Use of Side Pockets by Collective Investment Schemes

Side pockets are devices used by funds to rectify situations when assets of the fund’s portfolio become illiquid or hard to value, thereby hindering both calculation of the Net Asset Value as well as the redemption of units by investors.  The Malta Financial Services Authority (“MFSA”) has issued guidance notes regarding the use of side pockets for Professional Investor Funds (UCITS and non-UCITS Schemes are expressly excluded).

Side pockets allow for the designation of an asset as illiquid or hard to value and segregate these assets from the main pool of assets.  Only existing participants in the fund acquire units in the side pockets (calculated in proportion of their interest in the side pocket asset).  The other classes of units within the sub-fund will cease to have an interest in the illiquid assets.

The Offering Memorandum of the Collective Investment Scheme would need to include in a clear and unequivocal manner, the circumstances where side pockets may be employed, as well as the policy for transferring assets, including the nature of the assets.  Limits on the size of the side pockets including maximum percentage of the fund / sub-fund should also be disclosed, as well as the valuation methodology of the assets in the side-pockets, as well as the relevant risk warnings should also be clearly delineated in the offering memorandum.

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