The European Commission (EC) has today published its proposed amendments to the current UCITS rules covering the tasks and liabilities of all depositaries acting on behalf of a UCITS fund. The draft directive aims to clarify and to harmonize the level of investor protection in the EU following the financial crisis and more specifically the Madoff case, through the alignment of tasks and responsibilities that are expected from the depositaries of UCITS.
The Association of the Luxembourg Fund Industry (ALFI) said it welcomed the general thrust of the proposed text, adding that an optimum and uniform standard of investor protection across European Member States is important for European UCITS funds to remain a success story for EU retail investors. However, it said open questions remain with regard to the overall level of liability that can reasonably be expected from depositaries.
On the depositary liability regime, the proposal clarifies that a strict liability standard applies to the depositary in cases of loss suffered by UCITS as a result of a depositary’s negligent or intentional failure to perform its duties or in the case of the loss of financial instruments held in custody. The depositary will in these cases be obliged to return financial instruments of an identical type or of a corresponding amount to the UCITS. It is proposed that the same level of liability will apply to the depositary where custody of financial instruments has been delegated to a sub-custodian. The EC suggests that the depositary should carry the burden of proof that it has complied with its obligations in a situation where failure to perform its duties is suspected.
The draft proposes the following amendments:- Eligibility required to be able to act as a depositary: the impact assessment has concluded that credit institutions and regulated investment firms provide sufficient guarantees in terms of prudential regulation, capital requirements and effective supervision to act as UCITS depositaries;
– Delegation of custody: the impact assessment has concluded that the delegation of custody should be governed by rules on diligence in selecting and appointing a sub-custodian, as well as the ongoing monitoring of the activities of the sub-custodian;
– Liability for depositaries; a strict liability is considered appropriate and an obligation is placed on depositaries to return instruments lost in custody irrespective of fault or negligence and will, in the Commissions view, ensure a high level of investor protection and achieve a uniform standard across the EU;
– UCITS managers remuneration: the Commission are looking to introduce a requirement for a UCITS management company to implement a remuneration policy that is consistent with sound risk management of the UCITS fund and complies with minimum remuneration principles. The UCITS management company would also be required to disclose the amount of remuneration for the financial year with appropriate detail in the annual report of the UCITS fund; and
– Sanctions for breaches of UCITS obligations: the Commission identified inconsistencies in three areas: (1) differences in the amounts of fines applied to the same categories of breaches; (2) different criteria was applied in determining the amount of administrative sanctions; and (3) variations in the level of the use of sanctions.
AlFI said that although the law regarding the depositary regime in Luxembourg is fully in line with current EU directives, it welcomes these new regulations that aim to further harmonize the depositarys liabilities throughout the EU. However, ALFI hopes that the final Level 1 provisions will strike the right equilibrium of obligations and rights between all stakeholders of the investment fund value chain, including the end investors.
Open questions remain, especially with regard to the overall level of liability that can reasonably be expected from depositaries. Should depositaries cover all categories of risk, including e.g. insolvency and fraud? ALFI believes that if depositaries are held liable for investment losses in all circumstances, they become insurers for risks beyond their control. It is feared that such additional investor protection measures, close to an absolute protection under a strict liability regime, will come with a cost that is likely to be ultimately borne by the end investor. Besides, there may be a moral hazard associated with investors believing their investment is risk-free.
Equally, if depositaries need to provide full coverage, and duties and liabilities are thus no longer shared by all participants in the UCITS value chain, ALFI points out that this concentration of risk in a small group of depositaries may result in increased systemic risk.ALFI said the final text of the directive therefore should take into account the need to balance risk and reward, as well as asset and investor protection and cost-efficiency within a sustainable industry framework.
Camille Thommes, director general of ALFI, said: Detailed discussions are still needed in order to ensure that the UCITS V directive does further strengthen the development of the European UCITS brand, also with regards to the provisions on the remuneration of UCITS managers and the sanctions regime. Overall, ALFI is confident that the final directive will help determine the most appropriate rules for funds and fund depositaries whose activity is essential for the development of long-term savings in Europe and worldwide. It is ALFIs strong intention to contribute constructively towards the discussions leading up to the final text.
The draft directive will now be discussed by the 27 member states until a compromise text can be submitted to the Council and Parliament. It is likely that this procedure will be completed under the current EC Presidency.
(JDC)