The fifth iteration of the Undertakings for Collective Investment in Transferable Securities Directive (UCITS V) is scheduled to be implemented throughout the European Union by March 18, 2016 (Implementation Date). Although the scope of the UCITS V Directive is relatively modest and largely in line with equivalent provisions of the Alternative Investment Fund Managers Directive (AIFMD), time is running out for managers to consider how to comply with the new measures ahead of the Implementation Date.
This Update is designed to assist UCITS managers in assessing their readiness for UCITS V by providing an overview of the main requirements, together with a summary of the key steps to be taken in order to comply, which include:
Acknowledging the limited transitional provisions under UCITS V and the potential difficulties for management companies in updating the relevant documentation by the Implementation Date, the Financial Conduct Authority (FCA) has authorized management companies of UCITS established in the United Kingdom to update (i) the relevant information in the prospectus at the next planned update by September 17, 2016, and (ii) the KIID at the next annual update after the Implementation Date. That said, the FCA encourages management companies to publish on a website the additional information about the depositary and the management company’s remuneration arrangements, to the extent available. However, it is appearing unlikely that national regulators of other key UCITS jurisdictions, including Ireland and Luxembourg, will be granting a similar grace period for the update of offering documents.
Remuneration is another key area where UCITS managers are likely to benefit from implementation leeway. Subject to final remuneration guidelines from the European Securities and Markets Authority (ESMA), UCITS management companies and investment managers that fall within the scope of the remuneration rules will most likely not be required to apply the UCITS remuneration principles until they commence their first full performance period starting on or after March 18, 2016 (e.g., if the accounting period of a UCITS management company ends on December 31 of each year, the remuneration principles will apply for the first time in relation to the accounting period ending on December 31, 2017).
UCITS V Overview – What Will Change?
A summary of the impact that UCITS V will have on the UCITS framework is described below.
A. Remuneration Policies and Practices
UCITS V introduces the requirement for UCITS management companies (or self-managed UCITS) to put in place remuneration policies and procedures to promote sound and effective risk management and to discourage short-term risk taking. The remuneration policies and procedures must comply with certain principles and will apply to all “risk takers,” senior management and employees whose activities have a material impact on the risk profile of the UCITS. The remuneration rules are subject to the principle of proportionality, whereby UCITS management companies (or self-managed UCITS) are required to apply the remuneration principles, “in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities.”
On October 29, 2015, ESMA published responses to its consultation concerning guidelines on sound remuneration policies under the UCITS V Directive and the AIFMD (Consultation). ESMA is yet to publish its final remuneration guidelines based on the feedback it has received on the Consultation and, while these are expected to be published in Q1 2016 (prior to the UCITS V directive transposition deadline), recent reports have indicated that the final text may not be issued until after this date. That said, the Consultation, as well as the responses to the Consultation, have given UCITS managers some indication as to where ESMA is likely to be heading in its final guidelines – and the position seems fairly accommodating for third-party investment managers. In particular, ESMA proposes to allow the principle of proportionality to disapply certain remuneration rules, as well as in relation to delegates performing portfolio management activities who are already subject to remuneration rules that are “equally as effective,” such as AIFMD or CRD IV rules.
B. Depositary Functions and Liability
Every UCITS must appoint a single depositary, which can be an EU credit institution, a national central bank or another entity authorized by an EU Member State to act as a depositary of a UCITS.
In addition to its current safe-keeping and oversight responsibilities, UCITS depositaries will be required to carry out cash-flow monitoring functions similar to those required under AIFMD. While depositaries may delegate their safe-keeping functions to third parties (subject to certain conditions), oversight responsibilities and cash monitoring may not be delegated.
Further, a “strict liability” standard will be introduced in the context of the loss of financial instruments held in custody. In the event of such loss by a depositary (or its delegate), an obligation will be imposed on the depositary to replace the financial instrument or pay the corresponding value to the UCITS without undue delay. Strict liability may only be avoided where the depositary is able to prove that the loss of a financial instrument was 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.”
C. Breaches and Sanctions
UCITS V introduces a list of breaches that must be enforced by national regulators, as well as a selection of administrative sanctions.
UCITS V Compliance – What Are the Next Steps?
In order to assess your readiness for UCITS V, we suggest you evaluate the following documentation and governance practices:
A. Have Remuneration Policies and Procedures Been Established or Revised?
The new UCITS V framework will require UCITS management companies to take the following steps in order to comply with the new remuneration requirements:
As has been the case with AIFMD, UCITS management companies will contractually require entities to which investment management activities have been delegated to comply with the remuneration principles. That said, the remuneration rules may be disapplied for delegate investment managers that are subject to regulatory requirements on remuneration that are “equally as effective” as those under UCITS V.
B. Has the Prospectus Been Updated to Include Prescribed UCITS V Disclosure?
The following additional disclosures must be reflected in the prospectus:
Each KIID must also contain a statement that the details of the up-to-date remuneration policy are available on a specified website and upon request.
C. Has the Depositary Agreement been Amended?
In addition to ensuring that the UCITS has appointed a single eligible depositary, UCITS management companies must update the depositary agreement (or enter into a new agreement) to reflect, inter alia, the following requirements introduced by UCITS V:
UCITS established as unit trusts will be required to enter into a depositary agreement for the first time. Accordingly, the trust deeds of existing unit trusts are likely to require amendments to enable the power for such an agreement to be entered into.
UCITS depositaries appointed prior to the Implementation Date that do not meet the new UCITS V eligibility criteria may continue to be retained until March 18, 2018.
D. Will UCITS V Also Impact the Content of Financial Reports?
Yes. Similar in scope to the disclosure requirements under AIFMD, UCITS annual reports will be required to include the following additional information:
Given the potential impact of the remuneration rules on delegates, third party investment managers are also likely to be caught within the above disclosure requirements.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
Sidley Investment Funds Practice
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This Update is designed to assist UCITS managers in assessing their readiness for UCITS V by providing an overview of the main requirements, together with a summary of the key steps to be taken in order to comply, which include:
- the establishment or revision of remuneration policies and procedures;
- changes and additional disclosure to be reflected in the prospectus and key investor information document (KIID);
- amendments to the depositary agreement; and
- additional disclosure to be reflected in the financial reports.
Acknowledging the limited transitional provisions under UCITS V and the potential difficulties for management companies in updating the relevant documentation by the Implementation Date, the Financial Conduct Authority (FCA) has authorized management companies of UCITS established in the United Kingdom to update (i) the relevant information in the prospectus at the next planned update by September 17, 2016, and (ii) the KIID at the next annual update after the Implementation Date. That said, the FCA encourages management companies to publish on a website the additional information about the depositary and the management company’s remuneration arrangements, to the extent available. However, it is appearing unlikely that national regulators of other key UCITS jurisdictions, including Ireland and Luxembourg, will be granting a similar grace period for the update of offering documents.
Remuneration is another key area where UCITS managers are likely to benefit from implementation leeway. Subject to final remuneration guidelines from the European Securities and Markets Authority (ESMA), UCITS management companies and investment managers that fall within the scope of the remuneration rules will most likely not be required to apply the UCITS remuneration principles until they commence their first full performance period starting on or after March 18, 2016 (e.g., if the accounting period of a UCITS management company ends on December 31 of each year, the remuneration principles will apply for the first time in relation to the accounting period ending on December 31, 2017).
UCITS V Overview – What Will Change?
A summary of the impact that UCITS V will have on the UCITS framework is described below.
A. Remuneration Policies and Practices
UCITS V introduces the requirement for UCITS management companies (or self-managed UCITS) to put in place remuneration policies and procedures to promote sound and effective risk management and to discourage short-term risk taking. The remuneration policies and procedures must comply with certain principles and will apply to all “risk takers,” senior management and employees whose activities have a material impact on the risk profile of the UCITS. The remuneration rules are subject to the principle of proportionality, whereby UCITS management companies (or self-managed UCITS) are required to apply the remuneration principles, “in a way and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities.”
On October 29, 2015, ESMA published responses to its consultation concerning guidelines on sound remuneration policies under the UCITS V Directive and the AIFMD (Consultation). ESMA is yet to publish its final remuneration guidelines based on the feedback it has received on the Consultation and, while these are expected to be published in Q1 2016 (prior to the UCITS V directive transposition deadline), recent reports have indicated that the final text may not be issued until after this date. That said, the Consultation, as well as the responses to the Consultation, have given UCITS managers some indication as to where ESMA is likely to be heading in its final guidelines – and the position seems fairly accommodating for third-party investment managers. In particular, ESMA proposes to allow the principle of proportionality to disapply certain remuneration rules, as well as in relation to delegates performing portfolio management activities who are already subject to remuneration rules that are “equally as effective,” such as AIFMD or CRD IV rules.
B. Depositary Functions and Liability
Every UCITS must appoint a single depositary, which can be an EU credit institution, a national central bank or another entity authorized by an EU Member State to act as a depositary of a UCITS.
In addition to its current safe-keeping and oversight responsibilities, UCITS depositaries will be required to carry out cash-flow monitoring functions similar to those required under AIFMD. While depositaries may delegate their safe-keeping functions to third parties (subject to certain conditions), oversight responsibilities and cash monitoring may not be delegated.
Further, a “strict liability” standard will be introduced in the context of the loss of financial instruments held in custody. In the event of such loss by a depositary (or its delegate), an obligation will be imposed on the depositary to replace the financial instrument or pay the corresponding value to the UCITS without undue delay. Strict liability may only be avoided where the depositary is able to prove that the loss of a financial instrument was 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.”
C. Breaches and Sanctions
UCITS V introduces a list of breaches that must be enforced by national regulators, as well as a selection of administrative sanctions.
UCITS V Compliance – What Are the Next Steps?
In order to assess your readiness for UCITS V, we suggest you evaluate the following documentation and governance practices:
A. Have Remuneration Policies and Procedures Been Established or Revised?
The new UCITS V framework will require UCITS management companies to take the following steps in order to comply with the new remuneration requirements:
- identify the members of staff targeted by the new remuneration rules (Identified Staff);
- draft remuneration policies or revise existing remuneration policies and procedures in line with the new UCITS V requirements; and
- adjust recruitment practices and contractual arrangements of Identified Staff in line with the new requirements.
As has been the case with AIFMD, UCITS management companies will contractually require entities to which investment management activities have been delegated to comply with the remuneration principles. That said, the remuneration rules may be disapplied for delegate investment managers that are subject to regulatory requirements on remuneration that are “equally as effective” as those under UCITS V.
B. Has the Prospectus Been Updated to Include Prescribed UCITS V Disclosure?
The following additional disclosures must be reflected in the prospectus:
- details of the remuneration policy and procedures. The prospectus must include either details of the remuneration policy itself – including a description of how remuneration and benefits are calculated, the persons (including the composition of the investment committee, if any) responsible for awarding the remuneration and benefits – OR a summary of that policy and a statement that the details of the policy are available on a specified website and that a paper copy will be made available free of charge upon request;
- description of any safe-keeping functions delegated by the depositary, including a full list of delegates and sub-delegates; and
- disclosure of any conflicts of interest that may arise from the delegation of safe-keeping duties by the depositary as well as any potential conflicts of interest between the UCITS (or its investors), the management company and the depositary (to the extent not yet disclosed in the prospectus).
Each KIID must also contain a statement that the details of the up-to-date remuneration policy are available on a specified website and upon request.
C. Has the Depositary Agreement been Amended?
In addition to ensuring that the UCITS has appointed a single eligible depositary, UCITS management companies must update the depositary agreement (or enter into a new agreement) to reflect, inter alia, the following requirements introduced by UCITS V:
- an updated description of the services to be provided by the depositary (as its duties will extend beyond safe-keeping and oversight to include cash-flow monitoring);
- changes to the liability provisions to reflect the new “strict liability” standard (i.e., full liability for the loss of financial instruments);
- new delegation requirements and restrictions (e.g., proper justification for delegation and the depositary’s requirement to carry out initial and ongoing due diligence of its delegates); and
- references to the reuse of assets held in custody by the depositary or its delegates in line with the new restrictions.
UCITS established as unit trusts will be required to enter into a depositary agreement for the first time. Accordingly, the trust deeds of existing unit trusts are likely to require amendments to enable the power for such an agreement to be entered into.
UCITS depositaries appointed prior to the Implementation Date that do not meet the new UCITS V eligibility criteria may continue to be retained until March 18, 2018.
D. Will UCITS V Also Impact the Content of Financial Reports?
Yes. Similar in scope to the disclosure requirements under AIFMD, UCITS annual reports will be required to include the following additional information:
- the aggregate amount of remuneration for the financial year, split into fixed and variable remuneration paid by the management company and by the investment company to its staff, together with the number of beneficiaries and, where applicable, performance fees paid by the UCITS;
- the aggregate amount of remuneration broken down by category of employees or other staff members;
- a description of how the remuneration and the benefits have been calculated;
- the outcome of the periodic reviews of the remuneration policy and its implementation; and
- a description of any material changes to the existing remuneration policy.
Given the potential impact of the remuneration rules on delegates, third party investment managers are also likely to be caught within the above disclosure requirements.
If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or
| James Oussedik Partner +44 20 7360 2057 JOussedik@sidley.com |
Stephen Ross Partner +44 20 7360 2080 SRoss@sidley.com |
Leonard Ng Partner +44 20 7360 3667 LNg@sidley.com |
Sidley Investment Funds Practice
To receive Sidley Updates, please subscribe at www.sidley.com/subscribe.
Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300; One South Dearborn, Chicago, IL 60603, 312.853.7000; and 1501 K Street, N.W., Washington, D.C. 20005, 202.736.8000.