(1)

Directive 85/611/EEC contains several definitions, sometimes interlinked, related to the assets which are eligible for investment by undertakings for collective investment in transferable securities, hereinafter ‘UCITS’, such as a definition of transferable securities and a definition of money market instruments.

(2)

Since the adoption of Directive 85/611/EEC, the variety of financial instruments traded on financial markets has increased considerably, leading to uncertainty in determining whether certain categories of financial instruments are encompassed by those definitions. Uncertainty in applying the definitions gives rise to divergent interpretations of the Directive.

(3)

In order to ensure a uniform application of Directive 85/611/EEC, to help Member States to develop a common understanding as to whether a given asset category is eligible for a UCITS and to ensure that the definitions are understood in a manner consistent with the principles underlying Directive 85/611/EEC, such as those governing risk-diversification and limits to exposure, the ability of the UCITS to redeem its units at the request of the unit-holders and to calculate its net asset value whenever units are issued or redeemed, it is necessary to provide competent authorities and market participants with more certainty in this respect. Greater certainty will also facilitate a better functioning of the notification procedure for the cross-border distribution of UCITS.

(4)

The clarifications provided by this Directive do not of themselves give rise to any new behavioural or operational obligations for competent authorities or market participants. Rather than establishing exhaustive lists of financial instruments and transactions, they elucidate basic criteria as an aid in assessing whether or not a class of financial instrument is covered by the various definitions.

(5)

The eligibility of an asset for a UCITS must be assessed not only with regard to whether it falls within the scope of the definitions as clarified by this text but also with regard to the other requirements of Directive 85/611/EEC. National competent authorities could work together through the Committee of European Securities Regulators (CESR) to develop common approaches on the practical, day-to-day application of those clarifications in the context of their supervisory duties, notably in connection with other requirements of Directive 85/611/EEC such as control or risk management procedures, and to ensure the smooth functioning of the product passport.

(6)

Directive 85/611/EEC defines transferable securities exclusively from a formal/legal point of view. Accordingly the definition of transferable securities is applicable to a wide range of financial products with differing features and different levels of liquidity. For each of those financial products, consistency between the definition of transferable securities and other provisions of the Directive should be ensured.

(7)

Closed end funds constitute an asset class which is not explicitly referred to as an eligible asset for a UCITS under Directive 85/611/EEC. However, the units of closed end funds are often treated as transferable securities and their admission to trading on a regulated market often gives grounds for such a treatment. It is therefore necessary to provide market participants and competent authorities with certainty as to whether units of closed end funds are covered by the definition of transferable securities. National competent authorities could work together through the CESR to develop common approaches as regards the practical, day-to-day application of the criteria applicable to closed end funds, notably in respect of minimum core standards in relation to corporate governance mechanisms.

(8)

Additional legal certainty is also necessary with regard to the categorisation, as transferable securities, of financial instruments which are linked to the performance of other assets, including assets which are not referred to by Directive 85/611/EEC itself, or which are backed by such assets. It should be made clear that if the linkage to the underlying or to another component of the instrument amounts to an element which has to be considered as an embedded derivative, the financial instrument falls in the subcategory of transferable securities embedding a derivative element. This has the consequence that the criteria for derivatives under Directive 85/611/EEC have to be applied in respect of that element.

(9)

In order to be covered by the definition of money market instruments in Directive 85/611/EEC, a financial instrument should fulfil certain criteria, notably it must normally be dealt in on the money market, it must be liquid and it must have a value which can be accurately determined at any time. It is necessary to ensure a uniform application of those criteria taking into account certain market practices. It is also necessary to clarify that the criteria have to be understood in coherence with other principles of Directive 85/611/EEC. The definition of money market instruments should extend to financial instruments which are not admitted to or dealt in on a regulated market and for which Directive 85/611/EEC sets out criteria in addition to the general criteria for money market instruments. It was therefore equally necessary to clarify those criteria in the light of investor protection requirements and taking into account principles of the Directive such as portfolio liquidity, as resulting from Article 37 thereof.

(10)

Under Directive 85/611/EEC financial derivative instruments are to be considered as liquid financial assets if they fulfil the criteria set out in that Directive. It is necessary to ensure a uniform application of those criteria and it is also necessary to make clear that the criteria have to be understood in a way which is consistent with other provisions of the Directive. It should also be made clear that if credit derivatives comply with those criteria, they are financial derivative instruments within the meaning of Directive 85/611/EEC and hence eligible for treatment as liquid financial assets.

(11)

The need for clarification is particularly pressing for derivatives on financial indices. There is currently a wide range of financial indices which function as the underlying for a derivative instrument. These indices may vary as regards their composition or the weighting of their components. In all cases it has to be ensured that the UCITS is able to fulfil its obligations as regards portfolio liquidity, as resulting from Article 37 of Directive 85/611/EEC, and the calculation of the net asset value and that those obligations are not negatively affected by the features of the underlying of a derivative. It should be clarified that derivatives on financial indices whose composition is sufficiently diversified, which represent an adequate benchmark to the market to which they refer and which are subject to appropriate information regarding the index composition and calculation fall under the category of derivatives as liquid financial assets. National competent authorities could work together through the CESR to develop common approaches as regards the practical, day-to-day application of those criteria in respect of indices based on assets which are not individually identified as eligible assets in the Directive.

(12)

Directive 85/611/EEC recognises as a sub-category of transferable securities and money market instruments those which embed a derivative element. Embedding a derivative element into a transferable security or money market instrument does not transform the whole financial instrument into a financial derivative instrument which would fall outside the definitions of transferable security or money market instrument. Therefore, it is necessary to make clear whether a financial derivative can be considered embedded in another instrument. In addition, embedding a derivative into a transferable security or money market instrument entails the risk that the rules for derivatives imposed by Directive 85/611/EEC are bypassed. For that reason, the Directive requires identification of the embedded derivative element and compliance with those rules. Given the level of financial innovation, the identification of an embedded derivative element is not always evident. In order to achieve more certainty in this respect, criteria for identifying such elements should be laid down.

(13)

Pursuant to Directive 85/611/EEC, techniques and instruments relating to transferable securities or money market instruments for the purpose of efficient portfolio management do not fall under the definitions of transferable securities and money market instruments. To clarify the boundaries of those definitions it is necessary to set out criteria to identify the transactions which would fall under those techniques and instruments. It is also necessary to recall that those techniques and instruments have to be understood in coherence with the other obligations of a UCITS, particularly as regards its risk profile. That is to say, they must be consistent with the rules laid down by Directive 85/611/EEC on risk management and on risk diversification, as well as with its restrictions on short sales and borrowing.

(14)

Directive 85/611/EEC sets out criteria to define UCITS which replicate bond or share indices. UCITS which comply with those criteria are subject to a more flexible treatment as regards issuer concentration limits. It is therefore necessary to develop a clear understanding of those criteria and to ensure their uniform application in all Member States. That entails giving further clarification as to whether a UCITS can be considered to be an index-replicating UCITS, and thus more certainty about the conditions which justify the preferential treatment of index-replicating UCITS.

(15)

The Committee of European Securities Regulators has been consulted for technical advice.

(16)

The measures provided for in this Directive are in accordance with the opinion of the European Securities Committee,