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Shariah compliant funds set to benefit from new EC rules

The European Council (EC)’s new regulations, targeted at strengthening its capital market and investor protection, augur well for the undertakings for Shariah compliant collective investment in transferable securities (UCITS) funds, as they should improve accessibility. This directive will add impetus in terms of modernizing the framework for UCITS.

It is seen as an advantageous move as the new regulation, known as the Alternative Investment Fund Managers Directive II (AIFMD II) amends the previous fund manager directive which regulates managers of hedge funds, private equity funds, private debt funds, real estate funds and other alternative investment funds in the EU.

“This will benefit all UCITS funds, including Shariah compliant UCITS investment funds, as it should improve accessibility, in particular during turbulent market conditions. Looking at the subset of Shariah compliant passive funds that track underlying Shariah compliant benchmarks, the screening is applied at the index level, but the rules apply at the fund level. We believe this will have minimal impact on such Shariah compliant funds other than to improve the overall liquidity profile of the fund itself,” Sefian Kasem, the global head of exchange-traded funds and indexing investment specialist at HSBC Global Asset Management, explains to IFN Investor.

The new rules enhance the integration of asset management markets in Europe and modernize the framework for key regulatory aspects. They improve the availability of liquidity management tools, with new requirements that include having managers provide for the activation of these instruments. This will help ensure that fund managers are well equipped to deal with significant outflows in times of financial uncertainty … Aside from this, the directive also modernizes the framework for UCITS, namely EU-harmonized retail investment funds such as unit trusts and investment companies, and will likely impact the non-EU sponsors of private investment funds that are marketed in the EU.

KPMG UK’s Wealth and Asset Management Sector Lead for the EMA Financial Services Regulatory Insight Centre David Collington explained: “AIFMD II signals a trend toward tightening the avenues through which non-EU sponsors can raise EU capital, which could further narrow over time. As a result, there may be a mismatch between requirements that apply to certain non-EU sponsors and to EU’s alternative investment fund managers, on the application of the new loan origination provisions. It remains to be seen if AIFMD II will further push EU investors to prioritize investment in EU-domiciled alternative investment funds.”

Concerning fund liquidity risk management, the amended rules will require UCITS management companies (Man Cos) to select at least two liquidity management tools (LMTs) in addition to suspension — underpinned by supporting analysis, policies and procedures. They will need to notify regulators when they activate/deactivate certain LMTs. The European Securities and Market Authority (ESMA) will develop guidelines on the characteristics of LMTs and their selection and calibration.

With regards to investor protection, ESMA will provide a report to the co-legislators assessing the costs charged by UCITS Man Cos, and develop guidelines on the circumstances where the name of a UCITS may be deemed unfair, unclear or misleading.

Sustainability risks will be a compulsory addition into UCITS Man Cos governance and risk management arrangements. ESMA needs to update its guidelines on remuneration policies to better align ESG risks with remuneration practices. UCITS Man Cos for the first time will need to regularly report data for each UCITS they manage on the instruments they trade, markets they trade in and on their exposures and assets, as well as liquidity management arrangements, risk profile and results of stress tests.

Since the rules have been approved by the European Parliament and the European Council, firms should prepare for implementation. Most requirements will become effective two years after the rules come into force which is likely to be Q1 or Q2 2026 except for regulatory reporting after three years. 

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