The UCITS V Directive (2014/91/EU) was transposed into Irish law on 21 March 2016 pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) (Amendment) Regulations 2016 – S.I. No. 143 of 2016 (the “Irish UCITS V Regulations”). As expected, the Irish UCITS V Regulations followed the UCITS V Directive closely with no substantial changes.
The Commission Delegated Regulation (EU) 2016/438, supplementing the UCITS V Directive with regard to obligations imposed on depositaries (Level 2 Regulations), was published in the Official Journal of the European Union on March 24, 2016 and comes into effect from October 13, 2016. The Level 2 Regulations expand on the depositary obligations set out under the UCITS V Directive.
The different effective dates between the UCITS V Directive and the Level 2 Regulations is unusual and makes it important for market participants, when planning implementation, to know which of the new duties flow from the Directive and which stem from the Level 2 Regulations.
The Directive focuses on three key areas:
- Alignment of depositary liability and duties with the Alternative Investment Fund Managers Directive (AIFMD) regime
- The requirement to establish a remuneration policy which aligns with the interests of the UCITS and, in particular, how variable remuneration should be paid to certain “identified staff” of the UCITS’ management company1 and delegates whose activities have a material impact on the risk profile of the UCITS or the UCITS management company
- Sanctions, which essentially set out minimum levels of penalties to be applied across the European Union (EU)
The duties imposed upon the Depositary under the UCITS V Directive are closely aligned with AIFMD.
The liability standard is the same except that, in contrast to AIFMD, the option to transfer liability to a sub-custodian (the so-called “contractual discharge provision”) is not available to depositaries under the UCITS V framework.
The obligation to verify ownership and to maintain records of all assets belonging to the UCITS (not just equities, bonds and collective investment schemes) is the same as under AIFMD and it has been supplemented by the duty to be able to produce a complete and up-to-date inventory of the assets belonging to the UCITS at all times and to provide it regularly to the UCITS Management Company.
The duty to monitor on a daily basis all significant cash flows, in particular those that may be inconsistent with the UCITS’ operations, is the same as AIFMD. However, the greater volume of cash flows associated with a UCITS, on account of the frequency of subscriptions and redemptions in a UCITS, makes this a more challenging exercise for UCITS depositaries.
The traditional oversight duties performed by depositaries are unchanged by the UCITS V Directive but the Level 2 Regulations now prescribe in more detail how these duties should be fulfilled and discharged. The Level 2 Regulations have effectively merged the varying approaches of
The UCITS V Directive requires that a UCITS management company has a remuneration policy which is consistent with, and promotes, sound and effective risk management and which discourages excessive risk taking. The policy must address the manner in which variable remuneration (“VR”) is paid to “identified staff” (which includes senior management, risk takers and control functions).
A number of detailed rules are included in the UCITS V Directive, although these are subject to the principle of proportionality. The key provisions relating to VR (the so-called “pay-out provisions”) can be summarised as follows:
- At least 40% of VR must be deferred for a minimum period of three years;
- At least 50% of the VR must be paid by way of units in the UCITS, or equivalent arrangements; and
- The VR should be subject to clawback, for example if subsequent investment performance is poor.
The pay-out provisions mirror the corresponding requirements relating to the payment of VR under AIFMD. Until recently, the bulk of the debate on this topic centred on the extent to which the VR rules would apply to delegates of the UCITS management company (in particular, those delegates outside of the EU who would not necessarily be subject to remuneration rules that would be regarded as equally effective as those set out under UCITS V such as the MiFID or AIFMD regimes). The UCITS V Directive recognises that UCITS management companies should comply with the remuneration provisions in a way, and to the extent, that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities.
Furthermore, the AIFMD Guidelines published by the European Securities and Markets Authority (ESMA) allowed one or more of the pay-out provisions to be disapplied in their entirety based on proportionality principles. It was expected that ESMA would take a similar approach under UCITS V but in its final UCITS Guidelines on remuneration published on March 31 2016 , it did not expressly allow for the pay-out provisions to be disapplied based on proportionality grounds. Instead, ESMA wrote to the European Commission, European Parliament and European Council seeking guidance on the circumstances and scenarios under which a UCITS management company might disapply some of the pay-out provisions based on proportionality principles. ESMA said that legislative change could bring clarity to this issue and could ensure a more consistent application of remuneration requirements across the asset management sector. It is not known when a response to ESMA’s letter is expected from the EU institutions.
The strict liability provisions imposed on depositaries under the UCITS V Directive, while challenging, had been anticipated and they have responded accordingly. The new requirements largely mirror the strict liability provisions imposed on depositaries under AIFMD (with the exception of the contractual discharge provision). Therefore, the relatively small community of depositaries have already been operating under a strict liability requirement for some time.
However, the remuneration provisions under UCITS V impact a much larger, and more disparate, body and there still remains a significant level of uncertainty as to whom those provisions should be applied in practice, in particular to the management company’s delegates. The recently published ESMA Guidelines have not addressed this uncertainty, which has caused concern among some market participants.
The Guidelines do not take effect until January 1, 2017 so asset managers face a period of uncertainty, until further guidance emerges, about the extent to which the remuneration provisions apply to delegates and the circumstances under which UCITS management companies and their delegates can avoid the more rigorous payout provisions.
1References to UCITS management companies includes self-managed UCITS which do not have a management company.
Director, Trustee & Depositary Services
RBC Investor & Treasury Services