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Special alfi global distribution conference in association with nicsa & hkifa
“UCITS are likely to enter a new era” Freddy Brausch
Partner, Linklaters Luxembourg
Depositaries
UCITS V on its way Proposed retail fund regulations have been published, and they share much in common with the draft rules for alternatives. Text Freddy Brausch Illustration Vanda Romão
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n 3 July 2012, the European Commission released the long-awaited proposal for a UCITS V Directive. The proposal aims to strengthen investor protection by focusing on the UCITS depositary role and liability, remuneration of UCITS managers (not dealt with here), and sanctions for non-compliance. Some had hoped that shortcomings – there are some – under UCITS IV would be tackled on this occasion. This will not be the case. It is rumoured that more might come, though this will not be under UCITS V. The proposed directive, attempting to clarify the requirements applied to a UCITS depositary, heavily relies on – the much debated – provisions under the AIFMD, going sometimes one step further.
UCITS depositary role and liability The UCITS depositary regime is clarified under the proposal (appointment of a single depositary for each UCITS; written contract with the depositary; rules establishing the flow of information — September - October 2012
for the depositary to perform its functions) as are the entities eligible to serve as UCITS depositary (EU registered credit institutions and certain EU MiFID authorised investment firms). The obligations of the depositary (monitoring and oversight roles; proper monitoring of cash flows; safe-keeping of financial instruments and other UCITS assets) are also clarified. The introduction, taken from the AIFMD, of safe-keeping duties relating to financial instruments that can be held in custody and of safekeeping relating to other assets should be welcomed by all. The required due skill, care and diligence in the selection, appointment, periodic review and ongoing monitoring of delegates by the depositary do not fundamentally deviate from the depositary’s present situation. The enlargement of the scope of delegates beyond the traditional network of sub-custodians is not without concern though to the community of depositaries. The same goes for the proposed provisions on the liability regime of UCITS depositaries. The strict liability regime (with now a reversed burden
of proof, the onus being on the depositary) will, for most depositaries, be a major departure from the presently applicable liability regimes they are used to. The duty of restitution for lost financial instruments in custody (safe where the depositary 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 its reasonable efforts to the contrary), introduces a standard on the depositary that is particularly tough, some claim unreasonably tough. They argue that the impact of the proposal on pricing – where fund products are already at a disadvantage, compared to other financial products – will ultimately harm the fund product. The depositaries argue further that beyond pricing issues, the investment in less developed and hence more risky countries by their fund clients may result in certain fund products having to be discontinued. Finally, depositaries are worried by situations where the depositary may have to accept liability for an agent over whom the depositary has little or no control. Same where the depositary’s liability may be at stake for the keeping of certain types of collateral. It may further be the case of the depositary’s potential liability for third-party fraud and in case of a potential liability in a “meltdown situation”, which are departures from the present regime. The debate among the several European lawmaking bodies towards the adoption of the proposal will be the subject of much attention from the industry in all its several constituencies. It is unlikely though that the standards the commission is endeavouring to set in its proposal will be materially altered during the legislative process. UCITS are likely to enter a new era.
Sanctions The third element of the proposal introduces rules similar to those that have been included in all the commission’s recent proposals in the context of its horizontal policy making.