Implementation of UCITS V in the UK Karagh Gilliatt and Aidan - - PowerPoint PPT Presentation

UK – 210969696.1 | 20 January 2016

Implementation of UCITS V in the UK

Karagh Gilliatt and Aidan Campbell

UK – 210969696.1 | 20 January 2016 CMS Firm

Agenda

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• Overview of the key elements of UCITS V
• Highlight where the provisions differ from the equivalent AIFMD

provisions

• Summary of UK proposals for implementation

UK – 210969696.1 | 20 January 2016 CMS Firm

Snapshot of UCITS V Legislative History

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• Recast UCITS Directive (2009/65/EC)
• Implemented in UK
• UCITS V Directive (2014/91/EC)
• Requires Member State Implementation
• Commission's Delegated Regulation on obligations of Depositaries

– “Level 2”

• Directly applicable – no Member State implementation required
• ESMA Guidelines on Sound Remuneration Policies – “Level 3”
• Requires Member State adoption

UK – 210969696.1 | 20 January 2016 CMS Firm

UK Proposed Implementation

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• Amendments to Collective Investment Schemes Sourcebook (“COLL”)
• COLL 4.2.5: prospectus updates
• COLL 4.7: KIID update
• COLL 4.5: Annual report
• COLL 6.6A: requirements regarding ManCo in respect of depositaries
• New COLL 6.6B: requirements on UCITS depositaries
• Requirements in COLL 6.6A and 6.6B broadly similar to FUND 3.11
• New SYSC19E
• Other amendments to Glossary, CASS, SUP and IPRU (INV)
• Amendment to FSMA and secondary legislation

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Timeline

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UCITS V Directive published 28 August 2014 23 July 2015 3 September 2015 23 October 2015 FCA publishes CP15/27 ESMA publishes draft Guidelines on sound remuneration under UCITS V and AIFMD UCITS V Level 2 Regulations issued by European Commission Deadline for implementation by Member States HM Treasury publishes consultation Level 2 Regulations to be finalised and published in Official Journal Expect: FCA Policy Statement and made legislation Date of application

• f Level 2

Regulations? 17 December 2015 Q1 2016 18 March 2016 Q3 2016

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UCITS V – Key Elements

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• The key elements of UCITS V are uniform rules on:
• UCITS depositary functions
• UCITS Management company (“ManCo”) remuneration requirements
• Sanctions

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Depositary Provisions

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• Depositary provisions have not changed since introduction of UCITS

in 1985 - readjustment arguably overdue!

• Principal components:
• Appointment and eligibility of the depositary
• Safekeeping of assets
• Delegation
• Oversight
• Liability
• Many of the detailed UCITS V depositary requirements are contained

in delegated European Commission Regulations (“Level 2 Regulations”)

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Depositary – Eligibility Criteria

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• Prescribed classes of institution eligible to be depositaries
• National central banks
• Credit institutions
• Other legal entities authorised to carry out UCITS depositary activities
• (“non-bank depositaries”), which must
• be subject to prudential regulation requirements
• be subject to regulatory supervision
• meet certain minimum operational requirements
• FCA “gold-plating”

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Depositary – Appointment (1)

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• ManCo must appoint a single depositary for each UCITS it manages
• ManCo must have in place a decision-making process for choosing

the depositary

• ManCo must demonstrate satisfaction of appointment to the UCITS’

home Member State competent authority

• ManCo must also justify to UCITS investors, on request, its choice of

depositary

• Must be written contract in place between ManCo and depositary
• Both UCITS depositary and ManCo must act “honestly, fairly,

professionally and solely in the interests of the UCITS and the investors of the UCITS”

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Depositary – Appointment (2)

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• Level 2 Regulations, Chapter 4: independence requirements
• ManCo and depositary must at all times comply with certain conditions

which are designed to ensure independence of the depositary.

• In certain limited circumstances, ManCo may appoint a linked depositary.
• Tends not to be an issue for UK funds and provisions are designed to allow

continuation of practices in Continental Europe.

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Depositary – Written Contact (1)

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• The Level 2 Regulations require the written contract with the

depositary to include (broadly):

• Description of services
• Information flows
• Processes and procedures

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Depositary – Written Contact (2)

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• More specifically:
• A description of depositary services and the depositary’s procedures for

each type of assets in which the UCITS may invest;

• A description of how the safekeeping and oversight functions will be

performed;

• The term of the contract and the requirements for amendment and

termination;

• The parties’ respective confidentiality obligations;
• Provisions regarding transmission of information between depositary and

ManCo (and, if applicable, any third party);

• Procedures to be followed when considering an amendment to the UCITS’

rules, instrument of incorporation or offering documents;

• Information which must be exchanged in respect of sale, subscription,

redemption, issue, cancellation and repurchase of units of the UCITS;

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Depositary – Written Contact (3)

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• A commitment to regularly provide details of any third party appointed by

the ManCo or depositary, and, upon request, information on the selection criteria and on monitoring procedures regarding the appointment;

• The parties’ obligations regarding prevention of money laundering and

terrorist financing;

• Information on cash accounts in the ManCo’s name on the UCITS’ behalf

and procedures for ensuring the depositary is notified of the opening of new accounts;

• Details of the depositary’s escalation procedures;
• A commitment by the depositary to notify the ManCo that the segregation
• f assets is no longer sufficient to ensure protection from insolvency of a

third party to whom safekeeping has been delegated;

• Procedures for ensuring the depositary has the ability to enquire into the

conduct of the ManCo, including rights of access, and for ensuring the ManCo can review the performance of the depositary.

• Requirements broadly mirror the requirements for depositary contracts

prescribed by AIFMD.

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Depositary – Safekeeping of Assets

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• Division of asset types
• Financial Instruments which can be held in custody
• Transferable securities (including those embedding derivatives)
• MMIs
• CIS units (but not necessarily all)
• Other assets
• Cash deposits
• Derivatives
• Other CIS units
• Comprehensive inventory of all assets to be provided by depositary

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Depositary – Safekeeping of Assets: Custody

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• Where the depositary holds FIs in custody its duties include:
• Ensure proper registration
• Ensure segregation
• Perform asset reconciliation
• Maintain records
• Prohibition on the re-use of assets
• Limited exception
• Stock lending subject to certain criteria.

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Depositary - Safekeeping of Assets: Other Assets

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• No requirement to hold legal title to those other assets
• Ownership verification required
• Depositary to maintain record

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Depositary – Delegation (1)

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• Restrictions on delegation by depositary
• Depositary may only delegate custody function
• Such delegation only permitted where:
• it is not aimed at avoiding UCITS V requirements;
• there is an objective reason for delegation;
• due skill, care and diligence has been exercised in the selection and

appointment

• ongoing monitoring of the delegate required
• No contractual discharge of liability is permitted
• AIF depositaries may discharge liability in certain circumstances
• Depositary must ensure delegate complies with depositary’s obligations

under written agreement with ManCo

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Depositary – Delegation (2)

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• Depositary required to ensure the delegate takes all necessary steps

to ensure that the assets of a UCITS held by it in custody are unavailable for delegate’s creditors in event of its insolvency

• High standard
• independent legal advice required
• Early termination of agreement
• Inform ManCo
• ManCo to inform FCA and take all appropriate measures
• EEA delegate required to provide a regular statement to the depositary

detailing the assets

• Also when a change occurs
• Provisions to apply down the custody chain

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Depositary – Oversight Obligations (1)

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• Oversight obligations on depositary in respect of:
• Cash monitoring
• Valuation
• Sale/issue/redemption/cancellation of Shares
• Income Distribution
• Strategy & risk profile of UCITS relevant

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Depositary – Liability (1)

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• Depositary liability provisions mirror AIFMD provisions
• depositary is liable for losses of financial instruments held in custody,

unless it can show that loss has arisen “as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary”

• No need to establish fault
• Also liable for all other losses suffered by UCITS and investors as a result
• f the depositary’s “negligent or intentional failure to properly fulfil its
• bligations”
• Applies to all asset types.

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Depositary – Liability (2)

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• Chapter 3 of the Level 2 Regulations: sets out the circumstances in

which a financial instrument held in custody shall be deemed to be “lost”

• A financial instrument held in custody is “lost” if any of the following
• ccurs:
• a stated right of ownership of the UCITS is demonstrated not to be valid

because it either ceased to exist or never existed;

• the UCITS has been definitively deprived of its right of ownership over the

instrument; or

• the UCITS is definitively unable to directly or indirectly dispose of the

instrument.

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Depositary – Liability (3)

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• Article 19 of the Level 2 Regulations sets out the circumstances where

the depositary is not liable for loss of financial instruments held in custody, broadly:

• No act or omission of the depositary or its delegate;
• The depositary could not have reasonably prevented the occurrence of the

event despite adopting all reasonable precautions; and

• The depositary could not have prevented the loss despite rigorous and

comprehensive due diligence, documented in accordance with the requirements of the Level 2 Regulations

UK – 210969696.1 | 20 January 2016 CMS Firm

Remuneration - Background

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• Part of broader campaign by European Commission:
• Perceived disconnect between remuneration of certain staff and

performance

• “Variable remuneration” and disclosure seen as particular issue
• UCITS V remuneration requirements aimed at realigning the interests of

such staff with the UCITS they manage / provide services to

• Similar measures already in place in respect of AIFMD and CRD IV

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Remuneration - Key Requirements

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• ManCo required to put in place remuneration policies & practices that:
• are consistent with & promote sound & effective risk management; and
• do not encourage risk taking or impair compliance with duty to act in the

best interests of the UCITS

• Remuneration policies and practices must comply with 18 stated

remuneration principles, but no bonus cap

• FCA’s implementation:
• 14 Remuneration Principles under the Code
• Incorporate all 18 principles set out in UCITS V
• Broadly replicate the remuneration principles applicable to AIFMs under the

AIFMD Code but a number of differences

• Compliance with principles must be “appropriate to [the ManCo’s] size,

internal organisation and the nature, scope and complexity of their activities”

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What is “remuneration”?

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• UCITS V: “any benefit of any type paid by [ManCo]… any amount paid

directly by the UCITS itself, including performance fees… any transfer

• f units or shares in the UCITS”
• ESMA Guidance: “all forms of payments or benefits paid by the

management company, any amount paid by the UCITS itself and any transfer of units or shares in the UCITS, in exchange for professional services rendered by the management company’s identified staff”

• Includes fixed and variable components of salary and pension benefits

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Notable UCITS Remuneration Principles replicating AIFMD Code Principles

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• Remuneration Principle 1: Risk management
• Remuneration Principle 3: Governance
• Requirement for remuneration committees for “significant” ManCos
• Remuneration Principle 5(c): Fixed and variable components of total

remuneration

• Remuneration Principle 8: Personal investment strategies

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Differences between UCITS Code and AIFMD Code (1): Governance

UCITS Code

• management body required to

review “at least annually” the general principles of the remuneration policy

• remuneration committee

required to take into account the public interest when preparing its decisions AIFMD Code

• management body must

“periodically review” policy

• no such requirement

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UK – 210969696.1 | 20 January 2016 CMS Firm

Differences between UCITS Code and AIFMD Code (2): Assessment of Performance

UCITS Code

• ManCo must ensure that

assessment of performance- related remuneration takes into account the investment risks of the UCITS and the risks of the ManCo, as well as overall results and long-term performance AIFMD Code

• no requirement to consider risks

as part of assessment process, but must spread payment of remuneration over period which takes account of redemption policy of AIFs and their investment risks.

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UK – 210969696.1 | 20 January 2016 CMS Firm

Differences between UCITS Code and AIFMD Code (3): Retention of Units, shares etc

UCITS Code

• a substantial portion, and at

least 50%, of variable remuneration must comprise certain financial instruments or equivalent non-cash instruments with equally effective incentives as the other instruments. AIFMD Code

• no requirement for equivalent

non-cash instruments to have equally effective incentives

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UK – 210969696.1 | 20 January 2016 CMS Firm

Differences between UCITS Code and AIFMD Code (4): Deferral

UCITS Code

• at least 40% of variable

remuneration should be deferred for at least three years AIFMD Code

• deferral should be for at least

three to five years, unless the lifecycle of the AIF is shorter.

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Who must policies/practices apply to?

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• Identified Staff
• Those categories of staff whose professional activities have a material

impact on ManCo’s risk profile or risk profile of the UCITS managed by it

• includes senior mgmt, risk takers, control functions and any employee receiving

total remuneration that falls into the bracket of senior mgmt/risk takers

• Delegates and others not employed directly by ManCo
• Equivalence test

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Multiplicity of Remuneration Codes

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• Recognition that some Identified Staff may be subject to different

sectoral remuneration codes. ESMA proposes the following basis for calculation of remuneration:

• Pro rate; or
• Apply sectoral code which is most effective in discouraging excessive risk

taking.

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Remuneration - Proportionality

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• ManCos are required to comply with the Remuneration Principles in a

proportionate manner

• Size
• internal organisation
• nature, scope and complexity of activities
• Proportionality to different categories of staff
• Certain remuneration principals may be disapplied
• Deferral
• Instruments
• Malus/clawback
• Rationale for disapplication

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Remuneration – Proportionality: FCA Stance

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• FCA proposed that pay-out process may be disapplied when both:
• Variable remuneration in respect of X is no more than 33% of total

remuneration; and

• Total remuneration is no more than £500,000.
• FCA may consider further guidance or changes to its approach in

future.

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Sanctions (1)

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• Member States required to impose administrative sanctions & other

measures for breaches of national implementing measures

• Sanctions required to be “effective, proportionate and dissuasive”
• Sanctions will apply to members of management body of UCITS /

ManCo/ depositary

• Administrative penalties must include at least the following:
• Public statement identifying the infringing person and nature of

infringement;

• Cease and desist orders;
• Pecuniary sanctions (i.e. fines)

UK – 210969696.1 | 20 January 2016 CMS Firm

Sanctions (2)

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• 19 specific grounds for administrative penalties set out in UCITS V
• Member States have discretion to “gold plate” offences
• Minor amendments proposed to FSMA to clarify that breaches of UK

legislation implementing the UCITS Directive trigger the FCA’s existing sanctions

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Sanctions (3)

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• Member States required to establish whistle-blowing mechanisms
• Sufficient whistle-blowing requirements arguably already in place in

UK

• Public Interest Disclosure Act 1998 (PIDA)
• SYSC 18
• HM Treasury proposes only minor changes to existing rules
• FCA also proposes including provisions in Handbook requiring ManCo and

depositaries to implement whistleblowing procedures for use by employees to report breaches

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Changes to documentation

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• Updates required to fund documentation:
• Prospectuses
• Trust Deeds
• Annual reports
• KIIDs
• Updates required to agreements e.g. ACD agreements, Depositary

agreement, IMAs and contracts of employment

• Compliant remuneration policy
• Transitional provisions for certain fund documentation updates
• No transitional provisions for other documentation: must be compliant

by 18 March 2016

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Next Steps

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• Publication of final guidance and technical standards by ESMA :

expected February 2016

• FCA Policy Statement setting out final rules: expected soon
• Domestic implementing measures: must be in place by 18 March 2016

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Contact us

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• Karagh Gilliatt, Partner
• karagh.gilliatt@cms-cmck.com
• +44 131 200 7308
• Aidan Campbell, Partner
• aidan.campbell@cms-cmck.com
• +44 141 304 6112
• www.cms-cmck.com

UK - 210969696.1 | 20 January 2016 CMS Firm 41

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