EFAMA comments to the Commission consultation on
the UCITS Depositary Function
EFAMA 1 welcomes the Commission’s Consultation on the UCITS Depositary Function
issued on 3 July 2009. Indeed, this Consultation is a logical step in the Commission‟s
intention to undertaking a comprehensive review of requirements that are applicable to the
function of a UCITS depositary. EFAMA congratulates the Commission services for this
consistent document dealing with all aspects of the UCITS depositary function.
However, we are extremely concerned about the scope of this Consultation: Nearly all
issues raised in the Consultation Paper are also relevant for the depositary of alternative
investment funds in the meaning of the AIFM Directive proposal 2 while the Consultation
seems to take for granted that the proposals made in Articles 17 and 38 of the AIFM Directive
will be adopted. We believe the normal and at least more prudent approach would have been
to carry out this Consultation before drafting the corresponding AIFM Directive articles and
to include the depositary function in respect of AIF‟s within the scope of the Consultation.
Instead – at the end – the Commission will need to bring together the conclusions of this
Consultation with the rules regarding depositaries in the AIFM Directive. We are concerned
that this cannot be achieved in a consistent manner, given that Council and European
Parliament are already discussing this proposal. Rather than the legal framework of the fund,
the type of asset class is decisive when it comes to defining functions, duties, and liabilities
for safe keeping and supervision.
Secondly, EFAMA deeply regrets that this Consultation was launched by the Commission
without giving any information about the findings of the investigation commissioned to CESR
end of January this year. Indeed, when considering changes to a current European regulatory
regime, it is fundamental to know how it has been implemented in Member States, how it
operates, how it is enforced and where possible problems are. CESR‟s review should be
completed before changes to the current depositary regime can seriously be discussed!
A final more general comment concerns the broader regulatory environment: In reading the
Consultation Paper, it is becoming evident that the Commission‟s 2004 Communication on
Depositaries, the lessons learned from the Madoff Affair (currently under review of CESR/
Commission), the already mentioned AIMF proposal, the proposal for modifying the 1997
Investor Compensation Schemes Directive 3, the planned legislation on Legal Certainty of
1
EFAMA is the representative association for the European investment management industry. It
represents through its 26 member associations and 44 corporate members approximately EUR 11
trillion in assets under management of which EUR 6.1 trillion was managed by approximately 53,000
funds by the end of 2008. Just over 37,000 of these funds were UCITS funds. For more information
about EFAMA, please visit www.efama.org.
2
COM(2009) 207 of 30. 04. 2009
3
Directive 1997/9/EC – Call for evidence
18 Square de Meeûs B-1050 Bruxelles
+32 2 513 39 69 Fax +32 2 513 26 43 e-mail : info@efama.org www.efama.org
2
Commission Consultation on the UCITS Depositary Function
Securities Holdings 4 and this Consultation must be seen and addressed together. Indeed, in
particular the last issue might affect fundamental concepts of property rights, holdings and
dispositions on the securities‟ asset class; EFAMA might come back on this issue later in a
separate paper. We are not sure that this broader regulatory aspect is taken into account by the
Commission services. In any case, these broader implications have not been considered in the
context of the AIFM proposal.
Finally, based on experience to date with regard to the depositary issue concerning both the
UCITS Directive and the draft AIFM Directive, EFAMA would very much welcome clearer
procedures and more openness as to next steps envisaged by the Commission.
DETAILED COMMENTS ON THE COM CONSULTATION DOCUMENT
INTRODUCTION
The Commission‟s introduction raises a number of highly important issues which require
some comments:
“From the investors‟ perspective, the market risk associated with their UCITS investment is
the only acceptable risk they should have to bear”
This statement raises at least two questions: What is market risk? And where is this said?
That investors have to bear only market risk (the risk that the value of an investment will
decrease due to moves in market factors) is simply wrong; UCITS prospectuses often include
more than 30 different risks. The 1985 UCITS Directive is silent regarding this issue.
For CESR Market risk means:
“the risk of fluctuation in the market value of a position attributable to changes in market
variables, such as interest rates, foreign exchange rates, equity and commodity prices and
issuers’ creditworthiness 5.
Recent market events have brought into focus that investors also bear many other risks,
among them:
Liquidity risk was on the top of the agenda some months ago when redemption of
certain funds (deemed to be liquid) had to be stopped due to assets which became
illiquid;
4
COM Consultation Paper: Legislation on Legal Certainty of Securities Holdings and Dispositions
[G2/PP D (2009)]
5
Section IV, CESR technical advice to the European Commission, on the implementing measures on risk
management [Article 51 (4)(a) of the UCITS Directive] - Definitions
3
Commission Consultation on the UCITS Depositary Function
Counterparty risk became an issue for certain funds invested in certain OTC
derivatives - therefore now the discussion about CCPs (Central Counterparties);
Operational risk, in particular when investing in certain emerging markets which are
less developed for example regarding settlement and/ or recognition of ownership
rights regarding securities; then these issues are becoming regional market risk.
Already these few examples demonstrate that investors bear a significant number of risks
depending on markets where the fund is invested and/ or the types of assets. Indeed, it is not
the purpose of the UCITS regime to insulate investors from risks that are inherent in the
investment process.
“More recently the Madoff fraud and the Lehman default have revealed the existence of
new forms of risk associated with the depositary function”
EFAMA fundamentally disagrees with this statement. The two affairs – even if they are very
different from each other 6- have not revealed any new forms of risk associated with the
depositary function. Both, the risk of fraud and the counterparty risk were always present and
should be understood by all parties involved, including investors. They should have been
taken into account by depositaries, asset managers, administrators, accountancy firms, legal
advisers and regulatory authorities alike. Indeed, there are many depositaries whose policies
and procedures were designed not to allow the ongoing appointment of a Madoff or a Lehman
as sub-custodians.
“... the Madoff fraud and the Lehman default have underlined the lack of a level playing
field in the protection offered to UCITS investors across Europe”
Both, CESR and the Commission were asked to analyse what really happened regarding
investor protection and in how far investors are “treated” differently in the various
jurisdictions 7. We deeply regret that the Consultation document does not give any
information regarding the findings of the investigations. In May the Commission had
announced that the “outcome of this review by CESR is now known” without revealing any of
the detailed findings. The Financial Times reported on 24 August that CESR has abandoned
its mapping undertaking without concluding it .
From our point of view it does not make sense to start modifying the rules for the depositary
laid down in the UCITS Directive with the argument that their differing implementation in
member States leads to an unlevelled playing field in terms of investor protection without
being able to show any evidence for this argument. EFAMA therefore believes that it is
critical to know the outcome of the Commission‟s research in this respect and CESR‟s
mapping exercise before any changes to the current UCITS requirements are considered.
However, already in its 2004 Communication on UCITS depositaries 8 the Commission
stated that there are a number of key policy issues which must be addressed. The Commission
6
Lehman is a bankruptcy case meaning that properly segregated assets should normally be identified and
restituted, although not immediately. Madoff is a fraud where the assets never really existed.
7
Indeed, the Commission should check the legal side while CESR should check the practical
implications for supervisors
8
COM(2004) 207 final
4
Commission Consultation on the UCITS Depositary Function
particularly highlighted the diversity of legal regimes across the EU and the sometimes
uncertain limits of the depositary‟s liability and concluded:”retail investors actually bear a
risk (and costs) which are a priori hidden to them. Against these findings, the Commission
proposed four fields for action. However, in its impact assessment attached to the November
2006 White Paper on enhancing the Single Market framework for investment funds, the
Commission concluded that whilst a modification of the UCITS Directive regarding
depositaries would be useful, the feasibility was considered to be “doubtful”.
Both, the Madoff affair and the Lehman default are the wrong anchors for this discussion.
Two competent authorities (the French and the Luxembourg) declared that there was
“improper performance” at the level of management companies/ depositaries; in both cases
the concerned parties did not accept the findings of the authorities. In both cases courts are
now dealing with the issue and we must wait for the outcome. The apparent difference in
treatment of investors put forward by one jurisdiction has – at this stage - nothing to do with
the UCITS Directive but with national administrative law.
“Under the proposed AIFM Directive, AIF depositary liabilities have been strengthened to
include an inversion of the burden of proof ....”
If this was the only intention in changing the wording of Articles 9 and 16 of the UCITS
Directive, why was in Article 17(5) AIFM proposal the term “unjustifiable” dropped? As a
matter of consistency, the Commission should – even if introducing an inversion of the
burden of proof – as far as possible stick to the wording in the UCITS Directive.
If the wording remains as it is, the clear impression is given that the Commission did not only
want an inversion of the burden of proof but also a stricter liability regime.
“... with the view to increasing the level of investor protection of the UCITS investors at
least to the level of protection offered to professional investors”
With this statement, the Commission behaves as if the AIFM Directive proposal is already
adopted which is not acceptable. The benchmark is still the UCITS regulation and only this
Consultation will show what needs to be changed.
Regarding the AIFM proposal, it is questionable whether it is right to increase protection of
professional investors compared to the protection mechanism in the UCITS Directive. This
question needs still to be answered.
Regarding the UCITS retail investor, the first question should be whether and if yes, to what
extent the admittedly already well protected investors are in need of further protection.
Regarding this question, the Commission could, of course, refer to the findings in the already
mentioned 2004 Communication. Arguing with the Madoff fraud and the Lehman default
does not work as explained above.
“The Consultation also covers ..... (other) issues of particular relevance for ensuring an
increased level of investor protection ... for example valuation”.
5
Commission Consultation on the UCITS Depositary Function
There is no evidence that the current valuation mechanism does not work; at least, we are not
aware of any problems with UCITS NAV calculation.
Finally, before going into the details, we would like to underline that we have in Europe under
the UCITS Directive two legal structures for funds: contractual type funds (including unit
trusts) and corporate type funds. This means that any reference made in these EFAMA
comments to the “management company”, should also be understood as encompassing the
“management/ board of a self-managed corporate type fund”. Important in the context of this
consultation is to be aware that the functions of the depositary are different, depending on the
legal structure of the fund (for example regarding NAV calculation).
DEPOSITARY’S DUTIES
Since the Commission started to work on modifying the rules for the UCITS depositary,
EFAMA emphasised that it would be helpful to clarify the depositary‟s functions and
operational standards regarding both safe-keeping and supervision of the management
company.
In this context, it is important to clearly distinguish between functions (ie defining their role)
and operational standards (ie defining how they should perform their role) which are dealt
with at Questions 1 and 2 and legal duties and liability which are dealt with at Questions 13
and 14. We believe that there needs to be a common understanding in the EU as to what a
depositary is meant to be doing – its functions. and Once the functions have been identified
and agreed they should be set out in an Annex to the Directive in the same way as it is done
for the functions of a management company in the current Annex II to the Directive. We also
believe that operational standards should be clarified. In relation to custody, by far most
EFAMA members are of the opinion that Articles 13(7) and 13(8) of the MiFID Directive 9
and Articles 16 – 19 of the corresponding implementation Directive 10 could be a starting
point even if they are not fully applicable.
11
Safe-keeping functions
Most importantly, a common understanding is needed on what is understood by “assets”. One
could – for example – argue whether an OTC contract is an asset and, if so, what kind of asset
On the other hand, if one takes the UCITS concept as whole, one could argue with the
accountants that contracts are assets (receivables). For clarity in this EFAMA paper all
financial instruments including derivatives contract will be considered as assets.
9
Directive 2004/39/EC of 21 April 2004
10
COM Directive 2006/73/EC of 10 August 2006
11
The Commission speaks about „duties‟
6
Commission Consultation on the UCITS Depositary Function
Questions 1 & 2
Do you agree that the safe-keeping (and administration) duties of depositaries should be
clarified?
Do you agree these duties should be clarified for each class of assets eligible to the UCITS
portfolio?
We agree that clarification of what safe-keeping means is crucial. Indeed, without knowing
exactly what safe-keeping means, it is impossible to clarify the safe-keeping functions. This
again is conditio sine qua non for defining the corresponding duties and liabilities. This is true
for UCITS but also for non-UCITS and from our point of view the key issue is the protection
of the financial situation of any investor.
If this is right, the approach taken by the AIFM Directive proposal (simply differentiating
between “safekeeping of financial instruments” and “verification of the ownership of all other
assets”) is far too unclear to differentiate meaningfully; for example, OTC or listed derivative
contracts are, according to the MiFID definition, financial instruments. However, it is
impossible to safe-keep a derivative contract but the execution of the contract can be
monitored
This is why most EFAMA members are of the opinion that depositaries‟ functions relating to
the safe-keeping of funds‟ assets should be defined separately for each class of assets eligible
for being held in a UCITS portfolio even if this might be difficult (for example: what is real
estate? 12). Furthermore the way those assets are held should also be taken into account.
If a depositary is to hold assets it can only do so in the way those assets can legally be held
under the law of the relevant jurisdiction. The way assets are held is fundamentally affected
by where the assets are located and the intermediaries in the custody chain. For a Japanese
equity for example, ownership rights will be recognised at the Japanese CSD. The depositary
should hold ultimately the Japanese equity in an account at the CSD. He is therefore using a
chain of intermediaries (sub custodians). Other securities, such as units of investment funds
(UCITS) are very often not held by a CSD but by a registrar. The depositary of a UCITS
investing in such fund has to register the fund‟s assets in that registrar. In the case of the
Japanese equity, the CSD and the chain of intermediaries are all regulated entities and the
depositary has in most cases been able to choose its sub custodian and is performing due
diligence on its providers. Contrary to the CSD, a registrar is not a regulated entity and has
been chosen by the fund. There is no choice for the depositary; he has to use this entity in
order to ensure recognition of the ownership of its client asset.
Against this background we could - as starting point for the discussion and being aware that
this is a very complex issue that will require extensive consultation of all parties involved –
distinguish between the following four categories of assets:
Cash
12
In this context we would like to recall the extensive work undertaken by the Open Ended Real Estate
Funds (OEREF) Expert Group set up by the Commission in 2007 and to the Expert group report
published on 13 March 2008
7
Commission Consultation on the UCITS Depositary Function
Securities ultimately held at a CSD, ICSD or CCP (most equity and bonds
worldwide)
Any other financial instruments (including units of funds, all derivatives contracts
listed and OTC); these assets normally are “held” by counterparties selected by the
management company and typically governed by bilateral agreements, which do
not include the depositary, assets transferred to a third party on the decision of the
management company)
Any other assets (real estate, art, commodities …)
The depositary‟s functions for each of these asset classes could then be defined as follows
Financial instrument Description of functions
Cash Deposit function
The depositary holds the cash account of the fund in its book
Asset managers may also be requested by fund rules or law to
deposit cash in other institutions, depositary will process the
cash movements according to the asset manager instructions
Securities ultimately held in a CSD/ Custody function
ICSD
The depositary holds the assets in its books, trough segregated
accounts in the name of the fund
In case of recourse to a sub-custodian, the depositary must
perform appropriate due diligence and periodic reviews
The depositary carries out the instructions of the management
company and process all corporate actions
Other financial instruments Position keeping function
The depositary maintains an inventory of positions held by the
fund in these various instruments
The depositary checks the ownership of the contracts
The depositary‟s duties are performed on basis of information
received from the management company or the relevant third
party (e.g. registrar of the issuer).
Other assets Supervisory function
The depositary verifies the ownership of the assets
Depositary‟s duties are performed on basis of information
received from the management company
From our point of view when speaking – as in the AIFM proposal - about verification of the
ownership/ creditor ship of all other assets in accordance with general market practice the
depositary‟s responsibility should stand for seeking confirmation that a transaction took place
as expected and that relevant legal documentation have been provided that the transaction has
been effectively completed. It should not mean to perform a physical control to ensure the
8
Commission Consultation on the UCITS Depositary Function
existence of a real estate asset for example but it should include the obligation of the
depositary to periodically verify that the issuer books reflect correctly the proprietary rights of
the UCITS regarding these assets.
As also UCITS can make use of derivatives,, they often make use of prime brokers instead of
OTC counterparties or other service providers to benefit of their superior margining and
reporting technology. Therefore - when speaking of safe-keeping - many EFAMA members
are of the opinion that the tri-lateral relationship of management company, depositary and
prime broker (or equivalent), which are often complex, needs to be clarified.
In this context, most EFAMA members are of the opinion that contractual relationships as
regards stock-lending and repo arrangements also need to be clarified, in particular with
respect to collaterals.
Question 3
Are there any other appropriate approaches?
We believe that the above described approach is the right one. Depositaries are an essential
pillar for investor protection due to their twofold function: safekeeping of the fund assets but
also control of the fund NAV and asset management decisions with regards to the fund.
The issue is ensuring that depositaries are in position to perform their duties and bear their
responsibilities (adequate expertise, IT, financial strength…). The challenge is to define a
level of responsibilities that provides sufficient comfort in terms of the high level of investor
protection promoted by the UCITS Directive while being possible to implement at a
reasonable costs and without limiting fund managers – and indirectly investors - in terms of
products or investment strategies.
By far most EFAMA members believe such balance can only be achieved if the depositary‟s
safekeeping role with regards to the assets of the fund and the related level of regulatory
responsibilities is defined by asset classes. As said above, Articles 13(7) and 13(8) of the
MiFID Directive and Articles 16 – 19 of the corresponding implementation Directive could be
a starting point even if they are not fully applicable.
Question 4
Do you agree to a common horizontal and functional approach of the custody duties on the
listed financial instruments, to be applied to UCITS depositaries?
The Consultation paper does not define a “common horizontal and functional approach”.
From our point of view, a common approach across jurisdictions and all types of funds
(UCITS and non-UCITS) would enhance transparency and reduce uncertainties. However,
this would mean applying findings and conclusions of this Consultation consistently to the
currently discussed AIFM Directive.
9
Commission Consultation on the UCITS Depositary Function
However, as explained above, the sole distinction between listed financial instruments and
other eligible asset is not appropriate as it does not fully recognise the different ways of
holding assets in the industry. Moreover listed instruments include derivatives contracts
which cannot be held in custody as other type of securities.
Question 5
Is there some specificity that may be applicable to the custody functions of a UCITS
depositary that should be taken into account?
We do not see any specificity that may be applicable to the custody functions of a UCITS
depositary. Specificities only exist at the level of asset classes and local civil and
administrative law.
Supervisory duties
EFAMA always emphasised that the fund manager‟s supervision by the depositary as laid
down in Article 22(3) 13 was a crucial pillar regarding investor protection and crucial for the
UCITS quality label. In fact this makes the most important difference between UCITS and
nearly all other funds worldwide. Moreover, as the past 20 years have shown, this oversight
works pretty well.
Question 6
Do you agree that the existing supervisory duties of the UCITS depositary should be
clarified?
As long ago as 2002 EFAMA expressed to the Commission 14 that the practical applications
of the control function of the depositary are described very differently from one Member
State to another. Some Member States provide relatively general descriptions of monitoring
obligations, mainly by copying the Directive text. Others are far more detailed in their
provisions. However, it is difficult to say whether these different approaches (for example
regarding the rules for NAV calculation/ control) have any material impact. Also, it should be
noted that the Commission in its 2004 Communication did not mention any material problem.
Therefore, whilst a clearer description and more harmonisation might be helpful, it is difficult
to assess how essential this is for increasing investor protection. However, in the context of
question 29 (a possible EU passport for depositaries) such harmonisation would of course be
necessary.
13
Article 22 (3) of the UCITS Directive stipulates that a "Depositary shall:
- ensure that the sale, issue, re-purchase, redemption and cancellation of units effected on behalf of a common
fund or by a management company are carried out in accordance with the law and the fund rules;
- ensure that the value of units is calculated in accordance with the law and the fund rules;
- carry out the instructions of the management company, unless they conflict with the law or the fund rules;
- ensure that in transactions involving a common fund's assets any consideration is remitted to it within the
usual time limits;
- ensure that a common fund's income is applied in accordance with the law and the fund rules."
14
In the context of the public consultation launched by the Commission in 2002
10
Commission Consultation on the UCITS Depositary Function
Notwithstanding this in general cautious position, the example mentioned by the Commission
regarding NAV calculations shows that in some – precise cases – clarification might be
necessary. Indeed, EFAMA is of the opinion that the depositary should not be required to
recalculate NAV, but he should ensure that the appropriate processes and procedures are in
place and enforced to perform a correct calculation. A full recalculation only results in
additional costs. This does, of course, not cause any change regarding the depositary‟s
liability regarding NAV calculation, where applicable.
More generally we would like to highlight that depositaries‟ supervisory duties are in all cases
carried out in addition to controls performed by the management company itself. As clearly
described in the Directive, the management company has to implement a number of controls
regarding notably the risk management policy, the conflicts of interest and day-to-day
operational processes. Supervisory duties performed by the depositary can be defined as
“independent controls” that implies that these controls should not consist in replicating
operations executed by the management company or its service providers, but should rather
correspond to tests controls.
Questions 7 & 8
If so, what clarification do you suggest?
To what extent does the list of supervisory duties need to be extended?
The supervisory duties, as described in Article 22(3), mix-up tasks referring to compliance
controls with those referring to the sake-keeping function. Clarification would be helpful.
Most EFAMA members are of the opinion that “supervisory duties” are limited to
compliance controls, the other “controls” (4th & 5th indent) are part of the safe-keeping
function itself.
If more detailed guidance in respect of supervision is to be prescribed, we recommend
adhering to the general principle that the depositary has suitable record keeping
arrangements in place in order to be sure of the location of the assets of the fund. In this
connection, the depositary would be expected to undertake an ongoing supervisory
responsibility with a view to protecting the interests of investors in such assets. The manner
in which this responsibility is to be undertaken will depend on the nature and legal
characteristics inherent in each asset type, however, the depositary is expected to demonstrate
it has undertaken due care to determine how it may reasonably undertake this responsibility.
In particular, we believe that the depositary should be in charge of attesting the inventory of
assets and reconciling the actual assets with the accounting statements. Depositaries‟
supervisory obligations should include checking that the fund‟s subscription rules are
complied with.
To support the depositary in carrying out its supervisory responsibilities, the management
company or the governing body of the fund (such as a Board) should be responsible for
providing all information the depositary might require and for otherwise cooperating to the
fullest extent.
11
Commission Consultation on the UCITS Depositary Function
Question 9
Do you agree that the 'only one depositary' requirement should be clarified?
As far as we know, the “single depositary principle” meaning that a UCITS can only have one
depositary, is applied in all Member States. Any other solution would – from our point of
view – only lead to complications and a lower level of investor protection. We suppose that
the number of funds still falling under the exception of Article 55 (old) / 113 (2) (new) UCITS
Directive are rather limited. However, this principle should be clarified with respect to the
role of prime brokers and derivative clearers.
RESPONSIBILITY REGIME
We agree with the Commission services that clarification regarding the responsibility regime
is necessary. However, the Commission must be aware that any decision of national
authorities can be challenged by courts which will apply local civil or administrative law
simply because there is neither a European law of obligation nor any European administrative
law. This means there will always be differences on this level.
Identification of the associated risks
Questions 10 & 11
Do you think that the risks related to improper performance have been correctly identified?
Do you foresee other situations where a risk associated with improper performance of the
depositary duties might materialize?
As explained under question 1 & 2, this question can only fully be answered once the
functions are clarified.
However, as a preliminary answer, we would like to underline that the situation is far more
complex than described in the Consultation Paper and that some comments are needed which
can of course at this stage only be very high level. The issues involved require much more
detailed work:
Loss of assets in case of sub delegation
To be able to properly identify the assets of the UCITS, they are segregated in a
specific account at depositary level. This requirement, which is fundamental in interest
of investor protection, is also applied by all other actors in the chain. They also
12
Commission Consultation on the UCITS Depositary Function
segregate their third party clients‟ assets from their own assets. Segregating the
UCITS‟ assets further in separate omnibus accounts for funds through the entire
value chain would not provide significant additional protection 15 but would be very
costly if at all possible.
In this context, it should be underlined that – as far as we know - it is customary for
custodians to exclude liability in relation to clearing and settlement systems over
which the custodian has no choice or control in their selection (e.g. Euroclear).
Loss of assets in case of insolvency of the sub custodian
As mentioned above, insolvency law may or may not provide that segregated third
party clients‟ assets are not included in the liquidation trust. If they are part of the
liquidation trust, the UCITS will be treated as any other debtor of the sub custodian
and might lose the assets held through this sub-custodian. If the assets are not part of
the liquidation trust, the UCITS will recover its assets as soon as the liquidator has
identified the various ownerships. The UCITS has therefore not lost its assets but those
assets are “immobilised” for a certain time and the UCITS cannot dispose of them.
Improper performance on safe-keeping of other asset
For derivatives contracts and other non financial assets the depositary fully relies on
the asset manager‟s information to be able to perform its duties. On those assets, the
depositary cannot identify the assets if the asset manager (or a third party, issuer or
registrar) does not provide the necessary information. In this case, improper
performance of the depositary must be understood as failure to hold an asset inventory
although the asset manager or a third party has provided the required information.
Improper performance of supervisory duties
While we agree with the Commission that one of the predominant risks regarding
improper performance of the supervisory duties is mis-valuation of the fund, it must be
underlined that in most jurisdictions 16 NAV calculations falls in first line under the
asset manager‟s responsibility who can delegate it to other service providers 17.
However, apart from the risk of NAV miscalculation, there are other risks associated
with improper performance of the depositary‟s supervisory duties, which must not be
underestimated such as the risk that might arise from the processing of corporate
actions or risks linked with the depositary‟s duties regarding investments in funds that
the depositary cannot safe-keep and for which the UCITS is registered in the book of
the registrar of the target fund, namely the need of periodic verification of the book of
this registrar in order to ensure that the position does actually exist. In such case, the
main risk is to “lose the position of such assets” if the position is not correctly
reflected in the name of the UCITS in the book of the registrar.
15
See also footnote 19
16
Exception for example Austria, Germany, France,
17
For more details, see comments to questions 30 & 31
13
Commission Consultation on the UCITS Depositary Function
Question 12
Do you agree that safeguards against the risk associated with the improper performance of
depositary duties, such as requiring that UCITS assets be segregated from the depositary‟s
and sub-custodian's assets, should be introduced?
We do not really understand what the Commission understands by “safeguards against the
risk associated with the improper performance of depositary duties”. The segregation of the
UCITS assets from the assets of the depositary and sub-custodian is already required by
Banking law and MiFID
For most EFAMA members, segregation as described above provides for sufficient
protection. Some EFAMA members, however, would ask for full segregation in special funds‟
accounts throughout the sub-custody chain.
Liability regime: Unconditional performance vs. Obligation of means
We agree with the Commission services that there is a need for harmonisation. However, we
have the feeling that the full dimension of this issue was not seen by the Commission services.
From our point of view, there are at least two questions that need to be answered before
starting discussion about the regime itself:
Do we only speak about liability for the custody duties or also about liability for the
supervisory duties? We believe that, in order to ensure a full protection of investors,
the liability of the UCITS depositary should relate to both functions: safekeeping (or
holding of positions when safe-keeping is not practicable) and supervision.
Regarding custody, the reach of the depositaries liability vs. the liability of other
service providers (TA) needs to be defined.
Questions 13 & 14
Do you agree that there should be a general clarification of the liability regime applicable
to the UCITS depositary in cases of improper performance of custody duties?
What adjustments to the liability regime associated to the custody duties of the UCITS
depositary would be appropriate and under what conditions?
As already underlined, we need the CESR review to be completed. The main challenge is then
to ensure clarity on the functions followed by a clarification of operational standards of the
depositary. Indeed one of the major differences for investor protection between Member
States is firstly due to differences in interpretation of the functions of the depositary.
Once this is done a broad majority of EFAMA members is of the opinion that there should
then be clarification and, as far as possible, harmonisation of the liability regime even though
EFAMA believes that the current definition of liability in the UCITS directive is adequate.
Legal uncertainties or national discrepancies to the detriment of the investor are not
acceptable. However, reference to unjustifiable failure and improper performance should
remain.
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Commission Consultation on the UCITS Depositary Function
According to the UCITS Directive, the depositary is liable for “its unjustifiable failure to
perform its obligations or improper performance of them”. In general terms this means that
depositaries need to perform their various duties with due care. As of today this definition has
been sufficient to protect the investor. In the case of Madoff, the CSSF has confirmed that the
depositary of UCITS fund (Lux alpha) had performed improperly and should be hence
considered as liable.
Most member of EFAMA are furthermore of the opinion that the level of liability should also
take into account whether the depositary is in control or not. For example the depositary
should not be liable for any cash that the asset manager decided to deposit in other banks and
not in depositary books 18. Similarly the depositary cannot be held liable for an error of a
provider chosen by the asset manager. Securities held in registrar are in the same situation as
the depositary has no choice regarding the registrar and no control over it. Under question 1 &
2 we have – from our point of view - delivered a set of ideas which should serve as starting
point for this discussion. This approach would ensure a high standard of investor protection as
the depositary should perform strict due diligence on its sub-custodian network. In case of
failure of its obligation he would be considered as liable.
There is one further issue which needs to be raised when speaking about liability and which is
briefly mentioned by the Commission when describing the two scenarios: Even if the UCITS
is entitled to claim for full compensation, most EFAMA members are of the opinion that
immediate compensation should not be required. If the assets are still there but can only not
be returned to the UCITS for a certain time, they are not lost and have still a value (underlying
units in a fund of fund where redemption is stopped) 19.
Regarding the proposed inversion of the burden of proof, most EFAMA members are of the
opinion that this would certainly increase investor protection as it would oblige the
depositary/ custodian to more transparency regarding their duties and the way they fulfil them
within their sub-custodian network. Under the current regime it is nearly impossible for a
management company to prove a claim
However, nearly all EFAMA believe the wording chosen in the AIFM Directive that “the
depositary can only discharge itself of its liability if it can prove that it could not have
avoided the loss which has occurred” seems to go beyond a simple reverse of the burden of
proof as this is in most cases impossible. Indeed, almost all EFAMA members believe that a
qualification of “failure” is necessary not to impose unlimited liability on the depositary. The
principle of the reversed burden of proof can only work if it is based on a clear description of
the depositary‟s functions and duties. Only if a depositary did not undertake appropriate due
diligence and regular monitoring regarding these functions, should it be liable for the loss.
18
See already Vandamme in “Toward an European Market for the undertakings for collective investment”
- Commission document
19
In the case where a sub-custodian goes bankrupt but the fund‟s assets (equities) are in a segregated
account, one possibility to get them “freed” faster, could be achieved through agreement among CSDs
regarding segregation at their level but this might be a major undertaking going far beyond the UCITS
issue.
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Commission Consultation on the UCITS Depositary Function
Liability regime of depositaries in cases of delegation
While there is a – legal – discussion in certain jurisdictions whether using sub-custodians can
be considered as “delegation” or not, EFAMA is of the opinion that the issue should be seen
from the practical point of view in order to ensure that only one party is liable for the
safekeeping of a UCITS assets and the control of its management company. This clarification
is necessary to avoid complication and would enhance confidence of investors.
Questions 15 & 16
Do you agree that the conditions upon which the UCITS depositary shall be able to
delegate its duties to a third party should be clarified?
Under which conditions should the depositary be allowed to delegate the performance of its
duties to a third party?
We would like to start this discussion with a terminology issue: The term “depositary” covers
two functions, safekeeping and annexed duties (see above) and supervision of the
management company. As such, there is no „sub-depositary” but only a „sub-custodian”.
As we already pointed out, clarification of the functions of the depositary is key and this
clarification would include the issue of delegation which would then automatically clarify the
conditions under which the UCITS depositary shall be able to delegate its functions to a third
party (see comments to question 1 & 2). Insofar the Commission is right when saying that
delegation to sub-custodians creates additional risk (geographical and depending on the types
of instruments).
However we must underline that the delegation issue is very complex. The AIFM Directive
proposal provision that depositaries may delegate their task only to other depositaries is
unworkable, in particular in globally diversified portfolios where securities must be held by
local sub-custodians. Besides, the “depositary” as specific function is typical for the UCITS
Directive and only exists in very few countries outside EEA (for example in Switzerland).
Very often there are also other legally binding national structures which must be taken into
account (see extensive comments to question 5). This does not impact at all the general
principle that responsibility cannot be delegated and always remains with the depositary.
Re-hypothecation is not used in the UCITS area – in any case, no re-use should be allowed
without formal approval of the management company.
If the Commission is considering additional regulation, in the interest of investor protection
the following five principles should be taken into account
Improvements might probably best be done in respect to the due diligence
procedures
Binding UCITS regulation must not be circumvented
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Commission Consultation on the UCITS Depositary Function
Any regulation should be built - as far as possible/ meaningful – on the delegation
rules laid down in Article 13 UCITS Directive and in Article 13(5) MiFID /
Articles 13-15 MiFID implementation Directive
The scope of delegation must be described in the contract with the fund manager
The fund manager is not bound to perform any oversight of the depositary‟s
delegated providers
We also agree with the proposal to disclose information to unit-holders on the potential
existence of a sub-custodian network and on the risks associated. Such safeguard would
contribute to re-enforcing transparency vis-à-vis investors.
Question 17
Do you agree that the depositary should be subject to additional ongoing due diligence
requirements when delegating the performance of its duties to a third party?
Yes, the depositary should be subject to additional due diligence procedures when delegating
certain functions to a third party 20. In particular depositaries should be able to demonstrate
that they have a documented procedure on the choice and monitoring of their sub-custodians
or any third party they outsource the performance of some of their duties to. In no case should
management companies be under any obligation to oversee depositaries‟ delegated providers
chosen and selected by the depositary. In this respect, the annual certification by independent
auditors should comfort management companies of selection and oversight processes in place
at the depositaries they work with. Clear due diligence procedures would also help the
depositary to prove that– as the case may be - its duties were carried out without
unjustifiable failure and/or performed properly.
Default
Questions 18 and 19 were subject to a specific Consultation of the Commission and we would
like to simply refer to our response of 7 April 2009 to the Commission‟s Call for evidence on
Directive 1997/9/EC on Investor Compensation Schemes.
ORGANISATIONAL REQUIREMENTS
The Commissions seems to be worried regarding the management of conflicts of interest.
Already in its 2004 Communication, the Commission states that “progress is needed on
convergence of the prudential frameworks, regarding in particular a common typology of
conflicts of interest and the necessary prevention of redress measures. This convergence
should include the list of functions that the depositary can receive from the fund manager by
delegation and, conversely, the list of the depositary activities which may be delegated”.
Already at that time EFAMA (FEFSI) underlined that the effectiveness and robustness of
20
EFAMA is currently working on such procedures together with the depositaries and we would be happy
to share our work with the Commission services and to support Commission/ CESR in this respect.
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Commission Consultation on the UCITS Depositary Function
procedural safeguards established by the banking system will enable bankers and fund
managers in case of a conflict of interest to offer solutions that are fully in line with the
principle of at all times acting in the sole interest of an investment fund‟s unit-(/share)holders.
It would be interesting to hear from the Commission whether any evidence has been adduced
that investors‟ interest were at any moment not properly taken into account.
Questions 20 - 23
Do you agree that the general organization requirements that are applicable to a UCITS
depositary should be clarified?
If so, do what extent?
Do you agree that requirements on conflicts of interest applicable to UCITS depositaries
should be clarified?
If so, do what extent?
In general we have the impression that the existing provisions are sufficient. However,
clarification could be considered if there is evidence that current procedures do not function
properly. Only if the Commission intends to introduce a passport for the depositary as
requested by some EFAMA members, harmonisation of the depositary‟s general organization
requirement would be needed.
ELIGIBLE DEPOSITARY INSTITUTIONS
Questions 24 – 26
Do you agree that there is a need for clarifying the type of institutions that should be
eligible to act as UCITS depositary?
Do you agree that only institutions subject to the CDR should be eligible to act as UCITS
depositary?
If not, which types of institutions should be eligible to act as UCITS depositaries, and why?
While agreeing with the Commission that the type of institutions acting as UCITS
depositaries are very heterogeneous throughout Europe, this does not necessarily mean that
the type of institutions that are eligible to act of UCITS depositaries needs to be defined more
clearly.
Indeed a 2002 EFAMA (FEFSI) survey showed that in a large number of European countries
(i.e. Austria, Czech Republic, Germany, Italy, Luxembourg, Portugal) depositaries are banks
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Commission Consultation on the UCITS Depositary Function
or credit institutions. Nevertheless, in some cases, apart from banks and credit institutions, the
role of the depositary can also be entrusted to other legal entities like investment firms,
brokerage firms entitled to hold assets or insurance companies (for instance France, Finland,
Ireland). More importantly, rules concerning capital requirements for the establishment of the
depositary vary from country to country. In Germany and Austria, the depositary needs own
capital of at least € 5 million, in Portugal own funds cannot be lower than € 7,5 million, while
in Italy the regulatory capital for a bank to undertake the role of a depositary must be at least
€100,000,000. In Czech Republic the capital must be at least 500 million CZK, in Ireland
€6,25 million, whereas in France the capital is depended on the structure of the depositary.
Finally, in UK the general capital requirements for depositaries and trustees are ₤ 4 million 21.
Whereas a number of EFAMA members support the Commission‟s proposal that only credit
institutions should be eligible as depositaries, other EFAMA members are of the opinion that
it would be more important that these institutions are subject to similar regulation regarding
capital requirements (CRD) or MiFID rules in terms of investor protection and conflicts of
interest and risk mitigation to ensure a proper level playing field.
SUPERVISION ISSUES
Supervision by auditors
Question 27
Do you agree that additional auditing requirements should be imposed, such as an annual
certification of the depositary's accounts by independent auditors?
As the Commission underlines, depositaries are already today audited throughout Europe,
either under banking regulation or MiFID. As such an audit includes statement regarding the
accounts we do not see any need for additional audit requirements.
To raise the comfort of the fund manager regarding the choice of a depositary, a specific
organizational audit regarding a firm‟s capacity for serving as depositary might be considered.
Supervision by national regulators
Question 28
Do you agree that UCITS depositaries should be subject to a specific „depositary‟ approval
by national regulators?
21
All figures for 2002
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Commission Consultation on the UCITS Depositary Function
Be it under banking legislation or MiFID, depositaries are already today subject to
supervision by the competent authority and – as far as we know – all Member States have
national regulation regarding the possibility to act as depositaries.
As for response to question 27, we are of the opinion that such requirements should be
extended to any counterparty appointed by the management company for the safe-keeping of
certain assets.
A EUROPEAN PASSPORT FOR THE DEPOSITARY
Question 29
Do you believe that there is need to promote further harmonisation of the supervision and
cooperation by European regulators of depositary activities? What are your views on the
creation of an EU passport for UCITS depositaries ?
Since the 1992 proposal for a modification of the UCITS Directive, this issue is on the
Commission‟s agenda. For the European investment funds industry, it was never a priority
issue. Indeed, such passport would need far deeper harmonization of all depositary functions
than necessary in the interest of investor protection. In particular against the background of
the current discussion on CESR level 2 regarding the depositary‟s obligations related to the
management company passport, most EFAMA members are of the opinion that the
Commission should – at this stage – not open this “chantier” but concentrate on what is
needed to implement the lessons learned from the Madoff affair.
However, for alternative investment funds, the AIFM proposal introduces in Article 17 (3)
indirectly a passport for European non-UCITS funds. For example, a fund of funds, not
covered by the UCITS Directive but marketed to retail investors on national level could have
a depositary in another jurisdiction than that of the fund while a UCITS fund of funds must
choose a depositary in its own jurisdiction. This would create significant inconsistencies with
the UCITS Directive. This again illustrates how important consistency between the different
legal frameworks is since otherwise both, industry and investors are confronted with
substantial legal uncertainty.
OTHER INVESTOR PROTECTION ISSUES - NAV Calculation
Questions 30 & 31
As far as the UCITS portfolio and UCITS units or shares are concerned, do you agree that
their value should be assessed by an independent valuator ?
If so, what should be the applicable conditions for an entity to be eligible to act as an
UCITS valuator ?
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Commission Consultation on the UCITS Depositary Function
We are not aware of any problem regarding the current way to calculate NAV. Both, fund
management companies and depositaries have developed over the years efficient and
sophisticated organizational structures to handle this issue based on the principle of
organizational independence.
According to Annex II of the UCITS IV Directive, “valuation and pricing” are part of the
administrative functions that are included in the activity of collective portfolio management.
As such, the final responsibility for valuation lies – as said above – in most jurisdictions with
the management company 22 which has to respect the rules for the valuation of assets and the
rules for calculating the sale or issue price and the re-purchase or redemption price of the
units of a UCITS which are laid down in the law, in the fund rules or in the instruments of
incorporation of the investment company (Article 85). In case of cross-border collective
portfolio management, the rules of the UCITS home Member State are the ones (Article 19
(3) (e)) to be respected by the management company (Article 19 (4) and (6)). It is possible to
outsource the valuation function where the law of the management company‟s home Member
State permits (Article 13).
Article 22 (3) (b) requires the depositary to “ensure that the value of units is calculated in
accordance with the law and the fund rules”.
In practice NAV calculation is performed by different entities, i.e. the management company
(i.e. via an internal pricing committee), the depositary or a fund administrator. Where
valuation is carried out within the management company, this function is independent from
the portfolio management function and subject to an audit. Such functional independence is
sufficient, in particular where underlying prices are market prices obtained from external
sources (price vendors such as Reuters). Often it might be appropriate to (partly) delegate
valuation to third parties in particular if specific expertise is needed. However, also in this
case final responsibility is with the management company/ fund Board and the depositary.
Mandatory appointment of a separate external valuator will not enhance the valuation process
but involve significant additional cost and raise new questions about eligible firms and
liability. We are of the strong opinion that this Consultation is not the right place to discuss
this issue.
Peter De Proft
Director General
15 September 2009
[09-4083]
22
Where this responsibility lies with the depositary, the latter has – of course – to follow the same rules