Exchange Traded Commodities – Are they eligible?
The Undertakings for the Collective Investment in Transferable Securities (UCITS) rules forbid funds to invest in commodities or in financial derivatives instruments of commodities with embedded delivery mechanisms.
Nevertheless, fund managers have several other avenues to explore in order to gain exposure to the price of commodities, however there are certain requirements that need to be met depending on the route taken. A non-exhaustive list of available products in regard to gaining exposure to the price of commodities is: Commodity Index Futures, Commodity Exchange Traded Funds (Commodity ETFs), Total Return Swaps (TRS), Exchange Trade Commodities, and others. This article focuses on Exchange Trade Commodities (ETCs) and their eligibility as transferable securities for UCITS investment requirements.
Exchange Traded Commodities are undated non-interest bearing debt securities, issued by special purpose vehicles, and designed to track the price of physical metal or track the return of commodities using indices linked to futures contracts. They are similar, but not identical, to Exchange Traded Funds as outlined in papers written by ESMA/2012/44[1], IOSCO[2], and BIS[3]. The difference between Exchange Traded Commodities and Exchange Traded Funds is that ETCs are non-interest bearing debt securities while all open-ended ETFs are considered, by UCITS Rules, as Collective Investment Schemes.
In addition Exchange Traded Commodities trade and settle exactly like normal shares on their own dedicated sector. ETCs also have dedicated market maker support and are open-ended debt securities, created and redeemed on demand by the issuer, as stated by the London Stock Exchange[4].
With all the definition given above, the question still remains: Are Exchange Traded Commodities eligible assets?
We shall not provide an answer to the question above without considering what makes a security eligible under UCITS rules, and for that it’s essential to delve into CESR/07-044b[5] which offer the “guidelines concerning eligible assets for investment by UCITS”. A security is considered eligible if it fulfils all the UCITS transferable securities requirements described on CESR/07-044b. Outlined below, is an analysis on how Exchange Traded Commodities (ETCs) fulfil these requirements:
- ETCs’ potential loss is limited to the amount invested;
- ETCs’ liquidity is daily and on demand;
- ETCs have reliable valuation in place as they are traded on the stock exchange;
- All the information required by the investor is made available by the issuer;
- ETCs are fully negotiable;
- ETCs can be integrated with the investment objective and risk management process of the fund.
In light the of the analysis above, RiskSystem is of the opinion that Exchange Traded Commodities are eligible assets for a UCITS fund and as such, they are transferable securities for the purposes of the UCITS investment requirements. A point to remember, however, is that you should investigate further the risks involved with ETCs, which will vary according to the product of your choice.
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[1] http://www.esma.europa.eu/system/files/2012-44_0.pdf
[2] http://www.iosco.org/library/pubdocs/pdf/IOSCOPD414.pdf
[3] http://www.bis.org/publ/work343.pdf
[4] http://www.lseg.com/sites/default/files/content/documents/etcbrochure_0.pdf
[5] http://www.esma.europa.eu/system/files/07_044.pdf
