Key takeaways
- Proposed changes by the European Securities and Markets Authority (ESMA) could substantially impact asset management firms, creating both new opportunities and increased compliance requirements.
- If approved, asset managers may need to begin reviewing their strategies and preparing for a shifting regulatory landscape.
ESMA has recently recommended notable amendments to the UCITS Eligible Assets Directive, which sets the standards for permissible investments by UCITS funds across Europe. These reforms could redefine permissible investment approaches, significantly impacting both European-based asset managers managing EU UCITS and US managers providing investment management services to them.
The proposed reforms include several critical adjustments aimed at modernising the UCITS framework and providing clarity amid market innovations:
- 90% Traditional Assets Requirement: Funds must hold at least 90% of their assets in explicitly eligible investments, primarily publicly traded stocks, bonds, and money-market instruments. This will require asset managers to undertake rigorous due diligence to verify and document the underlying securities, especially when utilising complex structured products and derivatives.
- 10% Alternative Asset Allowance: For the first time, ESMA explicitly allows UCITS funds to indirectly hold alternative assets—up to a limit of 10%. Permitted alternative investments include commodities, cryptocurrencies, and catastrophe bonds, but these must meet stringent criteria related to liquidity, valuation transparency, and operational clarity. This allowance could open new avenues for strategic diversification and product innovation, but also places additional compliance burdens on managers to ensure adherence to regulatory standards.
- Enhanced Definitions and Liquidity Assessments: ESMA proposes clarifying and harmonising essential definitions used in UCITS regulation with existing EU frameworks, notably MiFID II. Furthermore, the automatic presumption of liquidity for exchange-listed assets will be abolished, and asset managers will need to explicitly assess and document the liquidity status of every asset held in a UCITS portfolio. These enhanced requirements significantly raise the bar for ongoing compliance and risk management practices.
Asset management firms must be prepared for both the strategic and operational implications of these proposed changes:
- Firms may need to reconsider investment strategies and product structures.
- The increased need for detailed documentation and verification processes is expected to elevate compliance costs and operational complexities.
- Nevertheless, clearer regulatory guidance could provide asset managers with opportunities to develop innovative and clearly compliant UCITS products, potentially enhancing competitive positioning within the European market.
At this stage, ESMA's recommendations are currently advisory. However, the European Commission is anticipated to initiate formal consultations in 2026 and asset managers should watch this space and evaluate future proposals against their existing and planned UCITS strategies.
Khadijah Hasan, Paralegal, also contributed to this article.
