European Union (EU) legislators have reached agreement on new amending legislation for investment funds established pursuant to the Directive on Undertakings for Collective Investment in Transferable Securities (UCITS). These changes are colloquially referred to as “UCITS V” and were formally adopted by the European Parliament on 15 April 2014. The three main areas of reform relate to the role of the depositary; manager remuneration; and regulatory sanctions. The intention behind these developments is to enhance investor protection and ensure more standardised conditions for UCITS across the EU in this regard. In particular, the amendments seek to clarify and upgrade one of the cornerstones of UCITS which had remained substantially unchanged since 1985, the depositary function, in addition to aligning UCITS with certain aspects of the Alternative Investment Fund Managers Directive (AIFMD) which are already applicable to alternative investment fund managers.
Regarding the new depositary provisions, UCITS V harmonises the eligibility of entities which may be permitted to act as a depositary, tightening up the previous position which had been less defined. The safekeeping and oversight duties which a depositary must carry out with respect to UCITS are clarified, and a new cash monitoring obligation is provided for. The circumstances in which a depositary may delegate safekeeping duties are now prescribed at EU level, and depositary liability is strengthened - a depositary is liable for the loss of any financial instrument of the UCITS held in custody unless it can prove that the loss is attributable to an external event beyond its reasonable control, the consequences of which are unavoidable despite all reasonable efforts to the contrary. UCITS V provides that a depositary is also liable for all other losses suffered by either the UCITS or its unitholders arising as a result of the depositary’s negligent or intentional failure to properly fulfil its obligations under the directive. The depositary remains liable for losses suffered even where it has delegated its responsibilities to a third party, and it cannot contractually discharge liability. This is in contrast to the AIFMD which does provide for contractual discharge of liability in favour of a delegate in certain circumstances.
New remuneration provisions for UCITS management companies are introduced by UCITS V. These seek to ensure that remuneration policies and practices which are consistent with and promote sound and effective risk management are put in place. These rules are relevant for staff whose professional activities have a material impact on the risk profile of the management company or the UCITS. For bonus payments/variable remuneration, the new rules will require deferral of payment of between 40 to 60 per cent for at least three year period and at least half of such pay must be in units of the UCITS concerned, or in equivalent non-cash instruments. With regard to the categories of persons to whom the remuneration provisions will apply, the European Securities Markets Authority is expected to issue guidelines on scope, and on the proportionate application of the new rules on pay. It may be noted that although a bonus cap on variable remuneration (1:1 with fixed salary) had been on the table during the negotiation of UCITS V, this was not backed by the European Parliament and does not appear in the text which has now been agreed.
The issue of regulatory sanctions constitute the third limb of reform within UCITS V. In order to address discrepancies within the EU member states, a more harmonised approach with respect to breaches of UCITS rules is introduced. This includes a requirement on Member States to impose sanctions on companies and persons for breaches of national provisions transposing the UCITS directives, and an obligation to apply at a minimum the range of specified penalties and measures which are set out. A specific list of UCITS breaches is provided for in the text for which penalties must be enshrined at domestic level. Whistle-blower protections are also introduced.
The UCITS V Directive was formally approved by the European Council on 23 July 2014. It was published in the Official Journal of the EU on 28 August 2014 and is now in force since 17 September 2014. Member states now have 18 months from that date to transpose it into national law, meaning that it may be applicable across the EU by 18 March 2016.
Shay Lydon, Matheson
Co-Chair of the IFIA UCITS Working Group