UCITS V: New Rules

By Jonathan Burger

Posted: 6th February 2015 08:45

On 23 July 2014, the European Union adopted Directive 2014/91/EU (UCITS V) of the European Parliament and of the Council amending Directive 2009/65/EC (UCITS IV) on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) regarding depositary functions, remuneration policies and administrative sanctions.  Published in the Official Journal of the European Union on 28 August 2014, the Directive will have to be implemented by Member States into national law by 18 March 2016 at the latest. 
 
Even though UCITS IV has mainly contributed to the development of the investment fund industry, recent financial scandals such as the Madoff fraud and the Lehman Brothers insolvency have highlighted some weaknesses.  This has led the European Union to adopt UCITS V aiming to provide retail investors with more protection, and limiting unreasonable risk taking by UCITS managers. 

In order to achieve these objectives, UCITS V intends to learn from the financial crisis by restructuring three main aspects of the asset management regulation: the role of depositaries, managers' remuneration and administrative sanctions.
 
New depositary's role
 
Under the UCITS V rules, a UCITS will have to appoint a single depositary chosen between eligible entities which are national central banks, authorised credit institutions or another legal entity (i) authorised to carry out depositary activities, (ii) subject to prudential regulation and (iii) subject to specific capital adequacy requirements.  This single depositary must be located in the same Member State as the UCITS and its appointment must be evidenced by written contract.  This means that managers of existing UCITS may have to appoint a compliant entity if the current depositary doesn't undertake the required change. 
 
UCITS V also introduces new duties for depositaries covering many of their activities.  There are new oversight duties consisting, inter alia, in ensuring 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.  The depositary will also have to control net asset value calculations.  The depositary shall also carry out the instructions of the management company or an investment company, unless they conflict with applicable national laws or fund rules.  Furthermore, they must ensure that in transactions involving the assets of the UCITS any consideration is remitted to the UCITS within the usual time limits.
 
New duties can also be noticed regarding cash-monitoring.  Depositaries must ensure that the cash flows of the UCITS are properly monitored.  This includes the verification that all payments made by or on behalf of investors upon the subscription of the units of the UCITS have been received, and that all cash of the UCITS has been 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 acting on behalf of the UCITS.
 
Concerning the safe-keeping duties, the depositaries' new duties depend on whether it concerns the safe-keeping of financial instruments or of other assets.  With regard to safe-keeping of financial instruments, the depositaries must hold in custody all financial instruments that may be registered in a financial instruments account opened in the depositaries' books and shall also ensure that all financial instruments that can be registered in such an account are registered in the depositaries' books within segregated accounts.  Regarding the safe-keeping of other assets, the depositaries must verify the ownership by the UCITS or by the management company acting on behalf of the UCITS of such assets and shall maintain an up-to-date record of those assets.
 
Alongside appointment requirements and duties improvement, UCITS V creates a stronger depositary's liability regime.  This means in particular that the depositary is 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 pursuant to UCITS V.  The depositary will also be liable for the loss by itself or a third party to whom custody has been delegated.  Contrary to the depositary regime set under the AIFM Directive, the depositary will not be able to contractually discharge from liability.
It should be noted that UCITS V regulates the delegation procedure by only allowing the delegation of safe-keeping duties while cash-monitoring and oversight duties have to be performed by the appointed depositary.
 
New rules governing remuneration
 
Under UCITS V, self-managed UCITS and management companies will have to establish and apply remuneration policies and practices that are consistent with and promote sound and effective risk management and that do not encourage inconsistent risk taking according to the risk profiles, rules or instruments of incorporation of the UCITS that they manage nor impair compliance with the management company’s duty to act in the best interest of the UCITS.  While establishing the remuneration policies, management companies shall ensure that those remuneration policies are in line with the business strategy, objectives, values and interests of the management company and the UCITS that it manages and of the investors in such UCITS, and include measures to avoid conflicts of interest.
 
The remuneration requirements concern a wide range of staff including senior management, risk takers, control functions and any employee receiving total remuneration that falls within the remuneration bracket of senior management and risk takers whose professional activities have a material impact on the risk profiles of the management companies or of the UCITS that they manage.
 
Where it is justified by the size of the management companies or the size of the UCITS they manage, the management companies shall establish a remuneration committee, in a way that enables it to exercise competent and independent judgementon remuneration policies and practices, and the incentives created for managing risk. 
 
Sanction regime
 
In UCITS V, an important place is given to the sanctions regime and whistle-blowing.  Indeed, the directive provides a long list of about 20 breaches meant to be sanctioned and the administrative sanctions and measures to repress such breaches. 
 
Administrative sanctions and other administrative measures shall be effective, proportionate and dissuasive.  In addition to a public statement, Member States must ensure that the administrative penalties and other administrative measures that may be applied include at least, an order requiring the person responsible to cease the conduct, but also in the case of a UCITS or a management company, the suspension or withdrawal of the authorisation of the UCITS or the management company.  This can go as far as a temporary or, in case of repeated serious infringements, a permanent ban against a member of the management body of the management company or investment company or against any other natural person who is held responsible, from exercising management functions in those or in other such companies.
 
In the case of a legal person, maximum administrative pecuniary sanctions of at least EUR 5,000,000 may be applied. 
 
Finally, 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.

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