Central Bank Publishes Guidance On Use Of Side-Pocketing Arrangements By UCITS Facing Valuation Difficulties Due To The Russian Invasion Of Ukraine

• Published date: 19 May 2022
• Subject Matter: Finance and Banking, Wealth Management, Financial Services, Fund Management/ REITs, Wealth & Asset Management
• Law Firm: Dillon Eustace
• Author: Mr Shane Coveney

Key Points to Note:

• ESMA has published a public statement outlining appropriate action that can be taken by Impacted Funds experiencing valuation issues as a result of the Russian invasion of Ukraine
• In response to the ESMA Statement, the Central Bank has published its guidance on the use of side pocket arrangements by UCITS Impacted Funds which involves the transfer of liquid assets to a clone UCITS fund.

Background

On 16 May 2022, ESMA released a public statement setting out appropriate actions which could be taken by funds with material exposure to Russian, Belarusian and Ukrainian assets (Impacted Funds) in order to deal with valuation issues arising from the exceptional market conditions arising from the war in Ukraine (ESMA Statement).

The ESMA Statement notes the various liquidity management tools available to UCITS and AIF funds which include temporary suspension of dealing, total write-off of relevant assets or the liquidation of the relevant Impacted Fund as well as the segregation of illiquid assets from liquid assets in the fund portfolio.

The ESMA Statement notes that the UCITS framework does not currently contemplate the use of side pockets. It confirms that for the purpose of managing the impact of the Russian invasion of Ukraine on the portfolio of an Impacted Fund, arrangements to create a side pocket in UCITS could be permitted provided that certain conditions have been satisfied.

In response to the ESMA Statement, the Central Bank subsequently published guidance on the use of side pocket arrangements by Irish UCITS Impacted Funds (Central Bank Guidance) which, if used, will involve the creation of a new UCITS product to which the liquid portion of the assets of the Impacted Fund are transferred.

What is a UCITS side pocket arrangement under the Central Bank Guidance?

Different to the side pocket arrangements permitted under existing Irish rules for an Irish QIAIF fund¹, both ESMA and the Central Bank describe a side pocket arrangement for a UCITS as the segregation of liquid and illiquid assets by:

1. transferring the liquid assets of the UCITS Impacted Fund (Original UCITS) to a newly established cloned UCITS fund (New UCITS);
2. retaining the illiquid/difficult to value securities (Affected Securities) in the Original UCITS;
3. investors in the Original UCITS receiving shares of the New UCITS in the same proportion as their investment in the Original UCITS while continuing to have a pro-rata holding in the Original UCITS; and
4. new investors...