Preparing for UCITS V and VI

What’s the current status of UCITS V and VI?

Imogen Garner, partner at Norton Rose Fulbright, says practitioners need to understand the new requirements of UCITS V and should be evaluating its impact on their clients’ businesses—particularly those with clients in the asset management, custodian and depositary spheres.

What is UCITS V?

UCITS V (Directive 2014/91/EU) is an EU Directive which makes a number of reforms to the rules governing UCITS funds and their management. It’s probably easiest to summarise UCITS V as focusing on three areas.

First, it makes a number of changes to the regime for UCITS depositaries. It introduces a cash monitoring role for UCITS depositaries, and introduces specific provisions around safe-keeping for different categories of assets (ie ‘custody assets’ versus ‘other assets’, which will be subject to an asset verification obligation). It also imposes restrictions on delegation by depositaries, and makes some changes to the existing rules on depositary liability (including making depositaries strictly liable to restitute lost custody assets except in fairly limited ‘force-majeure’-type circumstances). Many of these changes align the regime for UCITS depositaries to that already in place for depositaries of non-UCITS funds under the Alternative Investment Fund Managers Directive (Directive 2011/61/EU) (AIFMD)—although there are still a number of differences between the two regimes.

Second, UCITS V introduces a remuneration regime for UCITS management companies. Consistent with the approach we have already seen in the AIFMD (and elsewhere), UCITS management companies will need to implement remuneration policies for some categories of staff that are consistent with effective risk management and do not encourage inappropriate risk taking. The new rules will cover fixed and variable pay (including ensuring an appropriate balance between the two, requirements for deferral of variable remuneration and to pay a substantial proportion of it in non-cash instruments). They will also cover early termination payments and pension payments, and are to be applied on a proportionate basis by reference factors like the UCITS management company’s size and the complexity of its business. There was much debate, as the new rules were being developed, around the imposition of a bonus cap—but this did not find its way into the final text.

Finally, UCITS V introduces new provisions to harmonise the administrative penalties across member states for infringements of national provisions implementing the UCITS rules.

Why does UCITS IV need to be amended?

I’ve noted above that many of the changes seek to align the UCITS regime with that introduced for managers (and, indirectly, depositaries) of non-UCITS funds under the AIFMD. At their heart, both AIFMD and UCITS V have their origins in a strong investor protection agenda at European level, with the changes intended to tighten up the rules and bolster investor protection following events such as the Madoff fraud and the Lehman Brothers default. The view of many commentators seems to be that the changes (in both regimes) will probably help reduce the risk to investors to some extent, but can of course never completely eradicate them.

What is the current status of UCITS V?

The final text of UCITS V was published in the EU’s Official Journal (OJ) last August, and it came into force 20 days later. Member states now have to transpose it into national law by 18 March 2016 (18 months from publication in the OJ). In November 2014, the European Securities and Markets Authority delivered technical advice to the European Commission on delegated acts relating to the requirement for independence between management companies and depositaries, and the insolvency protection of UCITS assets when a depositary delegates safekeeping to a third party.

As far as UK transposition is concerned, the FCA’s Business Plan for 2014/15 indicated that implementation of UCITS V would take place throughout 2015.

What is UCITS VI?

UCITS VI is the term used to refer to potential further reform of the UCITS regime stemming from a consultation by the European Commission in July 2012.

How is UCITS VI different to UCITS V?

The focus of UCITS VI is quite different to that of UCITS V. The Commission’s UCITS VI consultation spanned a wide range of topics, including eligible assets for investment by UCITS, use of derivatives by UCITS (eg whether this should be limited to derivatives that are traded on-platform and centrally cleared, and how counterparty risk limits should be assessed for over the counter derivatives), the use of ‘efficient portfolio management’ techniques, the potential to introduce a depositary passport and a number of improvements to the functioning of the existing UCITS IV framework. It also raised a number of questions around money market funds and the accessibility to retail investors of opportunities to invest in long-term assets.

What is the current status of UCITS VI?

Its current status is, it is fair to say, a little unclear. No UCITS VI legislative resolution has yet been published, and Steven Maijoor commented publicly late last year that he felt many of the more pressing issues covered by UCITS VI have been or are being tackled via other measures, such as the proposed regulation on money market funds. It seems the focus is really now more on ensuring that the UCITS framework, as most recently amended by UCITS V, is correctly implemented in member states.

From a UK perspective, no reference was made to UCITS VI in the FCA’s 2014/15 Business Plan.

How can practitioners prepare for UCITS V and VI?

As far as UCITS VI is concerned, practitioners should be keeping a watching brief on any further developments. It will be difficult for them to do more than this, at this stage, given that the detail and timing of any further reform remains quite unclear.

The story is different, though, for UCITS V. Practitioners need to understand the new requirements of UCITS V and should be evaluating its impact on their clients’ businesses. It will particularly affect those with clients in the asset management, custodian and depositary spheres. Practitioners should be urging these clients to examine their existing business structures, aiming to identify any gaps and develop roadmaps to compliance.

More specifically, practitioners with depositary clients will need to analyse the impact of the new cash monitoring, safekeeping, delegation and liability requirements. Under the AIFMD, for instance, we have seen the new liability provisions cause depositaries to review their sub-custody networks and determine if changes are needed to initial and on-going due diligence processes. Depositary agreements will also need to be repapered and negotiated. For those with asset management clients, it is important to grasp the new remuneration requirements and carry out gap analyses to establish the extent to which existing structures need to change. Fund prospectuses, key investor information documents and related documentation may also need to change to reflect the new rules in relation both to remuneration and depositaries.

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.