- Service: Infrastructure, Legal Services, Legislative and Regulatory
- Industry: Financial Services, Fund Management
- Type: Business and industry issue, Publication series
- Date: 7/28/2014
On 3 July 2012 the EU Commission issued a proposal to amend the UCITS directive covering the depositary safe-keeping and oversight duties, manager remuneration and sanctions, which became commonly known as the “UCITS V” proposal.
Both the Madoff fraud case and the default of Lehman Brothers brought to the fore the weaknesses and lack of harmonisation of the depositary duties and liabilities across different EU countries. In fact, the depositary rules have remained unchanged since the original UCITS Directive came into being in 1985, although the framework had been revised several times over the years. The impetus for new depositary rules also came from the adoption of the Alternative Investment Fund Managers Directive (AIFMD) which regulates the alternative investment funds sector and significantly enhanced the investor protection regime for professional investors, making it all the more urgent to extend the same level of investor protection to retail fund investors.
The Directive entered into force on 17 September 2014. Member States have 18 months to implement the Directive into national law, i.e. until 18 March 2016.
Appointment & eligible entities
- The UCITS may only appoint a single depositary and all assets must be entrusted to the depositary.
- The appointment of the depositary needs to be evidenced by written contract.
- Eligible entities are credit institutions, national central banks, and “other legal entities” authorized under the laws of the Member State, subject to capital adequacy requirements, prudential regulation and ongoing supervision, and fulfilling certain further criteria as defined by the Directive.
- The UCITS manager will have two years after the transposition deadline to appoint a compliant entity if the current depositary does not undertake the required changes.
Oversight duties (uniform for both contractual & corporate UCITS)
- The depositary shall ensure that the sale, issue, re-purchase, redemption and cancellation of units of the UCITS are carried out in accordance with the applicable national laws and fund rules.
- It shall ensure that the value of the units is calculated in accordance with the applicable national laws and fund rules.
- It further shall carry out the instructions of the Management Company or an investment company, unless they conflict with the applicable national laws or fund rules.
- Transactions involving the assets of the UCITS and any consideration shall be remitted to the UCITS within the usual time limits.
- The depositary also shall ensure that the income of the UCITS is applied in accordance with applicable national laws and fund rules.
- The depositary shall ensure a proper monitoring of the cash flows of the UCITS. A cash account cannot be opened without the depositary’s knowledge.
- The depositary shall ensure that all payments made by or on behalf of investors upon the subscription of units of the UCITS have been received and all cash is booked in the accounts of a credit institution, central bank or third country bank, opened in the name of the UCITS, or its Management Company or depositary on behalf of the UCITS.
- The principle of segregation of client money from the depositary’s own funds will need to be applied.
1. Safe-keeping of Financial Instruments:
- The depositary has to hold in custody all financial instruments that can be registered in a financial instruments account opened in the depositary’s books and all financial instruments that can be physically delivered to the depositary.
- The depositary has to ensure that those financial instruments are registered in the depositary’s books within segregated accounts, opened in the name of the UCITS or its management company, so they can be clearly identified as belonging to the UCITS at all times.
- The reuse of assets held in custody by the depositary or its delegate is restricted and can only be performed if all of the following is fulfilled: the reuse is executed for the account of the UCITS, the depositary carries out the instructions of the Management Company on behalf of the UCITS, the reuse is for the benefit of the UCITS and its investors, and the UCITS receives a high quality and liquid collateral in return under a title transfer agreement, the value of which is at all times equal to the market value of the reused assets plus a premium.
- In the event of its insolvency, securities held by the depositary for the UCITS shall be unavailable for distribution among or realization for the benefit of creditors of the depositary.
2. Safe-keeping of all other assets:
- For all other assets the depositary has to verify the ownership of the UCITS or the Management Company acting on behalf of the UCITS of such assets, and has to maintain up-to-date records of those assets for which it is satisfied that the UCITS or the Management Company acting on behalf of the UCITS holds the ownership of such assets.
- The ownership verification should be based on information and documentation provided by the UCITS or the Management Company and, where available, on external evidence.
A comprehensive inventory of all assets of the UCITS shall be provided by the depositary to the management company or the investment company on a regular basis.
A comprehensive inventory of all assets of the UCITS shall be provided by the depositary to the management company or the investment company on a regular basis.
- Only safe-keeping duties may be delegated, whereas cash-monitoring and oversight duties must be performed by the appointed depositary.
- The depositary will have to demonstrate that the tasks are delegated for an objective reason, and that they are not delegated with the intention of avoiding the requirements of the Directive.
- It will further have to exercise all due skill, care and diligence in selecting and appointing the delegate (e.g. by performing an initial due diligence) as well as during its periodic review and ongoing monitoring of the delegate and the tasks performed.
- During the performance of its activities, the delegate will be subject to an on-going due diligence by the depositary and will have to comply at any time with the following requirements:
- it must have the structure and expertise in line with the nature and complexity of the assets received in custody;
- it must be subject to effective prudential regulation, including minimum capital requirements, and supervision in its jurisdiction;
- it must be subject to external periodic audit to make sure that financial instruments are in its possession;
- it has to ensure the segregation of the assets of the clients of the depositary from its own assets, and from the assets of the depositary, to ensure that clear identification of ownership is possible at any time;
- it must take all necessary steps to ensure that, in case of its own insolvency, the assets held in custody are not available to pay the creditors.
- The depositary’s liability is not affected by delegation.
- The depositary will be liable for all losses suffered by the UCITS or its investors as a result of the depositary’s negligent or intentional failure to properly fulfill its obligations.
- The depositary will also be liable for any loss of financial instruments held in custody, either by the depositary itself or by a third party to whom custody has been delegated (sub-delegation)
- If a financial instrument is lost, the depositary will have the obligation to return a financial instrument of the identical type or of the corresponding amount to the UCITS.
- The depositary can only discharge itself from liability if it can prove that the loss arose as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary.
- Unlike the depositary regime under the AIFMD, there will be no possibility to contractually discharge from liability.
Remuneration policies and practices
- UCITS Management Companies shall implement and apply remuneration policies that are consistent with and promote sound and effective risk management and discourage disproportionate risk-taking.
- A remuneration committee should be established where it is justified by the size of the UCITS manager and/or the UCITS it manages. In any case the remuneration policy must be adopted by the management body of the Management Company, and its implementation must be reviewed at least annually.
- The remuneration requirements will apply to those categories of staff whose professional activities have a material impact on the risk profiles of the Management Company or the UCITS they manage, including senior management, ‘risk takers’, those who exercise control functions and other employees with equivalent compensation packages, and will vary depending on the size and complexity of the Management Company and the UCITS they manage.
- The remuneration policies shall be in line with the business strategy, objectives, values and interests of the Management Company and the UCITS or the investors and must include measures to avoid conflicts of interest.
- The assessment of performance shall be set in a multi-year framework appropriate to the life cycle of the UCITS managed.
- The remuneration policies and practices shall include both fixed and variable components of salaries and discretionary pension benefits.
- In principle, the variable part shall not be guaranteed, and may only occur when hiring new staff, but limited to the first year.
- Fixed and variable components of remuneration need to be appropriately balanced, and the fixed component must represent a sufficiently high proportion.
- A substantial proportion, and at least 50% of variable remuneration, shall consists of units in the UCITS.
- A substantial proportion, and at least 40% of variable remuneration, will have to be deferred over a period which is appropriate in view of the holding period recommended to the investors of the managed UCITS and aligned to the risks of this UCITS; this period shall be at least three years.
- For the publication in the prospectus, the Management Companies will be given the choice to provide investors either with very detailed information on the remuneration policy and practices, or a summarized version of the remuneration policy with a reference to the publication of all further details on a website and on the possibility to obtain a copy free of charge.
- The UCITS Management Company must disclose in the annual report of each UCITS the amount of remuneration paid by the Management Company for the financial year, the number of beneficiaries and, where relevant, carried interest paid by the UCITS.
Sanctions regime & whistle-blowing
- Member States shall lay down rules on administrative sanctions and other administrative measures to be imposed on companies and persons in respect of breaches of national provisions transposing the Directive, and shall take all measures necessary to ensure that they are implemented.
- Listing about 20 breaches encountered during the implementation of Directive 2009/65/EC (UCITS IV), the text requires Member States to ensure that their laws, regulations or administrative provisions transposing the Directive shall provide for penalties to specifically address these breaches.
- Sanctions shall generally be published without undue delay on the website of the competent authority and shall include at least information on the type and nature of the breach as well as the identity of the person(s) responsible; however they can also be published anonymously, delayed or not at all, depending on a case-by-case assessment taking into account the principle of proportionality and effects on the financial stability or an on-going investigation.
- Besides the public statement, penalties and measures shall further include at least an order requiring the responsible person to cease the conduct, the suspension or withdrawal of the authorization of the UCITS or the Management Company where relevant, a temporary or permanent ban against the member of the management body or any other natural person held responsible, as well as pecuniary sanctions.
- Pecuniary sanctions for legal persons are set at a maximum of EUR 5 million or 10% of total annual turnover, and at a maximum of EUR 5 million for natural persons, or, even if higher, at the amount twice the benefit derived from the breach where that benefit can be determined.
- In order to encourage whistle-blowing by employees of depositaries, investment funds and Management Companies, Member States and ESMA will have to implement secured channels to receive and follow-up for the report of breaches of national provisions transposing the Directive.
28 November 2014- ESMA issues technical advice to EU Commission on depositary rules under UCITS V
On 26 September 2014, ESMA [ESMA] has published a Consultation Paper to gather views from the industry stakeholders in order to provide advice to the European Commission on depositary rules as required by the UCITS V Directive. Based on the responses from stakeholders to the Consultation Paper, ESMA issued its technical advice in November 2014 with the proposed following rules:
The protection of UCITS assets in case of insolvency of a delegate of the depositary
The advice introduces requirements that apply to the depositary, but also to the delegate who is expected to play an active role:
- General rules apply to all delegates, regardless of their localisation among which the obligation to: inform the depositary of the applicable insolvency rules in its country, maintain records and accounts providing detailed information on UCTIS’ assets, provide information on the assets to the depositary, put in place arrangements to protect funds’ rights, minimise the risk of loss and misuse of the assets.
- Where the delegate is located in an EU third country, it will also have to verify that (i) the applicable local rules recognise the segregation of the assets, ensuring that they are unavailable for distribution or realisation in case of insolvency, (ii) the conditions set by law, to consider that the assets are segregated, are permanently fulfilled during the contract. Moreover, it will need to inform the depositary if this is no longer the case.
- The rules reaffirm the general obligation of the depositary to perform a due-diligence on the delegate and the applicable legal framework.
- Where the delegate is located in a third country, the depositary must make all reasonable efforts to understand the material effects of the contract. This may include the receipt of a legal advice except where it has already been provided by the delegate. Further, the depositary shall ensure that the contract includes a clause for immediate termination if the conditions required to ensure the segregation of the assets are no longer met. In such case, the depositary must inform the management or investment company which, in turn must notify its competent authority.
Independence requirements between the depositary and the management company / investment company
Where the management/investment company and the depositary are not part of a same group and have no cross-shareholding links, the new rules would:
- Disallow members of the managing body of the management/ investment company from being a member of the managing body of the depositary;
- Disallow members of the managing body of the management/ investment company from being an employee of the managing body of the depositary and vice versa;
Some flexibility would be available where the management body of the management/investment company or the management body of the depositary are not in charge of the supervisory functions.
In case a cross-shareholding or same-group, the following rules would be recommended:
- The management/investment company shall put in place a robust decision-making process including objective pre-defined criteria for the choice of the depositary;
- Where (i) the management company has a qualifying holding in the depositary’s capital, or (ii) the depositary has a qualifying holding in the management company’s capital, or (iii) the management company and the depositary are part of the same group for the purposes of consolidation, safeguards at the entities or group level shall be put in place to avoid conflicts of interest, or – where conflicts of interest are identified – manage, monitor and disclose them. Furthermore, investors may request justification of the choice of the depositary;
- Prove to the competent authority of its home Member State that the depositary has been appointed in the sole interest of the UCITS and its investors, after comparing between the entity and its competitors on cost and qualitative aspects;
- Disclose to the investors the existing link to the depositary
- Where the group structure is applicable, further independence requirements at the level of management bodies of the management/investment company and of the depositary shall apply (1/3 of the management body of each entity or, where applicable of the entities’ body in charge of the supervisory functions with a minimum of 2 persons).
- The advice further provides elements to assess the independence of the members of the management body of the management company/investment company and of the depositary (no additional intra-group mandate, employee function and avoidance of business, family or other relationships).
The delegated regulation of the European Commission was initially expected for spring 2015 but is more likely to be issued in fall 2015.
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- Understanding the requirements of UCITS V and evaluating its impact on your business
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UCITS V Timeline - Next Steps