Supplements » Luxembourg 2011

UCITS V: No breathing space

CorsetCustodians had barely had time to take a breath following discussions around the controversial AIFM Directive, when suddenly Ucits V was tabled, rekindling the debate on depository responsibility, says Angele Spiteri Paris

The Ucits IV regulation has barely made it out of the gates when the first draft of what is dubbed “Ucits V” is already nipping at the industry’s heels. Like its regulatory cousin, the Alternative Investment Fund Managers Directive (AIFM), this latest EC consultation document on the Ucits despository function threatens to thrust greater responsibility on custodian banks, which means that for them that Ucits V could be as contested and as controversial as the AIFM.

Throughout the discussions on AIFM, despository banks fought tooth and nail to make sure they don’t become insurers for the asset management industry. 

And although AIFM has not yet been finalised, most custody banks feel the document has now been brought to a point where there is less danger of them becoming their clients’ insurers.

Sandrine Leclercq, general counsel at Caceis, says: “Interested parties were able to find a practical solution that stipulates that depositories should be responsible for anything they can control.”

But the Ucits V draft being tabled could take that comfort away.

The consultation paper issued by the EC on the Ucits despository function and on the Ucits managers remuneration was up for discussion during January.

The document was issued in mid-December 2010 and the industry was given six weeks to submit its response – an issue that was criticised by a number of industry players and is discussed later in this article.

After speaking to industry experts, it seems as though the issue on remuneration is not too much of a problem. By and large it was anticipated and does not, or at least should not, cause reverberations across the market.

But what could make players, custodians in particular, feel like they’re back to square one is the possibility of increased liability for despository banks that is outlined in the consultation document.

For them, this is disheartening, and they say it is a potential danger for the industry and its future wellbeing.

Most market participants spoken to by Funds Europe said the prospect of increased custody responsibility within the Ucits framework is of great concern.

Serge D’Orazio, head of investment funds and global custody services, KBL European Private Bankers, sums it up, saying: “Bankers are not insurance companies.”

The argument that custodians are not insurers for the asset management industry was made loud and clear in the consultations on the AIFM Directive and some essence of what they were saying seems to have got through.

Leclercq, at Caceis, says: “We would hope that the Ucits V regulation will be comparable to AIFM. Within AIFM, the prospect of being made responsible for elements we cannot control is not such a concern.”

Now custodians are facing the same battle, but this time within a Ucits context, which might actually make their cause more difficult to contend with.

Investor protection
Some may think that the Ucits framework, famed for its robustness and transparency, already provides sufficient investor protection. But, in the wake of AIFM, the issue of the despository bank responsibility within Ucits could seem to be wanting.

One market observer said: “If one were to question the need for increased despository responsibility, you would be more right to question it in an alternatives context rather than within that of Ucits.” 

 The client group the AIFM Directive is trying to protect are professional investors while Ucits deals with the retail market. Therefore, it would follow that if the despository responsibility around products for professional investors is so great, the protection around retail products should be just as great, if not greater.

Jean-Marc Goy, counsel for international affairs at the CSSF, the Luxembourg regulator, says: “Now that we have come to an agreement about the despository responsibility in AIFM, the proposal of the EU Commission to extend these requirements to the Ucits framework  makes sense.”

Nathalie Dogniez, partner, head of investment funds, KPMG, says: “It doesn’t make sense to have stricter rules in the AIFM directive than in the Ucits one.”

Laurent Fessmann, partner at law firm Baker & McKenzie, says: "In principle, it would be sensible to have a more robust responsibility framework for the retail market compared to the non-retail sector. But the past, and likely the outstanding lawsuits, has shown that the liability outlined in Ucits III was sufficient to protect savings."

Clearly, the EC doesn’t feel that way.

One problem is that when putting in place that increased protection, regulators run the risk of creating a larger risk than the one they’re trying to avoid.

D’Orazio, at KBL, says: “If the responsibility of the despository bank is increased, then there will be a premium to be paid. After all, it has also to be underlined that over the last 25 years there was no other case like the Madoff one."

The danger of making custodians insurers for their clients was an issue already highlighted and discussed at length throughout the AIFM consultation process. 

Camille Thommes, director general at the Luxembourg funds association, Alfi, says: “Making the despository an insurer of the investment fund and be held liable in all circumstances for risks beyond their control could engender systemic risk. While we are supportive of the Commission’s approach to clarify and harmonise certain despository functions, we believe that one should properly assess the envisaged measures and the increased cost of additional protection ”.

If the measures are too strict, then the potential creation of systemic risk is very real. This is because a significant increase in the burden of responsibility leads to the cost of running that business also rising. 

The cost issue may then force many actors in the market to pack up their business, which in turn, will leave few players in a very concentrated market. In this environment, the systemic risk would be huge, thus defeating the goal of improving investor protection.

Thommes says: “This is exactly why you need to strike a balance between increased protection and fair distribution of responsibility.”

Whether this balance will be found in this first round of Ucits V discussions is a matter still to be seen. 

Fessman says: “It will be useful to strengthen and clarify the position of the Ucits despository bank, providing the cost of doing that won’t be higher than the benefits of investor protection.”

“Ucits rules should be aligned with those of the AIFM Directive. Going beyond that would create unjustified differences and impose additional costs and possibly reduced investment in Ucits vehicles,” says Jean Michel Loehr, chief industry and government relations at RBC Dexia Investor Services.

Dogniez, at KPMG, believes some of the concerns expressed may by jumping the gun.

“The regulation is still at the consultation phase so its premature to say that it will lead to the creation of systemic risk,” she warns. 

 “However, a too-extreme approach could lead to systemic risk if it would end up in reducing the number of custodian banks to a few global players only and could even restrict the type of investments custodian will accept to take on board,” Dogniez adds.

According to D’Orazio, the custodian’s responsibility was already well-defined under Ucits I. He says: “The custodian needs to know where and how the assets are invested and any sub-custodian appointed under the Custodian’s supervision needs to be reputable, competent and have sufficient financial resources.

“This responsibility alone is already far-reaching and I think we’ve always lived up to our responsibilities.”

The one thing the majority of the industry players commented on was the short turnaround time the EC gave for responses.

Thommes, at Alfi, says: “The general comment from our members has been that the consultation period is too short. The financial crisis brought about new regulation with short timeframes and it may be difficult to have to work out a proper response. The deadlines are set by the EC/Esma, which are under a lot of pressure themselves.”

Catherine Brady, Emea investor services business head, Citi, says: “The fact that the consultation period is just six weeks is definitely a concern. This directive is going to have a greater influence in many respects than AIFM Directive as it impacts a €6trn business.”  

Also, because the deadline was so tight, a number of players said they are not formulating their own company response, but rather are relying on Alfi and industry associations to respond on their behalf.

One market participant says: “We’re not sure we’re going to respond to the consultation. It’s hard to justify the commitment it takes to put together a credible response within this timeframe.”

Thommes, at Alfi, says: “It is important to respond to consultations and take the opportunity to present your views. It’s clear that new proposals and new consultations create an additional workload but I wouldn’t recommend interested parties to abstain from participating.”

Goy says: “Abstaining is not a very constructive approach. One of the complaints around AIFM was that there was not enough consultation. Therefore, any opportunity to consult should be taken and not missed.”

Having organisations not responding to the consultation could throw the relevance of it into question. D’Orazio says: “The short timeframe could negate the consultation process because many players don’t have the time to respond.”

However, Goy from the CSSF, says: “We have to keep in mind that although, granted, the timeframe for the consultation is short, the two issues outlined in the document have already been discussed in the past, also by the industry.”

Others say the regulation was anticipated so interested parties should be ready to respond.

Leclercq, at Caceis, says: “The timeframe is short, but the majority of issues have already been debated within the framework of AIFM.” However, Brady, at Citi, disagrees. She says: “We understand the consultation process needs to be faster. Aligning the implementation with AIFM Directive will be targeted. However, the current timeline is not condusive to ensuring the establishment of a proportional legislative framework.” 

The EC said the tight deadline was given because  it intends to publish a legislative proposal early 2011 focused these issues. “Given the tight schedule to conduct the Commission's programme, it is not possible to allow a consultation period of eight weeks and the Commission believes that a period of – weeks should be enough for all stakeholders to provide evidenced contributions.”

At the time of going to press none of the responses had yet been published on the Commission’s website.

©2011 funds europe

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