In July 3 2012, the European Commission published a proposal for regulations and administrative provisions in respect of depositary functions, remuneration policies and sanctions related to UCITS. With UCITS V, the European Commission proposed a new depositary regime. In its impact assessment which accompanied the 2009 consultation document, the Commission highlighted that national divergences in the depositary regime could be the origin of significant legal uncertainty and could lead to different levels of investor protection across the EU. It should be noted that these rules have been included in the Directive on Alternative Investment Fund Managers (AIFMD) which governs alternative investment funds. The proposed rules governing remuneration will ensure that compensation of senior management, risk and controls functions is consistent with the UCITS risk management and profile. Regarding the harmonised sanctions regime, member states will have to compile a list of minimum penalties for three types of offences; (1) fund authorisation (2) fund operational and (3) reporting rules. The penalties shall range from a public warning to a temporary suspension and fines.
The Depositary’s Role
The Madoff case and Lehmans Brothers insolvency has led the legislator to focus on the depositary’s role. In addition to the safekeeping of assets, depositories are required to ensure that all transactions made by or on behalf of UCITS funds are carried out in accordance with the law and the fund documentation. Moreover, depositories, must act independently and solely in the interest of the investors to effectively discharge this role.
Requirements for a Depositary to be appointed
Under the new rules, a UCITS has to appoint a single depositary from among a list of entities eligible to act as UCITS depositaries which are authorized to provide depository activities, are subject to prudential supervision and to CRD IV capital adequacy requirements.
Furthermore, the depositary has to be located in the same Member State as the UCITS Member State.
Moreover, the appointment of the depositary has to be evidenced by a written contract entrusting the depositary with the safekeeping, oversight and cash flow monitoring functions.
The duties of the Depositar
UCITS V makes a distinction between:
(i) Custody duties relating to financial instruments which can be held in custody; and
(ii) Asset monitoring duties related to other assets.
Under the first category, assets need to be segregated from the depositary’s own assets and will not be available for distribution to third party creditors. The duties in relation to other assets are limited to ownership verification and record keeping.
UCITS V introduces a list of oversight duties, which the depositary has to perform, irrespective of the type of UCITS. The depositary has to perform the following duties:
- Control of issue, repurchase, redemption and cancellation of shares;
- Control of the NAV calculation;
- Control that the consideration to the fund’s transactions is remitted within the usual time limits;
- Ensure compliance with the investments restrictions; and
- Control that the UCITS’ income is applied correctly.
Cash flow monitoring
The depositary is responsible for the proper monitoring of the UCITS cash flows, in particular it has to:
- Ensure subscription and monies are properly received by the UCITS; and
- Ensure that all cash is properly booked in segregated accounts opened in the name of the management company or the UCITS.
Delegation of the Depositary’s Duties
Under UCITS V, like under AIFMD, the only function which the depositary can delegate to a third party is the safekeeping. This, must however, meet the following requirements which are similar to those under the AIFMD:
- The tasks are not delegated with the intention of avoiding the requirements of the UCITS V Directive;
- There is an objective reason for delegation;
- The depositary has exercised all due skill, care and diligence in the selection and the appointment of the third party and keeps exercising all due skill, care and diligence in the periodic review and ongoing monitoring; and
- The depositary shall warrant that the third party:
- Has structures and expertise which are adequate and proportionate to the nature and complexity of the assets of the UCITS or the management company acting on behalf of the UCITS which have been entrusted to it;
- In relation to custody tasks, the third party is subject to effective prudential regulation and supervision, including minimum capital requirements and external periodic audit to ensure that the financial instruments are in its possession;
- Segregates the assets of the clients of the depositary from its own assets and from the assets of the depositary in such a way that they can at any time be clearly identified as belonging to clients of a particular depositary;
- Takes all the necessary steps to ensure that in the event of insolvency of the third party. Assets of a UCITS held by the third party in custody are unavailable for distribution among the creditors of the third party; and
- Complies with the general obligations and prohibitions which are applicable to the depositary.
The third party, may in turn sub-delegate these functions, subject to the same obligations and requirements.
Liability of the Depositary
Under UCITS V, depositaries can neither discharge liability for loss of financial assets, even if they prove that they delegated properly, nor transfer that liability to the third delegated party by agreement.
The depositary will remain liable for any loss suffered by the UCITS and/or by investors as a result of any breach of its duties. The depositary will be required to return a financial instrument of identical type or the corresponding amount to the UCITS or the management company acting on behalf of the UCITS without undue delay.
The depositary is also liable to the UCITS and to the investors of the UCITS, for all other losses suffered by them as a result of the depositary’s negligent or wilful failure to properly fulfil its obligations pursuant to UCITS V.
The depositary shall only not be liable if it can prove that the loss suffered has been due to an external event beyond its reasonable control and the consequences of which would have been unavoidable despite all of its reasonable efforts to the contrary.
UCITS V gives the same rights to all UCITS
cinvestors, allowing them to sue depositaries, either directly or indirectly through the management company, depending on the legal nature of the relationship between the depositary, the management company and the investors.
UCITS V requires UCITS management companies and self-managed UCITS to introduce remuneration policies and procedures in order to prevent conflicts of interest and discourage risk-taking which is inconsistent with the risk profile of the UCITS being managed.
The manager of the management company is required to establish, maintain and approve the remuneration policy and in larger management companies, a remuneration committee to exercise independent and competent judgment on remuneration policies and practices.
Moreover, members of the remuneration committee shall not perform any executive functions in the management company. Also, the remuneration of senior officers of the company, shall be overseen by the remuneration committee.
The remuneration policy shall be reviewed at least annually.
The remuneration requirements will apply to 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 companies and the UCITS they manage.
Remuneration policies must 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 remuneration structures are required to include:
- Rules for conducting performance assessment based on financial and non-financial criteria;
- Rules for deferral, retention and payment in instruments of variable remuneration;
- Rules for guaranteed variable remuneration;
- Rules for payments related to termination of employment; and
- Rules on pension benefits.
In the annual report of each UCITS, the UCITS management company must disclose in the annual report, the amount of remuneration (split into fixed and variable remuneration) paid by the management company for the financial year, the number of beneficiaries and where relevant carried interest paid by the UCITS.
The assessment of performance should be set in a multi-year framework appropriate to the life cycle of the UCITS managed.
Guaranteed variable remuneration is exceptional.
Fixed and variable components of remuneration need to be appropriately balanced, and the fixed component must represent a sufficiently high proportion.
At least fifty percent (50%) of variable remuneration consists of shares in the UCITS.
Forty percent (40%) of variable remuneration is deferred over at least three (3) to five (5) years.
In order to harmonise the application of sanctions across member states, UCITS V sets down an exhaustive list of breaches which require sanctions by competent authorities. These sanctions include public statements, suspension or withdrawal of the management company authorization and maximum administrative pecuniary sanctions. Fines amount to at least twice the amount of the benefit deriving from the breach or:
- For legal persons up to at least five million euro (EUR 5,000,000) or ten percent (10%) of its total turnover;
- For natural persons up to at least one million euro (EUR 1,000,000).
penalty or sanctions to the list to the list of management companies available on its website.
UCITS V requires Member States to establish mechanisms encouraging the reporting of potential or actual breaches of the national provisions implementing the directive, including secure communication channels for the reporting of such breaches
EU regulators will publish any administrative sanction on their official website and will maintain such publication for a period of at least five years. Furthermore, the European Securities and Markets Authority (the “ESMA”) maintains a central database of all sanctions communicated to it by national competent authorities.
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This newsletter is for information purposes only. It does not constitute professional advice or an opinion. Please contact Mr. Dominique Lecocq on email@example.com for any questions.