UCITS: Commission proposes to increase liability of depositaries
By Manon Malhère | Friday 08 June 2012
To limit the risks inherent to undertakings for collective investment in transferable securities – UCITS – and thus protect consumers who invest in these often extremely complex financial products
(1), the European Commission intends to reinforce the obligations and liability of depositaries. The draft legislation amending the UCITS Directive 2009/65/EC is set to be presented before the summer. The text, seen by
Europolitics, which is still subject to change, obliges depositaries to return lost UCITS assets and entities could not be discharged from this liabilty even if the losses are caused by a sub-custodian.
For the Commission, it is clear that existing regulations give the member states too much leeway on interpreting the obligations and liability of depositaries, who are the custodians entrusted with the safekeeping of the assets and monitoring and oversight of the lawfulness of the UCITS’ decisions (functions provided by credit institutions or insurance companies). The rules in question have not really changed since adoption of the first directive (85/611/EEC) in this field, in 1985, but UCITS have become increasingly complex in the meantime.
To illustrate the most serious consequences that can result from these regulatory limits, the Commission mentions the bankruptcy of Lehman Brothers International Europe and above all the Madoff case (a financial fraud detected in 2008). It also refers to the Luxembourg-based LuxAlpha Fund (a SICAV, which is a type of UCITS), which lost nearly €1.4 billion due to Madoff Investments that turned out to be fictitious. LuxAlpha’s depositary was the Swiss bank UBS, which delegated custody for the assets to an entity managed by Bernard Madoff himself (the sub-custodian). In 2009, the Commission also noted that depositaries for several UCITS funds (four) had delegated assets to entities run by Madoff, resulting in substantial losses for investors. The executive stressed that the states monitoring said depositaries had implemented the directive in their national law.
The Commission therefore intends with its proposal to clarify and tighten rules on the obligations of depositaries, the delegation of these functions to sub-custodians and above all the liability of depositaries. Internal Market Commissioner Michel Barnier confirmed this recently: “We want to protect those who invest in these products by introducing stricter liability for the loss of assets in the safekeeping of a depositary bank”. Liability will be stricter because existing legislation is limited to cases of “unjustifiable failure to perform obligations” or “improper performance” of custodial duties.
The Commission proposes that, in the event of the loss of the assets under custody, the depositary will be obliged to return financial instruments of the identical type or of the corresponding amount to the UCITS “without undue delay”. Most importantly, the depositary is liable in cases where the instruments are lost by a sub-custodian (a third party entrusted with safekeeping of the assets). The depositary therefore may not be discharged from this liability unless it can prove that the loss results from an “external event beyond its reasonable control”.
“Raising the requirements will inevitably lead to a situation where depositaries feel that the liability risks they can assume exceed the economics of the business case, leading to reduced service offers or withdrawal from certain segments, Robert Priester, director for financial markets and banking supervision at the European Banking Federation (FEB), told
Europolitics. He added that the federation would be very attentive to clarification of this liability. “Sub-custodianships in particular, which currently serve to offer a complete geographical or instrument depositary service (as few custodians have a truly globally complete reach), risk being restricted and withdrawn,” he added.
The European Consumers’ Organisation BEUC already supported this measure in its response to the Commission’s consultation document.
The text also covers rules for the delegation of custodial tasks by the depositary to a sub-custodian. Overall, it will bring conditions into line with those laid down in Directive 2011/61/EU on alternative investment fund managers (AIFM). This means in particular that the sub-custodian must have the means required to fulfil these obligations, that it must separate assets correctly and that it must not use the assets without the prior consent of the UCITS or the management company acting on behalf of the UCITS.
Concerning the obligations of depositaries, the proposal introduces a distinction between the assets that are in the custody of a depositary (such as securities) and other types of assets (such as derivatives contracts) to which supervision obligations apply. This distinction is important because the obligation to return lost assets applies only to the category of assets under custody.
The draft specifies that a single depositary shall be appointed for each UCITS fund and introduces a uniform list of oversight duties.
Last but not least, the Commission spells out criteria for eligibility to act as a depositary. Existing legislation gives the member states significant discretion in this respect, a situation that can result in legal uncertainty. Under the new rules, depositaries will have to be a credit institution or investment firm because only such entities can offer sufficient guarantees (prudential rules, capital requirements and oversight).
The text includes measures on the remuneration of management companies (in charge of the UCITS’ portfolio of financial instruments).
UCITS (Undertakings for Collective Investment in Transferable Securities) are investment funds established in accordance with the 1985 UCITS Directive 85/611/EEC. UCITS have proven to be successful and are widely used by European households and are regularly sol to investors outside the EU. Investment funds are specially constituted investment vehicles, created with the sole purpose of gathering assets from investors and investing those assets in a diversified pool of assets. In this way, small investors have access, at reasonable cost, to a diversified basket of financial instruments.(1) UCITS are investment funds, more specifically, standardised types of grouping of assets (financial instruments), generally sold to retail investors and regulated at EU level.