UCITS eligibility criteria for derivative counterparties

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From the Central Bank of Ireland notices:

3. Financial derivative instruments (FDI) must be dealt in on a market which is regulated, operating regularly, recognised and open to the public in a Member State or non-Member State. The trust deed, the deed of constitution or the articles of association must list the markets on which the UCITS may invest. Restrictions in respect of individual stock exchanges and markets may be imposed by the Central Bank on a case-by-case basis.

4. Notwithstanding paragraph 3, a UCITS may invest in FDI dealt in over-the-counter, "OTC derivatives" provided that: (i) the counterparty is a credit institution listed in sub-paragraphs 1.4 (i), (ii) or (iii) of Notice UCITS 9 or an investment firm, authorised in accordance with the Markets in Financial Instruments Directive in an EEA Member State, or is an entity subject to regulation as a Consolidated Supervised Entity (“CSE”) by the US Securities and Exchange Commission;
(ii) In the case of a counterparty which is not a credit institution, the counterparty has a minimum credit rating of A-2 or equivalent, or is deemed by the UCITS to have an implied rating of A-2 or equivalent. Alternatively, an unrated counterparty will be acceptable where the UCITS is indemnified or guaranteed against losses suffered as a result of a failure by the counterparty, by an entity which has and maintains a rating of A-2 or equivalent;
(iii) in the case of subsequent novation of the OTC derivative contract, the counterparty is one of:

  • the entities set out in paragraph (i) or;
  • a central counterparty (CCP) authorised, or recognised by ESMA, under Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR) or, pending recognition by ESMA under Article 25 of EMIR, an entity classified as a derivatives clearing organisation by the Commodity Futures Trading Commission or a clearing agency by the SEC (both CCP).

(iv) risk exposure to the counterparty does not exceed the limits set out in Regulation 70(1)(c). In this regard the UCITS shall calculate the exposure using the positive mark-to-market value of the OTC derivative contract with that counterparty. The UCITS may net the derivative positions with the same counterparty, provided that the UCITS is able to legally enforce netting arrangements with the counterparty. Netting is only permissible with respect to OTC derivative instruments with the same counterparty and not in relation to any other exposures the UCITS may have with the same counterparty;

5. Risk exposure to an OTC derivative counterparty may be reduced where the counterparty will provide the UCITS with collateral. UCITS may disregard the counterparty risk on condition that the value of the collateral, valued at market price and taking into account appropriate discounts, exceeds the value of the amount exposed to risk at any given time.

UCITS Anatomy

This is an article about undertakings for collective investment in transferable securities directive (UCITS).

Resources: UCITS IV (2009/65/EC (EUR Lex)) | UCITS V (2014/91/EU (EUR Lex)) | ESMA Guidance on UCITS | Depositary comparison under AIFMD and UCITS
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