UCITS KIIDs - ESMA updates its Q&As with clarification on disclosure of past performance and benchmark indices

On 29 March 2019, ESMA published an update to its Q&As on the application of the UCITS Directive. The updated Q&As give guidance on the UCITS KIID benchmark and past performance obligations, and clarify that:

On the disclosure of benchmarks

• a UCITS should clearly indicate in its KIID whether its strategy is active/actively managed or passive/passively managed
• for a UCITS to be managed in reference to a benchmark, the benchmark must play a role in the management of the UCITS (eg in the explicit or implicit definition of its portfolio composition and/or performance objectives and measures), and
• UCITS should provide investors with an indication of how actively managed the UCITS is compared to its reference benchmark index.

On the disclosure of past performance

• where a UCITS names a target in its investment objectives and policies, the performance should be disclosed against that target, even where the comparator is not specifically termed a "benchmark", and
• performance disclosure regarding a benchmark index in the KIID should be consistent with disclosure of performance in other investor communications.

In all cases, changes to the KIID to incorporate this additional guidance should be made as soon as practicable, or by the next KIID update following publication of the Q&As (29 March 2019).

ESMA also reiterates that UCITS Management Companies (ManCos) should ensure that the information disclosed in the UCITS KIID is consistent with Investment Objective of the UCITS set out in the Prospectus.

Looking at ESMA’s new guidance in more detail:

What changes has ESMA made?

The changes, which affect Q. 4 and Q. 8 in Section II (Key Investor Information Documents (KIID) for UCITS), provide ESMA’s guidance on how a UCITS ManCo should deal with disclosures in the UCITS’s KIID in respect of past performance and benchmark indices.

What do the changes say?

(i) Questions on past performance

Modified Question 4b

This asks whether a UCITS, which refers in its investment objectives and policies to an index as a benchmark and measures performance against that index but does not intend to track it, needs to show the benchmark index’s performance in the past performance section of its KIID.

The modified answer to Q.4b confirms the previous position - ie the UCITS should refer to the benchmark index’s performance but should make it clear that the UCITS is not tracking the index.

ESMA has now added new guidance that these requirements apply:

• to all UCITS, including total/absolute return UCITS
• where the comparator is not specifically called a "benchmark" but where the investment policy makes it clear that it is a comparator which the UCITS aims to outperform, and
• where the UCITS aims to outperform the benchmark index over a period of time, the benchmark index’s annualised performance should be shown alongside that of the UCITS, even if the target is to outperform it over a longer period than a year.

Deleted Question 4c

This had said that, where a UCITS referred to an index in its investment policy but - unlike in Q.4b - did not intend to measure performance against it, there was no need to show the index’s performance in the past performance section of the KIID. This guidance has now been deleted.

New Question 4cbis

This Q&A confirms that the requirement for a UCITS KIID to be "fair, clear and not misleading" means that performance disclosed in the KIID regarding a benchmark index should be consistent with performance disclosure in other investor communications, including marketing materials.

ESMA adds that UCITS ManCos should ensure that disclosure of performance in the KIID is consistent:

• Across offering documents and marketing material, including the prospectus. The KIID should be consistent with other fund documents and the benchmark index used in these should be consistent.
• Across distribution channels - where, for example, a UCITS refers to an index in certain media, such as online platforms or financial data providers, it must make the same comparison in the KIID.
• Across investor types - all types of investors should receive consistent information as to whether the UCITS has a benchmark index.

(ii) Questions on disclosure of the benchmark index in the objectives and investment policies

New Question 8a

This confirms that a UCITS must provide a clear indication in the objectives and investment policy section of its KIID of whether it is actively or passively managed.

ESMA further explains that:

For an index-tracking (passive) UCITS:

• recommended practice is to use the terms "passive" or "passively managed" in addition to "index-tracking" to assist investor understanding
• the ManCo should consider providing additional wording to ensure that the meaning of the term "passive" or "passively managed" is clear, and
• an index-tracking UCITS must disclose the index it is tracking and show performance against that index in the past performance section of the KIID.

For an actively managed UCITS:

• it should be made clear to investors that the UCITS is actively managed
• the explicit use of the terms "active" or "actively managed" is recommended practice
• the UCITS ManCo should consider providing additional wording to ensure the meaning of the term "active" or "actively managed" is clear, and
• where the UCITS is managed in reference to an index:
  • additional disclosure should be made about the use of the benchmark index
  • past performance should be shown against the index, and
  • it should be clear which benchmark index (or indices) the UCITS is tracking, or in reference to which it is being managed
• the degree of freedom from the benchmark should also be shown (see Q. 8c below)
• it is recommended practice for an active UCITS which is not managed in reference to a benchmark to make this fact clear to investors.

New Question 8b

For a UCITS to be managed "in reference to a benchmark index" means that the index plays a role in the management of the UCITS, for example, in the explicit or implicit definition of the portfolio’s composition and/or the UCITS’ performance objectives and measures.

This may be from the time the UCITS is established or introduced during its life - in either case, the reference should be disclosed.

At the end of the day, it is the responsibility of the UCITS ManCo to identify whether or not a UCITS is managed in reference to a benchmark index.

ESMA provides the following non-exhaustive (and noncumulative) examples of where the ManCo might imply that the UCITS is so managed and disclose this fact:

Portfolio composition

• where a UCITS uses a benchmark index as a universe from which to select securities - even if only a minority of securities listed in the index are held in the portfolio and the UCITS’ portfolio holdings weightings diverge from those in the index, and
• where a UCITS’s portfolio holdings are based on those of the benchmark index. For example:
  • the individual holdings of the UCITS’ portfolio do not deviate materially from those of the benchmark index, and
  • the UCITS has monitoring systems to limit the extent to which portfolio holdings or weightings diverge from the composition of a benchmark index
• where a UCITS invests in units of other UCITS or AIFs in order to achieve similar performance to that of a benchmark index.

Performance measures

• where performance fees are calculated on the basis of performance against a reference benchmark index
• where a UCITS has an internal or external target to outperform a benchmark index
• where contracts between the UCITS ManCo and third parties or between the ManCo and its directors and employees state that the portfolio manager must seek to outperform a benchmark index
• where individual portfolio managers receive an element of performance-related remuneration based on the UCITS’s performance relative to a benchmark index
• where a UCITS is constrained by internal or external risk indicators that refer to a benchmark index, and
• where marketing issued to investors or potential investors by the UCITS ManCo shows performance of the UCITS compared with a benchmark index.

For clarity, a benchmark index may refer to an individual index or composite index comprised of more than one index or basket of indices.

New Question 8c

ESMA provides clarification of what is meant by "the degree of freedom from the benchmark", referred to in Article 7(1)(d) of Commission Regulation (EU) No 583/2010.

Accordingly, the ManCo of an actively managed UCITS whose investment approach includes or implies a reference to a benchmark index must take a number of factors into account when indicating in the KIID how much freedom from the benchmark index the UCITS has.

These factors include at least the following:

• the description of the UCITS’s “underlying investment universe” should indicate the extent to which the target investments are, or are not, part of the benchmark index and
• the KIID should describe “the degree or level of deviation of the UCITS” in respect of the benchmark index, considering, where applicable
  • the quantitative and/or qualitative deviation limitations underlying the investment approach, and
  • the narrowness of the investment universe.

Unless stricter requirements apply in a given Member State, a UCITS which is actively managed in reference to a benchmark index is not required to quantify the degree of freedom numerically. However, where the UCITS ManCo believes this information will assist investor understanding, it can do so by providing explanations in language which retail investors will be able to understand.

ESMA includes in the answer to Q.8c some illustrative (and non-exhaustive) examples of wording which could be used in such circumstances.

Where a UCITS’s defined strategy is to vary the risk it will take against an index, this should be disclosed. By way of example, a UCITS which is structured so it is managed in alignment with an index during periods of market volatility should disclose this.

This does not, though, mean that its KIID must be updated to reflect very short-term or one-off variations in the investment strategy during the lifecycle of the UCITS, provided it has already disclosed the capacity for such variations.