With less than three weeks and the effective date for the UCITS V Directive edging closer, it might be a good time to brush up on what it means and the changes it is going to bring.
“UCITS” or “undertakings for the collective investment in transferable securities” are investment funds regulated at European Union level. They account for around 75% of all collective investments by small investors in Europe. The legislative instrument covering these funds is Directive 2014/91/EU, better known as “UCITS V”.
The first Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive was adopted in 1985 and since it has been revised several times. However, the rules on depositaries remained more or less the same, which created ambiguity in respect of how national rules should interpret a depositary’s duties and liability and thus to an uneven playing field in different jurisdictions. Therefore investors faced uneven levels of protection, which became apparent during the financial crisis. This together with other weaknesses in its then current form of the regulatory framework led the Commission to review the situation and propose alongside other regulatory initiatives an amendment of the UCITS directive in the form of UCITS V.
For those that are not so familiar with UCITS and the role of UCITS depositaries in particular, the Commission provides a brief summary wherein it explains that a UCITS depositary is an entity that is independent from the UCITS fund and the UCITS fund’s investment manager. Neither the fund manager nor any prime brokers that act as so-called ‘counterparties’ to a fund may also act as the fund’s depositary. The independence of a depositary is necessary because the depositary essentially acts both as a supervisor (the ‘legal conscience’) of a UCITS fund, overseeing certain fund transactions (redemptions and investor payments to the fund) and as a custodian over the fund’s assets.
In addition, a depositary retains for safekeeping the assets in which a UCITS invests and thus maintains the UCITS’ and its investors’ property interests. While the safekeeping of investors’ assets is a core task of the depositary, the depositary also performs certain oversight functions. These functions include:
- verifying that a UCITS fund’s sales, repurchase and redemption of units or shares is carried out in accordance with applicable laws,
- verifying that the net asset value of units is calculated in line with national laws and fund rules, and
- ensuring that transactions of the fund manager comply with all applicable laws and that transactions involving the fund’s assets are carried out within the customary time periods.
The importance of depositaries for investors stems from the fact that while the fund manager makes investment decisions for the fund, the third-party depositary is in charge of holding the fund’s assets in custody on behalf of investors. The assets of the UCITS are segregated from the assets of both the depositary and the manager. Therefore, the UCITS assets are protected in case of a default by the manager or the depositary. This is a crucial pillar of investor protection in the UCITS framework. According to the Commission, in February 2014 total assets of UCITS amounted to €6.8 trillion, which represents a major part of the wider European investment market. Roughly 85% of the European investment fund sector’s assets are managed within funds governed by the UCITS framework. Proper safekeeping of UCITS assets is therefore of great importance for UCITS investors in Europe, as well as for investors in third countries.
The new rules aim to further strengthen the interests of the investor by emphasising the independence of depositaries as UCITS in the future will need to appoint a single depositary among a list of eligible entities (central banks, credit institutions and certain other legal entities) that have to be in the same country.
Together with the changes to the depositaries duties and liabilities, UCITS also makes amendments with regard to remuneration and introduces administrative sanctions, aligning the UCITS regime with the provisions on depositaries in the Alternative Investment Fund Managers Directive (AIFMD). The obligations under UCITS V in respect of remuneration apply to the management body of UCITS, which is required to establish and apply remuneration policies and practices to prevent conflicts of interest and discourage risk-taking inconsistent with the risk profile of the managed UCITS. These policies and practices must also apply to senior managers, 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 UCITS.
The catalogue of sanctions introduced by UCITS V ranges from public statements to suspension or withdrawal of the Management Company authorisation and maximum administrative pecuniary sanctions in case of a legal person of at least €5,000,000 or 10 % of the total annual turnover of the legal person.
UCITS V will become effective on 18th March 2016 and further information on the new rules such as the full text of the Directive and related documents can be found here on the Commission’s website.