Law 35/2003 on collective investment trusts, dated Nov. 4, has provided a more flexible regulatory framework for collective-investment institutions-IICs--in Spain. The law's aims, among others, are to:
* widen the range of investment products in which investors may invest, such as hedge funds or funds of hedge funds;
* extend the types of securities and financial products in which IICs may invest;
* simplify the administrative procedures applicable to IICs
and establish new rules to reinforce consumer protection.
This Learning Curve sets out some of the key aspects of the regulation regarding (i) the range of investment products, (ii) the types of assets and financial instruments in which investors may invest, and (iii) the rules on risk diversification which are applicable to Spanish IICs.
Investment Products
The updated regulation paves the way for IICs with different sub-funds, each bearing its own name as well as that of the IIC. The minimum number of investors per sub-fund must be 20, bearing in mind that the minimum number of participants of the corresponding IIC must be 100--except in the case of master-feeders and hedge funds.
In addition, the Regulation creates new types of IICs, in particular, Instituciones de Inversión Colectiva de Inversión Libre (i.e. hedge funds), Instituciones de Inversión Colectiva de Instituciones de Inversión Colectiva Inversión Libre (i.e. funds of hedge funds) and Fondos de Inversión Cotizados (i.e. exchange traded funds).
The Regulation also foresees the creation of IICs with different classes and series of units and shares, which will differ depending on the applicable fees. This measure enables the diversity of products to increase without the need to create several IICs.
Eligible Assets And Financial Instruments
The Law and the Regulation introduces new investment possibilities for Spanish IICs. In particular, both investment funds ("fondo de inversión") and investment companies ("sociedad de inversión"), may invest in the following assets and financial instruments:
i) listed securities and listed financial instruments set out in articles 2.1 and 2.2(a) of Law 24/1988, of 28 July, that are listed on a stock exchange or other organized market, irrespective of the state where they are located;
ii) securities and financial instruments mentioned in (i) above that have applied for admission to listing;
iii) shares and units of other IICs authorized in accordance with E.C. Directive 85/611/CEE (UCITS), subject to certain limitations applicable to waterfall investments (i.e. the target IIC shall not be allowed to invest more than 10% of its assets in shares or units of other IICs);
iv) shares and units of IICs not authorized in accordance with E.C. Directive 85/611/CEE (Non-UCITS), provided that the purpose of the latter is not to invest in other collective-investment trusts, and subject to other limitations (e.g. limitations to waterfall investments; those located within the OECD with equivalent supervision, not located in a tax haven);
v) deposits in sight or with a maturity term of less than 12 months in credit entities located within the E.U. or, if abroad, within a state with equivalent regulatory requirements;
vi) derivative financial instruments that are traded in an organized market and whose underlying assets consist of any of the assets or instruments listed in (i) through (iv) above, and whose credit risk, volatility, financial use by IICs has been approved by the Spanish Securities' Market Commission;
vii) over-the-counter derivative instruments, subject to certain additional requirements regarding counterparties and necessary liquidity;
viii) monetary market instruments, provided that they are liquid and their value may be determined at any time;
ix) in the case of investment companies, up to 15% of their net assets may be invested in movable assets or real estate necessary for their activity; and
x) other securities or financial instruments, up to a global maximum threshold of 10% of the net assets of the investing IIC, including, among others:
* shares and fixed yield securities admitted to listing in a market not complying with the general rules or with mechanisms ensuring their liquidity;
* shares or units of Non-UCITS provided that they are neither funds of funds nor hedge funds and are located within the OECD with information exchange;
* shares or units of hedge funds or funds of hedge funds, if liquid;
* shares or units of private equity entities, and
* deposits in credit entities.
Rules On Risk Diversification
In order to comply with the principle of risk diversification, IICs must comply with certain thresholds. As a general rule, the regulation maintains the general threshold of 5% of the net assets of the IICs applicable to investments in certain assets and financial instruments (i.e. those set out under (i), (ii), (viii) and (x) above) issued or guaranteed by the same issuer. The regulation, however, establishes the following exceptions:
i) the threshold may be increased up to 10%, provided that the investment in those issuers exceeding 5% does not exceed 40% of the net assets;
ii) the threshold may be increased up to 35% in the case of securities issued or guaranteed by member states of the E.U. or by public authorities;
iii) the threshold may be increased up to 25% in the event of investments in certain types of Spanish debt securities such as cédulas hipotecarias,bonos hipotecarios andcédulas territoriales;
iv) the threshold does not apply to those IICs replicating an index complying with certain requirements; in this case, the investment in securities or bonds of the same issuer may be up to 20% of the net assets of the IIC, although it may be increased up to 35% for only one issuer; and
v) the threshold does not apply to those IICs taking as reference an index complying with certain requirements; in this case, the investment in securities or bonds of the same issuer may total up to 10% of the net assets of the IIC. Likewise, an additional 10% of the net assets may be invested in such securities if the investment is made by means of derivative financial instruments which are traded in local or foreign official secondary markets. This global threshold of 20% may be increased up to 35% for only one issuer.
In addition, the regulation sets out new limits as to counterparty risk:
i) the investment in certain assets and financial instruments issued or guaranteed by the same issuer, the position vis-à vis such counterparty arising from derivative products and the deposits held by the IIC with such entity may not exceed as a whole 20% of the net assets of the IIC;
ii) the investment in certain assets and financial instruments issued or guaranteed by the same issuer, the investment in certain Spanish debt securities, the position vis-à-vis such counterparty arising from derivative products and the deposits held by the IIC with such entity may not exceed as a whole 35% of the net assets of the IIC; and
iii) the counterparty risk arising from OTC derivative instruments may not exceed 5% of the net assets of the IIC; such threshold is increased up to 10% if the counterparty is a credit entity meeting certain requirements.
The regulation also sets out certain thresholds to the interest stake held by one IIC one issuer:
i) the securities held by one IIC may not exceed 5% of the securities issued by an entity; in the case of a group, the securities held by the IIC of the same group or managing company cannot exceed 15% of the securities issued by one issuer; and
ii) the investment in shares or units issued by one IIC may not exceed 45% of the net assets of the IIC (except for principal-subordinated IIC).
Specific Rules Regarding Investment In Derivative Financial Instruments
The regulation establishes certain rules on risk diversification applicable to the investment in derivative instruments. In particular:
i) the fund manager or the investment company itself must have a risk management system;
ii) the total market risk exposure linked to derivative instruments shall not exceed the total net assets of the IIC; and
iii) the exposure to the market risk of the underlying assets linked to the use of derivative instruments shall be taken into account for the purpose of complying with the diversification limits (5%- 10%, 20%, 35%), except in the case of derivative instruments whose underlying is an index complying with certain requirements, interest rates, exchange rates, currencies or financial indexes.
This week's Learning Curve was written by Iñigo Gómez-Jordana, partner, and Magdalena Bertramand Luis de Valle, associates, at Allen & Overyin Madrid.
