According to the Committee, the decision to explore more thoroughly the potential inclusion of hedge fund indices in UCITS should be seen as part of the wider context of CESR’s final advice to the European Commission on clarification of definitions concerning eligible assets for investments of UCITS submitted in January 2006, which set out in detail its views on the criteria that should be met by a financial index for derivatives, in order for the index to be an eligible investment.

The CESR last week published a consultation paper entitled: 'Clarification of the definitions concerning eligible assets for investment by UCITS: can hedge fund indices be classified as financial indices for the purpose of UCITS?'. This consultation closes on 16 April, 2007; prior to that, a public meeting will be held to discuss the issue on 2 April, 2007.

The measures proposed will be adopted by CESR at "level 3". At level 1, the UCITS Directive governs the overall framework for the operation of EU-harmonised collective investment undertakings. A level 2 implementing Directive on eligible assets clarifies certain definitions in the UCITS Directive that are related to eligible assets, including financial indices. ‘Level 3’ measures concern strengthened co-operation between (national) regulators to ensure consistent and equivalent application of ‘Level 1’ and ‘Level 2’ legislation.

At this stage, the CESR said that on the issue of hedge fund indices diversification, taking into account that the diversification requirement set out in the UCITS Directive requires the index to have at least five underlyings, CESR considers there is no need for additional level 3 guidelines.

It is proposed that a hedge fund index will not meet the criterion of "representing an adequate benchmark" if the UCITS does not verify that the index provider: clearly defines and makes publicly available an explanation of what the index is trying to represent, and assesses whether the methodology of the index construction will affect the extent to which it is representative for the market to which it refers.

It is also proposed that the criterion of "publication in an appropriate manner" will not be met unless the UCITS confirms that the index provider makes publicly available the full methodology of the index and the UCITS verifies that the index will be subject to an independent audit at least annually.

The CESR considers that index methodology and standards will probably develop over time. In this respect, CESR proposes to monitor the evolution of the market to consider which measures might be necessary to cope with market developments.