Amidst the unbearable anticipation of what AIFMD will finally bring, the average investor would be forgiven for feeling a little bit too cared for, as the European Commission published its proposed amendments to the UCITS Directive. With retail investor protection at its core, the Directive covers three areas: depositories; UCITS Management Company remuneration policies; and sanctions for breaches of UCITS law.
Depository duties have been notoriously difficult to define, with European countries sometimes having wildly divergent views on its depositories role and responsibilities. Effectively, the Commission now wants to be able to compare apples with apples and move to a harmonized, consistent and codified interpretation of the Directive. Laudable indeed; however, the effect, particularly in the political goldfish bowl of current regulatory initiatives, is more prescriptive with stricter rules. And “strict” is the nom de jour, particularly with regard to depository liability, as the Directive goes further than the AIFMD. By introducing a “strict liability” standard requiring the return of assets lost in custody irrespective of fault or negligence (other than due to external events beyond the control of Depositories), the Directive holds the Depository responsible, even if the loss took place at sub-custodian level.
While the above is the headline act, the Directive also looks at other areas regarding depositories. Firstly, going back to basics, it defines who can act as a depository, namely: EU authorized credit institutions or MiFID authorized investment firms. There is a grandfathering provision of two years for existing UCITS with other arrangements. The Directive also brings in new rules regarding the circumstances in which custody can be delegated which previously have lacked clarity. The rules here do match the AIFMD. Furthermore, the Directive requires that the safekeeping arrangements be described comprehensively in the prospectus, and that this is stated where any safekeeping function is delegated to a third party. This sounds harmless in practice, but presents many operational issues on an ongoing basis in terms of keeping information up to date. As such many industry bodies are pushing back hard on this.
In requirements which echo AIFMD, the Directive also looks to introduce remuneration policies consistent with appropriate risk management and to discourage short term risk taking. The policies will apply to all “senior management” and those whose activities have a material impact on the risk profile of the UCITS. The rules here will need to be considered in light of other regulations regarding remuneration that asset managers are faced with.
Finally, the Directive introduces a harmonized list of breaches that must be prosecuted by national supervisory authorities as well as a menu of potential sanctions that can be levied on UCITS. Again, this is an interesting harmonizing measure and points to, what we believe, is a continued wish from the Commission that discretion is removed from national regulator hands.
So a lot of work is needed for the industry to prepare for the new rules. Depositories will need to analyze their own safe keeping arrangements and how the Directive will impact them. Asset Managers will be reviewing remuneration policies and how to fit them into the new Directive (and indeed other regulatory requirements coming down the track). And the entire industry will be considering, with some trepidation, the potential sanctions that their businesses could face.