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The European Securities and Markets Authority (ESMA) has published its Final Report, providing the European Commission (Commission) with technical advice on the review of the UCITS Eligible Assets Directive (UCITS EAD). The report delivers ESMA’s recommendations to clarify and update key concepts and definitions around UCITS asset eligibility, aiming to address divergent national practices and promote greater supervisory convergence across the EU.
ESMA’s advice follows a June 2023 mandate from the Commission to provide technical advice on the review of the UCITS EAD and, where appropriate, the UCITS Directive itself. To inform its recommendations, ESMA surveyed national competent authorities (NCAs) and conducted a public Call for Evidence (read more here), receiving 63 stakeholder responses. The feedback revealed significant divergences among Member States, particularly in interpreting asset eligibility and complex financial instruments.
Some of the changes proposed by ESMA, if introduced, would materially alter the UCITS fund landscape. In particular, ESMA is proposing applying a look through test to determine UCITS eligibility of assets, which would apply to the underlying exposures for delta-one securities, derivatives referencing financial indices and closed-ended funds.
Currently, under the UCITS EAD, if a financial index meets UCITS diversification and other requirements, a UCITS fund can have exposure to that index even if its constituents include assets that would be ineligible for direct investment by a UCITS. Similarly, under the existing regime, delta-one debt securities may be backed by, or linked to the performance of other assets, which may differ from those referred to in the UCITS Directive. The UCITS EAD also expressly permits shares or units in closed-ended funds to qualify as transferable securities, provided certain conditions are met, none of which currently require a look through to the underlying asset to determine eligibility.
ESMA proposes altering this fundamentally. Unhelpfully ESMA does not provide data to demonstrate how the current rules have caused harm to investors in the period since 2008 when the UCITS EAD came into force. The current rules have been in place through the global financial crash, various Eurozone crises and the Covid pandemic, which one would have thought would have proven their worth to retail investors. It is therefore difficult to reconcile aspects of ESMA’s proposals with its mandate from the Commission that ESMA’s technical advice “should aim to preserve and strengthen the well-functioning of the UCITS framework”.
While the Commission is not obliged to implement ESMA’s recommendations, it is required to have regard to ESMA’s advice as part of its policy-making and legislative process. Additionally, the Commission is expected to conduct a public consultation as part of its review, providing stakeholders with a good opportunity to advocate on key elements of the rules established since 2008. Fund managers should monitor developments closely as the Commission moves forward with its review and potential legislative changes.
Key policy proposals from ESMA
Look through approach
A central element of ESMA’s advice is the introduction of a look through approach for determining asset eligibility. ESMA considers this policy approach ensures a higher level of investor protection and transparency vis-à-vis UCITS investors thereby protecting the reputation and trust in the UCITS brand. Little evidence is provided as to any material detriment suffered by investors as a consequence of the current rules, which have seen investors through some very choppy waters.
This change would mean that UCITS would not be able to gain exposure to assets that are not backed by, or linked to, the performance of assets outside those referred to in Article 50(1) of the UCITS Directive. Under the proposals UCITS would not be able to gain exposure to ‘ineligible’ asset classes via instruments that in ESMA’s view merely “wrap” those exposures, like delta-one instruments, exchange-traded-notes, exchange-traded commodities, or financial derivatives on certain financial indices made up of ineligible assets or closed-ended funds. The look through would not apply to investments in traditional shares or bonds but would ensure that at least 90% of a UCITS portfolio remains in conventional eligible assets.
Guidance on the expected implications of the look through approach is provided under Annex V of the report.
Limited exposure to alternative assets
Recognising the diversification benefits of alternative assets, ESMA proposes that UCITS be permitted to obtain up to 10% indirect exposure to certain alternative asset classes, including commodities, catastrophe bonds, crypto-assets, structured/leveraged loans, unlisted equities, real estate, and other relevant assets, by broadening the so-called “UCITS trash ratio”. Currently this ratio includes unlisted securities and certain money market instruments. According to ESMA, this implies that the 10% limit would apply to all eligible asset classes listed in the UCITS Directive, including financial derivative instruments and units or shares in open-ended AIFs and would not be subject to the look through requirement. However, all other eligibility criteria, including those relating to risk, liquidity and valuation would still apply.
ESMA recommends a sufficiently long transitional period for UCITS currently exceeding this threshold, allowing time to adjust portfolios or consider conversion to an AIF under the AIFMD framework.
Additionally, ESMA questions the appropriateness of UCITS with significant investment in alternative assets, instead recommending the AIFMD framework. It points to EuVECA, EuSEF, and ELTIF as more suitable vehicles for such exposures. ESMA also suggests harmonising AIF marketing rules for retail investors and creating a new EU AIF product for non-eligible UCITS assets, to address demand for "semi-liquid" strategies.
ESMA notes that the data at ESMA’s disposal suggests that the risk of adverse market impact and related costs will be limited while at the same time highlights that there are significant data availability and quality limitations with respect to indirect exposures.
Liquidity
ESMA’s advice underscores liquidity as a foundational element of the UCITS framework. While acknowledging that recent regulatory developments, such as the AIFMD review and prior ESMA guidance have enhanced liquidity risk management practices, ESMA identifies specific areas for targeted improvements and clarifications, proposing:
Other proposed clarifications
Money market instruments: ESMA calls for clearer rules on the qualification of assets as money market instruments and focus on clarifying criteria for both qualification and liquidity assessment.
Transferable securities: ESMA proposes further clarification and ideally simplification of eligibility criteria, particularly around risk management, the consistency of investments with investment objectives or investment policies, and ‘reliable valuation’.
Financial derivatives: ESMA recommends criteria to assess if a transferable security or money market instrument can be regarded as embedding a derivative, and whether the derivative component should be a separate financial instrument.
Financial indices: ESMA proposes clarifications, notably on the look through approach and on alignment with the Benchmark Regulation.
UCITS investment in AIFs: ESMA recommends updates to the UCITS Directive and UCITS EAD to align with developments in the EU legislative framework, particularly the AIFMD. This aims to ensure that UCITS investments in AIFs do not circumvent UCITS investment restrictions and investor protections standards. The look through approach would also apply and allowing some flexibility for investment in AIFs within the 10% limit. ESMA also seeks to clarify the distinction between the eligibility of open-ended and closed-ended AIFs.
Ancillary liquid assets: ESMA recommends clarifying in the UCITS Directive that the 20% counterparty limit for deposits made with the same body applies also to ancillary liquid assets but does not see merits in prescribing a cap on ancillary liquid assets that UCITS may hold.
Efficient portfolio management (EPM): While not proposing changes to EPM rules, ESMA recommends that the Commission address EPM costs in a broader review of the UCITS Directive or in other relevant legislation, such as the Retail Investment Strategy. ESMA also suggests the Commission should consider the policy proposals included in the 2023 ESMA opinion on costs. ESMA also recommends clarifying that UCITS may use collateral arrangements without title transfer, in line with ESMA guidelines on ETF and other UCITS issues. Additionally, ESMA proposes clarifications on SFTR requirements and that EPM techniques shall never cause the UCITS to diverge from its investment objectives.
Other areas
The report also addresses investment in securitisations and in foreign currencies. Notably, ESMA refrained from putting forward policy proposals for larger-scale Level 1 UCITS Directive changes for any possible expansion or restriction of the list of directly eligible asset classes such as commodities or crypto assets like Bitcoin, noting that these would need to be assessed in a separate further workstream.
Conclusion
ESMA’s recommendations are likely to be evaluated within the broader ambitions of the Savings and Investments Union, which aims to reduce fragmentation across Member States and boost retail participation in EU capital markets. Maintaining the reputation and trust in the UCITS brand will no doubt be a priority. Hopefully some greater balance will prevail.
For more information, please any member of the Asset Management & Investment Funds team or your usual ALG contact.
Date published: 3 July 2025
