow redemptions on request from investors and regularly calculate its net asset value as required.

With the range of UCITS strategies and the assets within them having expanded significantly over the years since the structure has existed, it seems the concern is that some assets may not be as suited to its rules as others.

As we’ve explained before, on liquidity specifically, catastrophe bonds have repeatedly proven themselves to be liquid when the need arises, as the asset class is dominated by sophisticated and specialist investment managers and the secondary market functions well.

We’ve also seen no issues with allowing redemptions from cat bond funds, even after major events have threatened losses, while the calculation of asset values is something that many in the industry work hard to effectively produce.

Managers of cat bond funds will continue to watch ESMA’s process closely, with the outcome of the study potentially still some time away.

It stands to reason cat bond fund managers will already have explored possible alternative fund structures, just in case UCITS became a less accommodating fund type to utilise for offering cat bond strategies through.

We hope managers of UCITS cat bond funds will watch developments closely and interact with ESMA’s process to provide feedback and input to help the regulator understand the unique features of the catastrophe bond asset class.

For those wishing to read more about and respond to the request for evidence from ESMA, you can do so here.