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On 26 June 2025, ESMA published its long awaited technical advice to the European Commission on the review of the UCITS Eligible Assets Directive (2007/16/EC) (“EAD”). The advice follows ESMA’s Call for Evidence published in May 2024 (see our earlier blog post).
The EAD is an implementing directive providing clarification on the assets a UCITS can invest in. However, since the EAD’s introduction in 2007, the rapid expansion in the variety of financial instruments traded on financial markets has led to divergent views on the eligibility of certain asset classes. Responding to an EU Commission mandate delivered in June 2023, and further to its May 2024 call for input (see our earlier blog post), ESMA’s recent technical advice is informed by the responses to this call for input. It provides an assessment of the EAD’s implementation across Members States and makes amendment proposals to ensure regulatory clarity and uniformity across jurisdictions.
The technical advice sees ESMA make a number of proposals to address divergence in the interpretation across member states, as well as to improve clarity, and investor protection. Key proposals include:
A central proposal from ESMA is the application of a mandatory “look-through” approach to determine asset eligibility (applicable to at least 90% of the UCITS portfolio) meaning that asset classes should not be backed by, or linked to the performance of, other assets which differ from those referred to in Article 50(1) of the UCITS Directive (2009/65/EC). It should be noted that the look-through approach does not affect investments in traditional shares or bonds but rather aims to limit the use of instruments (e.g. certain delta-one instruments, ETNs, ETCs, AIFs etc.) that provide exposures to alternative assets.
Annex V of the technical advice includes a “UCITS eligibility table” providing a simplified overview of the expected implications of the look through approach on relevant asset classes (of course a case-by-case analysis of the relevant financial instrument will always be required, following a substance-over-form approach taking into account the characteristics of the relevant instrument).
Given the potential appetite of some retail investors to gain exposures to alternative assets and the possible benefits of some of these asset classes from a broader risk/economic perspective, ESMA proposes a “middle ground approach” that allows for up to 10% of a UCITS portfolio - a threshold often referred to as "the trash ratio" - to be exempted from the look-through approach and provide indirect exposures to alternative assets (such as commodities, catastrophe bonds and crypto-assets). Importantly, while investments made within the 10% limit do not require the application of the look-through approach, all the other conditions and criteria set out in the UCITS EAD for the eligibility of the asset class (e.g. on risks, liquidity or valuation) continue being applicable.
ESMA is of the view that further clarification and ideally simplifications are needed to improve clarity and supervisory convergence going forward. As part of this, ESMA sees merit in ensuring a greater alignment between the transferable securities concepts used in the UCITS framework and MIFID II (of course this will need careful calibration given the specific purpose served by the criteria set out in the EAD, namely to ensure clarity and convergence on their eligibility for UCITS investments).
The current framework allows UCITS to gather exposure to derivatives either through a direct investment in financial derivative instruments or transferable securities embedding a derivative. The distinction is important since some NCAs / stakeholders take the position that a look-through approach is only necessary in the case of transferable securities embedding a derivative, but not in the case of transferable securities backed by or linked to the performance of other assets.
Although the introduction of a look-through approach should provide greater certainty regarding the treatment of derivatives, ESMA sees merit in clarifying some aspects related to the perimeter of financial instruments embedding a directive. The technical advice includes legislative proposals setting out additional criteria for when a transferable security should be regarded as embedding a derivative. These criteria focus on the possibility that the derivative component can contractually or economically be considered an independent financial instrument from the host transferable security.
ESMA believes there is merit in providing greater legal clarity on financial indices, particularly in view of possible overlap or inconsistencies between the EAD and the Benchmarks Regulation, as well as the divergences among Member States. Again, however, it considers that the look-through approach should apply to financial indices, to address the convergence issues relating to the eligibility of financial indices comprising assets that are not eligible for direct investment. Notwithstanding this, UCITS would be able to invest in financial derivatives providing exposures to financial indices comprising assets that are not eligible for direct investment within the 10% limit (subject to the necessity of ensuring these indices are sufficiently diversified). Helpfully, the proposals provide that UCITS will not be required to assess the adequacy and the publication criteria when the financial indices and the benchmark administrator fall within the scope of the Benchmarks Regulation.
To ensure greater harmonisation and a level playing field, ESMA also recommends deleting the language granting NCAs discretion to raise the limits relating to financial indices under Articles 51(3) and 53 of the UCITS Directive, such that the raised limits will apply consistently across jurisdictions provided that certain requirements are met.
ESMA’s proposals aim to clarify the distinction between open ended and closed ended AIFs, and consistent with the rationale in other areas, to ensure that UCITS investments in AIFs do not result in a circumvention of the investment restrictions and investor protection standards set out in the UCITS Directive, the proposals provide for application of the look-through approach, while granting some level of flexibility to invest in AIFs without the application of a look-through within the 10% limit.
Since the UCITS I Directive, UCITS are permitted to hold ancillary liquid assets (with no express limits concerning the amount of ancillary liquid assets held) – given the counterparty risks that may arise from holding such assets, and the need for appropriate risk diversification, ESMA is recommending that the 20% counterparty limit for deposits made with the same body (as set out in the UCITS Directive) be applied also to ancillary liquid assets. It does not however see merit in prescribing a maximum amount of ancillary liquid assets that UCITS may hold, bearing in mind that they might be required to cover for exceptional payments and unfavourable market conditions.
The technical advice also proposes targeted clarifications of various key concepts and definitions, including the criteria to be used for assessing eligibility, specifically around liquidity, negotiability, risk management, and valuation. It also includes proposals on the EAD’s alignment with other EU pieces of legislation, including MiFID II, the DLT Pilot Regime Regulation and MiCA.
The European Commission is expected to consider ESMA’s recommendations as it prepares to revise the EAD. While the timeline for the formal adoption of any new rules remains unclear, firms will be heartened by ESMA’s advice to the European Commission, that to allow for an orderly transition and avoid any risks of fire sales or adverse impact on relevant asset classes and underlying markets, sufficiently long transitional periods should be granted for the application of the revised rules. The proposals provide for granting sufficiently long transitional periods to allow UCITS management companies to adapt their portfolios where needed. The advice cautions against grandfathering existing UCITS under existing rules in order to avoid a bifurcation of the UCITS brand.
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