One of the cornerstones of the European Union’s UCITS (Undertaking in Collective Investments in Transferable Securities) directives governing investment funds is the concept of investor protection. Built up by a series of laws that have come into effect between 1988 and July 2011, the UCITS regime aims to provide individuals with a secure environment for fund investing. It sets out universal rules on how these funds should be structured, managed and governed, and how their assets should be safeguarded. Funds that meet these criteria can be sold freely to the public in any EU country, provided that they meet the standard UCITS notification requirements. Arguably the UCITS standards of investor protection are the most important factor in their development over two decades into a trusted brand not just in Europe but worldwide. Therefore, it’s worth taking a closer look at various important aspects of investor protection contained in the UCITS framework: Eligible assets Diversification Liquidity Valuation Risk management and compliance Oversight and safekeeping Fund information Eligible assets UCITS funds are subject to rules on what kind of assets they are allowed to invest in (eligible assets), which you will find in the investment policy section of a fund’s prospectus. Generally, they must invest in transferable securities or in other liquid financial assets – for example, money-market instruments, bonds, shares and any other instruments offering the right to acquire these securities through subscription or exchange, as well as other funds and bank deposits. Under certain conditions they may also use financial derivative instruments, such as futures, options or swaps based on an eligible UCITS asset or an approved financial index – either for investment or hedging purposes (to reduce the risk of the portfolio). Since the UCITS directive defines eligible assets in general terms, European regulators have issued additional guidelines to ensure there is a common understanding of what kind of assets may be acquired by a UCITS fund. Diversification Diversification is a vital means of reducing risk for investors of all kinds, from the biggest pension schemes to individuals putting their savings into funds. Different types of fund give investors access to asset classes and strategies whose performance may vary according to the market and economic conditions. The vast range of UCITS funds on the market offers investors diversification in terms of the assets in which funds invest, the economic or business sectors they cover, and the countries or regions where investments are located. Since UCITS funds are designed to be suitable to the retail investors, their rules build in certain levels of diversification with the aim of reducing their vulnerability to the performance of a small number of assets. In general, the more different assets a fund holds, the less the risk to investors of losing a substantial portion of their portfolio if one particular asset falls in value. Liquidity One of the most important characteristics of UCITS is the ease of buying or selling a fund’s shares or units. This means that investors wishing to sell their holdings in a fund, whether because they believe the value may fall or for any other reason, can do so without delay. As a general rule, investors may buy or sell UCITS shares or units at least twice a month, subject to limited exceptions, but in fact the vast majority of UCITS funds offer daily liquidity. The sale or purchase price is determined by the Net Asset Value per share or NAV. NAV is equal to the net assets of the fund divided by the number of shares or units held by investors. In most cases sales and purchases are subject to fees and commission charges. Exchange-traded funds (ETFs) that are UCITS, which are themselves listed and traded on public markets, may enable investors to buy and sell shares at any time those markets are open. However, their ability to trade and the price offered will depend on the availability of other buyers or sellers. Valuation For investors to have confidence in a UCITS fund, they must be able to trust the valuations it uses for individual assets and for the NAV. Investors buy shares or units in a UCITS without knowing the exact price, which is only established after the deal has been placed. As a rule, the latest official market closing prices must be used to value publicly-traded securities, otherwise a ‘fair market value’ must be provided. This is designed to offer protection against late trading, market timing and other practices that can affect the value of a fund. There are also prescribed rules for valuing certain assets such as short-term commercial debt and OTC derivative instruments (short for over the counter) that are not listed or traded on public exchanges. The management company of a UCITS fund must put in place valuation procedures for derivatives that are appropriate to their level of complexity, and details of the process must be disclosed to investors. The manager may appoint an outside firm to carry out such valuations. If it does so in-house, the process must be independent of the portfolio management to avoid conflicts of interest. Risk management All investments involve at least some risk. What is important is that a UCITS fund adheres to the level of risk it has told investors it will take. Managers must have procedures to measure the risk of a fund’s investments at all times, and the risk management function must be independent of the portfolio management activity, to minimise the possibility of conflicts of interest. The manager may hire an outside firm to provide risk monitoring and measurement if necessary. The risk management procedure for a UCITS fund must be appropriate, fulfil specific requirements, be described in detail, and approved by the CSSF. Oversight and safekeeping There is broad range of supervision, checks and balances at different levels to ensure that the interests of investors are protected. First, management and investment companies of UCITS are responsible for the oversight of the fund’s activities and the safeguarding of investors’ interests. They must have