On 18 July 2019, The Central Bank of Ireland (the "Central Bank") published a press release and an industry letter (the "Letter") arising from its thematic review of UCITS funds on the subject of closet indexing, on the Central Bank website.


In December 2018, the Central Bank confirmed that it was analysing over 2,000 Irish domiciled UCITS which claim to be actively managed, to ensure investors are not disadvantaged by "funds operating in a manner that is not consistent with the way in which they have presented their objectives, policies and charges". The analysis involved an assessment of "closet indexing" where the investment policy (I) indicates that the fund operates an active strategy, while the fund's performance in reality adheres closely to a benchmark and therefore implements an investment strategy which requires less input from the investment manager and/or (II) charges management fees in line with those of funds that are considered to be actively managed.

This is the largest data driven thematic review of the funds industry to date. Detailed analysis was carried out on all of the 2,550 Irish authorised UCITS funds classified as actively managed as at March 2018 against a suite of over 2,500 indices using analytical parameters of Tracking Error Volatility, R-squared and Beta, in order to identify those UCITS funds that appeared to be closely moving in line with an index.

Key Findings

The Central Bank has completed specific follow up engagements with an initial group of 62 funds with which it is commencing a Risk Mitigation Programme to include a requirement that the Prospectus and key investor information documents ("KIID") of the UCITS be revised and the amended documentation be sent to all investors, together with details of the Central Bank's findings which prompted the amendments. The remainder of the 182 funds under investigation are set to be contacted by the regulator in the coming months.

The Letter highlights failures that the Central Bank has identified across the Industry with respect to fund offering documentation disclosures and has further noted that its analysis of actively-managed Irish UCITS identified "key supervisory issues" and "cases of poor governance" by fund management companies in 182 UCITS funds. The Central Bank has also highlighted insufficient oversight of offering documents by boards of directors of UCITS management companies (the "Board") in this respect. Furthermore, this review has drawn attention to broader issues around the effectiveness of investor disclosure and the legitimate expectations of investors in respect of the service provided by fund managers.

The Letter brings to light the following key supervisory issues identified in the review of closet indexing:

  • investors were not always given sufficient or accurate information about the fund's investment strategy in the Prospectus and KIID which affects their ability to make an informed decision on whether to invest in the fund;
  • instances of poor governance and controls by Boards;
  • instances where the fund had a target outperformance against an index that is less than the fee charged to certain share classes in the fund. The result is that, even if the UCITS provides a return at the upper end of its projections, investors in these share classes will not realise a positive return against the benchmark, as the fee charged will cancel out any outperformance achieved; and
  • in some cases, in the past performance section of the KIID no comparator was included so that investors in these funds were not able to determine whether the fund, irrespective of performance, represented good value relative to its benchmark.

Action to be taken

The Letter explicitly states that the Central Bank expects:

  1. the Letter to be brought to the attention of all members of the Board and to the relevant responsible persons within the Fund Service Providers and to Designated Persons;
  2. Boards to actively consider the contents of and findings in this Letter as they carry out their role, and review and revise their Prospectus and KIID where necessary;
  3. when considering the accuracy of the content of its Prospectus and KIID, the board of directors of each UCITS must ensure that:
    1. they are in compliance with all applicable legislative requirements and all relevant guidance. This includes Q&As issued by ESMA and the findings of the Central Bank in the Letter;
    2. any marketing material or other documentation provided to investors is consistent with information contained in the Prospectus and KIID;
  4. any necessary updates to the Prospectus and KIID to be submitted to the Central Bank by 31 March 2020; and
  5. when assessing the investment managers' annual presentation to the Board (delivered pursuant to the requirements of the Fund Management Companies Guidance), the Board of the UCITS management company should consider if the UCITS has delivered on the stated objective and remains a viable and suitable investment for investors. This review should be documented and assess, inter alia, the UCITS' performance, fee structure and investor base. The fees charged on all share classes within each UCITS should be reviewed to assess whether they are appropriate for the targeted level of outperformance of the UCITS against its benchmark.

Prospectus & KIID Review

The Letter requests that the Prospectus and KIIDs of a UCITS are revised where necessary to disclose, at a minimum, any benchmarks used, performance against such benchmark and how actively managed a fund is. Further, in the case where a fund tracks a benchmark, a full review of share class fees should be conducted annually to ensure they are appropriate. If the fund is managed in a constrained manner to a benchmark, this constraint should be disclosed in the KIID and the Prospectus and, where the fund is being managed with a performance target, this should be disclosed in the KIID and Prospectus in order to assist investors in making an informed decision.

The Central Bank's review follows an updated version of the European Securities and Markets Authority ("ESMA") UCITS Q&A, published in April 2019, which required certain disclosures in KIIDs, aimed at preventing closet-tracking, be made "as soon as practicable" or by the next KIID update. The Central Bank has allowed until the end of March 2020 for the accuracy of information provided to investors in the Prospectus to be considered and as necessary, amendments be made to the fund documentation on foot of these findings. Accordingly, the findings of the Central Bank's review will need to be closely considered by the Boards of UCITS management companies and by the UCITS and, if necessary, acted upon. In particular, UCITS fund documentation, including disclosures on investment policies and fee structures should be amended, where necessary to ensure they comply with the applicable requirements. The Central Bank has also made it clear that it will have regard to the contents of the Letter as part of any future supervisory engagement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.