UCITS V Directive: Impact Assessment
On 28 August 2014 the text of the UCITS V Directive (2014/91/EU) ("UCITS V") was published in the Official Journal of the EU ("OJ"). The Directive was adopted by the European Parliament and the Council of the EU on 15 April 2014 and 23 July 2014 respectively. The Directive will come into force 20 days after publication in the OJ (that is, on 17 September 2014). Member States must transpose it into national law by 18 March 2016.
This marks a further revision to the regime for Undertakings for Collective Investment in Transferable Securities ("UCITS") and is aimed specifically at enhancing certain measures within the UCITS framework, particularly in relation to investor protection.
Below is a high level assessment of the key elements addressed in UCITS V.
The UCITS regime was last updated pursuant to Directive 2009/65/EC together with various supporting directives and regulations (collectively "UCITS IV"). UCITS IV introduced a range of new measures to the regime with the broad aims of: (i) increasing EU cross-border efficiencies; and (ii) improving investor disclosure.
UCITS IV was initiated prior to the 2008 financial crisis – an event that became a significant political driver in European financial services regulation. The most notable result of this was the initiative to regulate alternative investment fund managers and the introduction of the Alternative Investment Fund Managers Directive (2011/61/EU) ("AIFMD").
The stated aim of UCITS V is to effectively bring the UCITS regime into line with AIFMD and introduce a range of corresponding measures that, in a UCITS context, had previously been regulated in less prescriptive terms.
UCITS V covers three key elements, namely:
- Depositary role (covering eligibility criteria, liability, delegation and oversight function relating to cash);
- Manager remuneration; and
- Regulatory sanctions.
These three key elements are considered below and Appendix I contains a summary analysis and consideration of the correlation with AIFMD.
1.1 Depositary eligibility criteria
Prior to UCITS V, the UCITS rules gave a certain degree of discretion to the EU Member States ("Member States") in relation to the types of entities that can act as a depositary. As a result, there was some divergence across the EU in terms of the eligibility criteria being applied and the types of entities performing the function. UCITS V sets out eligibility criteria for depositaries in much more prescriptive terms and provides that (in addition to national central banks and EU authorised credit institutions) entities may act as depositary where they are (a) authorised under the laws of the Member State to carry on UCITS depositary activities; (b) subject to specific capital requirements; and (c) subject to specific minimum requirements from a prudential regulation and ongoing supervision perspective.
Although there are some differences in terms of the exact level of details, this new depositary eligibility criteria for UCITS is aligned with the corresponding provisions in AIFMD. Indeed AIFMD directly cross-refers to a section of UCITS IV now being amended. This means that UCITS V will impact on the scope of eligible depositaries for both UCITS and AIFMD funds.
UCITS V provides for a grandfathering period for UCITS that, at the point this new requirement comes into effect, engage a non-compliant depositary.
1.2 Depositary liability
The operative standard of care for UCITS depositaries is that they shall be liable for any losses suffered due to the depositary’s "unjustifiable failure to perform its obligations or improper performance of them."
It has never been completely clear whether this standard of care corresponds to a standard of negligence or whether it could be interpreted as a stricter standard of care.
UCITS V now aligns the liability of a depositary with the higher standard of liability of a depositary under AIFMD.
The new liability standard will mean that the depositary of a UCITS shall be liable:
- for any losses of financial instruments held in custody suffered by the UCITS or its investors, unless the depositary "can prove that the loss has arisen 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"; and
- "for all other losses suffered by [the UCITS or its investors] as a result of the depositary’s negligent or intentional failure to properly fulfil its obligations."
Note, in relation to the first point above, the burden of proof regarding an external event beyond its reasonable control will be on the depositary.
In the event of the depositary being liable for losses relating to assets held in custody, the depositary will be required to return identical assets to the UCITS without undue delay. UCITS V, like AIFMD, acknowledges that certain financial assets cannot be held in custody and so this obligation will only apply for certain types of assets. As a result of distinguishing the different safekeeping duties regarding (i) financial assets that can be held in custody; and (ii) other assets, UCITS V effectively recasts two different levels of liability for safekeeping functions.
Depositaries will remain liable for the loss of assets, even where part or all of its safekeeping tasks have been delegated to a third party. This provision is unchanged from the current UCITS regime.
UCITS V aims to give the same rights to all UCITS investors, allowing them to sue depositaries, either directly or indirectly through the management company.
1.3 Depositary delegation
UCITS V provides that the safekeeping functions (but not the general oversight functions or the cash oversight function) can be delegated by the depositary to third parties, subject to certain conditions. Among these conditions is that there is an objective reason for the delegation and also a requirement that the depositary: "has exercised all due skill, care and diligence in the selection and the appointment of any third party to whom it wants to delegate parts of its tasks."
In addition, the depositary must ensure that the delegate safekeeping agent meets a range of specific conditions while it continues to carry out safekeeping functions on the depositary’s behalf.
UCITS V requires that the prospectus for a UCITS must contain a description of any safekeeping functions delegated by the depositary, the list of delegates and sub-delegates and any conflicts of interest that may arise from such a delegation. This provision corresponds with an investor disclosure requirement contained in AIFMD. However, in AIFMD it is only stipulated that this information must be provided to investors, not that it must specifically be contained in the prospectus. This prospectus disclosure requirement could present significant practical and operational challenges.
1.4 Depositary oversight function relating to cash
The UCITS regime already provides for oversight functions that must be discharged by the depositary and cannot be delegated to a third party. These include ensuring that the sale, redemption and cancellation of units in a UCITS are carried out in accordance with applicable national rules and the fund rules or instruments of incorporation.
UCITS V introduces a new depositary oversight function relating to cash. This requires that the depositary shall properly monitor the cash flows of the UCITS and ensure subscription monies are properly received by the UCITS. Additionally, the depositary shall ensure that all cash is properly booked in accounts opened with eligible banks in the name of the UCITS, the management company of the UCITS acting on its behalf or in the name of the depositary acting on its behalf. Where assets are held in the name of the depositary acting on the UCITS behalf, they must be held in an account separate to that of its own cash.
This replicates a cash monitoring obligation on depositaries contained in AIFMD.
UCITS V introduces a requirement that UCITS management companies put in place remuneration policies and practices for senior management and persons whose professional activities have a material impact on the risk profile of the management company or the UCITS. Such policies and practices must be consistent with and promote sound and effective risk management and discourage disproportionate risk taking by the UCITS.
The remuneration policy requirements broadly replicate the corresponding provisions in AIFMD.
Certain disclosure will be required to be made in the UCITS annual report in relation to fixed and variable remuneration paid by the management company / self-managed UCITS to its staff.
A point to note is that UCITS V does not stipulate that the remuneration requirements will apply to delegates carrying out investment management functions. However, Recital (2) of UCITS V states that the remuneration policies and practices "should apply, in a proportionate manner, to any third party which takes investment decisions that affect the risk profile of the UCITS because of functions which have been delegated…" It also indicates that ESMA shall draw up guidelines to support its remuneration requirements and that such guidelines should, where appropriate, "be aligned, to the extent possible" with the ESMA AIFMD remuneration guidelines. We can therefore expect such guidelines to take a similar approach to the ESMA AIFMD remuneration guidelines in terms of application of scope to delegates performing portfolio management or risk management activities.
Further information on these new manager remuneration rules can be found in our paper entitled "Remuneration rules under AIFMD and UCITS V – key elements" which is available on request.
UCITS V imposes administrative sanctions with maximum penalties of €5 million (or 10% of annual turnover) for a company or €5 million for individuals. The use of criminal sanctions is also captured so as to ensure a harmonised approach across Member States. Under AIFMD, Member States are to lay down the rules on measures and penalties applicable to infringements of the directive.
These measures expand on the broad principles in UCITS IV. While these provisions are in line with the sentiments in AIFMD, in relation to enhancing the powers of national competent authorities, they do not correspond in terms of substantive details.
By now, the key elements considered above are all quite familiar in an AIFMD context. UCITS V proposes to mark the introduction of corresponding measures in a UCITS context. To that end, it will effectively level the playing field between non-UCITS European funds (under AIFMD) and UCITS and avoid a situation where sophisticated investor funds are subject to a more onerous regulatory regime than retail investor funds. Nevertheless, the changes that existing UCITS will need to make in order to comply with the new measures will present the industry with significant challenges.
Time will tell whether UCITS V will achieve the stated aims of the European Commission to increase investor protection, enhance transparency on remuneration and foster investor confidence necessary for the continued relevance of the UCITS retail brand.
UCITS V is an amending directive and needs to be read in conjunction with the main UCITS Directive (2009/65/EC). To obtain a copy of the main UCITS Directive directly annotated by Maples to reflect and highlight the UCITS V changes, please contact your usual Maples and Calder contact.
APPENDIX I - UCITS V
Impact Assessment and AIFMD Gap Analysis
|Provision||UCITS IV||UCITS V||AIFMD/UCITS V Gap Analysis|
Certain criteria at EU level (depositary required to be subject to prudential regulation and ongoing supervision) – Member State discretion beyond this.
|Three categories |
(i) national central
banks; (ii) EU authorised
credit institutions; or (iii)
other legal entities which
have their registered office
or a branch in the UCITS'
home Member State and which are subject to specified prudential supervision and capital adequacy requirements. Grandfathering period to adapt.
|Corresponds broadly with AIFMD.|
|Depositary liability||Unjustifiable failure to perform.||Liable for loss of financial instruments held in custody other than due to an external event. Also liable for any losses due to negligent or intentional failure to perform duties.||Liability standards replicate AIFMD (but omit certain specific provisions regarding liability where a third party safekeeping agent is appointed).|
|Depositary delegation||No prescribed rules on New conditions for appointing a third party safekeeping agent.||New conditions for appointing a third party safekeeping agent.||UCITS V conditions broadly correspond with AIFMD. There is a new requirement on depositary or EU third party delegate insolvency not contained in AIFMD.|
|Depositary delegation||No prescribed rules on investor disclosure regarding third party safekeeping agents appointed.||Delegation arrangements and identity of delegates to be disclosed in fund prospectus.||UCITS V requirements correspond with an AIFMD provision, but AIFMD only required investor disclosure, not specifically prospectus disclosure.|
|Depositary cash |
|Not addressed in UCITS IV.||Cash flow monitoring obligations set out.||UCITS V requirements correspond with AIFMD.|
|Remuneration policy||Not addressed in UCITS IV.||Requirement for UCITS management companies and self-managed UCITS to put in place remuneration policies and practices.||UCITS V requirements correspond broadly with AIFMD.|
|Regulation sanctions||Broad, high level measures addressed in UCITS IV.||UCITS V imposes administrative sanctions. The use of criminal sanctions is also captured so as to ensure a harmonised approach across Member States.||Similar themes of increased powers of investigation and sanctioning powers in AIFMD, but provisions not aligned with UCITS V in terms of substantive details.|