Our panel considers questions that were posed in the Ucits V survey. What is clear is that much of the advancement towards the Ucits V environment rests on more guidance from Europe, and that those with AIFMD experience will benefit in the run-up to implementation.
William Gilson (Head of European operations, Babson Capital Management), Liz Moxham (Senior compliance manager, Aberdeen Asset Management)
Andrew Olding (Head of group fund services, F&C Asset Management), Paul Stillabower (Managing director, sales & distribution development, RBC Investor & Treasury Services)
Funds Europe: What action have you taken on Ucits V?
William Gilson, Babson Capital: If you are a Ucits manager that hasn’t gone through the AIFMD [Alternative Investment Fund Managers Directive] experience, you probably ought to be considering issues like remuneration and what the depositary is going to do on cash reconciliations. But if you have gone through AIFMD, then I think you can reasonably relax until more details come out.
Liz Moxham, Aberdeen AM: We initially started to look at Ucits V because Luxembourg said it wanted to implement early and we have a big Ucits range there. So that probably forced us to start. Having said that, the Luxembourg regulator has since announced that it can’t implement until the Level 2 requirements come out. So the original December implementation date in Luxembourg is to be pushed back to March. But working on the assumption that we’re not going to get the Level 2 details till fairly late in the day, there’s a very, very short timescale for implementation. A sensible approach is to use the AIFMD as a benchmark and plan now.
Andrew Olding, F&C: If you’ve been through the AIFMD experience, a lot of this is quite familiar, and if you’re used to operating a UK-regulated fund, there are some familiar concepts. We’ve had a depositary there for quite a long time and the responsibilities of that depositary have been enlarged by the AIFMD. They’ll be enlarged again under Ucits V. A lot of the core processes that we needed for the UK-regulated funds we were able to lift up and use from our Luxembourg clients and our Irish funds under AIFMD. That gives quite a robust platform to build out the infrastructure for Ucits V.
Paul Stillabower, RBC: There are some large outstanding and potentially disruptive issues that can only be clarified in the Level 2 documentation. One of these is the independence factor. Esma has suggested that the independence of the asset manager, management company (ManCo) and depositary is not an issue, but I’m not so sure. Everything I am hearing suggests there are mixed views on this.
Also, the way central securities depositaries (CSDs) are treated under Ucits V looks likely to be different than AIFMD. If CSDs are considered part of a network delegation, then that could be a challenge because CSDs don’t typically have a lot of capital and it is likely they wouldn’t meet standard network management criteria.
It is looking like funds and their prospectuses will have to list depositary networks, with information such as who is the sub-custodian in each market. That has a potential to cause a massive amount of repapering. From the experience with the AIFMD, when complex repapering is required, you can end up in a contractual scenario where there is a huge bottleneck at the end of the transition period.
Funds Europe: What stage are you at with reviewing contracts and fund arrangements? What has to change in contracts and agreements for you and your clients to achieve Ucits V compliance? How possible is it to make changes at present with the information available?
Stillabower: You can’t realistically repaper a contract until the Level 2 guidelines come out. One challenge is how the delegation of sub-custody will work outside of the EU. For the European Securities and Markets Authority (Esma), as long as assets are segregated in a sub-custodian’s books and records, then assets will be considered ring-fenced in the event of insolvency. This can be managed in Europe, where Esma has oversight; but is this actually the case outside of Europe? And there still has to be firm Level 2 guidance on how a prime broker as a sub-custodian will have to segregate assets.
Also, what happens in case of an insolvency of a sub-custodian in terms of segregation in a particular country if the rules on insolvency are not clear? Some countries don’t recognise segregation, so would the fund be able to get its assets back? Following Esma consultation, the idea was proposed that the depositary informs the ManCo and it is then up to the ManCo to act. But I don’t think that, in practice, this is likely to be recommended and the depositary may well end up having to make the decision in those scenarios.
Olding: The point around insolvency is really interesting from a UK perspective, because whenever we’ve had the discussions about what happens in an insolvency, the FCA’s rules on clients’ assets bump up against UK insolvency legislation. So from a very narrow UK perspective, Ucits V is quite welcome because it forces insolvency rules to be brought into line with regulation.
Ucits V will also reinforce something that the AIFMD started to crystallise, that separating your depositary and custody relationships is unhelpful and actually you want them together in the same organisation.
Gilson: Yes, there was an awful lot of scaremongering about the fees that depositaries were going to charge for AIFMD, and that didn’t come to fruition, and I don’t
think it will with Ucits V.
Stillabower: For small clients, there is a concern. It is not that they will not be serviced but the economics for providers could be less attractive, with small clients perhaps given a choice of either paying more or choosing a bundled service. The depositaries will naturally want to hold the asset that can be held in custody because that helps to mitigate their risk
A client could choose an independent depositary and an independent administrator, but I think over time the costs of doing that are going to be higher.
Funds Europe: Does the changing European landscape, including Ucits V, impact your view of the Ucits business? About 15% of respondents to our survey said they were concerned, but the majority see no impact. Are the 15% right to be concerned?
Gilson: They should only be concerned if they think the fees are going to go up. This is a directive for the investor, not for the manager, so the investor should feel happier. And for the asset manager, it may increase costs, but not dramatically. So I’m surprised anyone is saying it will be a concern.
Moxham: There was a bigger impact with the AIFMD because there were funds – private equity funds, for example – that were not used to operating in a regulated infrastructure, but I don’t think that will be the case for pure Ucits funds.
Stillabower: Ucits has some huge advantages on other fund types in terms of global distribution, legal infrastructure and brand that can appear to be unassailable. But I have one niggling concern that in Europe, the cost of regulation may begin to add up and in 10-15 years’ time, Europe could end up creating a model that is more costly than other jurisdictions. If you look at Asia, it has a demographic advantage and it is looking at fund passporting and other ways to compete with the Ucits brand.
Olding: If you set Ucits V in the context of all of the other European regulation that we’ve had, it is a relatively contained piece of regulation. We can just take it off the shelf, get it through the process and then start looking out for the next one. But when you add Emir, MiFID II, Solvency II, AIFMD and others, it all builds up and can feel like death by a thousand cuts.
Funds Europe: How will the new depositary laws make you examine your custody arrangements? The vast majority of survey respondents already comply with Ucits requirements or say they can adapt, and 14% say they do not know. How does the panel think custody models have changed?
Moxham: From my AIFMD experience, despite all the concerns about sub-custody in emerging markets, we certainly weren’t impacted. There were no markets we had to come out of or not go into, and I expect the same will happen with Ucits V. There is a slight difference in terms of the escalation process on potential loss implications and what we should do if there were an issue.
Stillabower: This is an area that requires the Level 2 guidelines – in particular about how assets are required to be held from a segregation standpoint, and the resulting escalation policy in the event of non-compliance. And also about how assets should be held by the prime broker when they are appointed as a sub-custodian of the depositary. Even with the AIFMD, which went live in July 2014, we are still waiting for the final guidelines on prime broker segregation.
Funds Europe: If the increased depositary liability will make you review your custodial arrangements, what are the key factors affecting your decisions? In the survey, product capabilities came out the strongest and geography also ranked highly. What does the panel make of that?
Gilson: You have to understand who you’ve appointed already and have clear reasons why you did. If any facts change, whether through regulation or any other driver, you have to consider whether that impacts your arrangement.
I don’t think Ucits V will be a reason to run requests for proposals for a new custodian, you just have to be able to ensure you are getting the appropriate deal at any point and are able to change.
Stillabower: Ucits is a bread-and-butter business for the top depositaries. The hard work involves the depositary network – repapering the contracts with clients. There may be some work needed in the future to make sure that costs remain under control and there are issues around forced bundling, but I don’t think getting this all over the line involves anything other than application and hard work.
Olding: Under AIFMD, we certainly haven’t had any difficulties opening or operating in markets where we’ve wanted to. So there’s some work to do with Ucits V, but I don’t believe it will affect our product range. It’s more about the investor strategies that we pursue, what market access we need and getting the right instruments to settle in a certain location.
Even prior to the recent acquisition of F&C by BMO, we already had that market access, but we still are well represented in emerging market strategies, which is probably the thorniest end to all of this. We’ve been able to do what we want in reasonable timescales.
Stillabower: Custodial services are available in the markets that are required, either directly or through sub-custodians. Most clients have investments in a maximum of 45-50 markets so I don’t see geography being an issue.
Funds Europe: We asked people if they were aware that Ucits V was going to require cash monitoring rules. The majority were, but nearly 25% were not. What does this quarter of respondents need to do now?
Moxham: Cash monitoring is part of our depositary operating model for our alternative investment fund managers (AIFs). We have a bundled deal, so the model that the depositary set up was very much leveraging off the fund accounting side.
We had to review the account opening process and keep the depositary involved in that. There was slightly more work involved with the AIFMD than with the Ucits model, as we could have cash accounts sitting outside the AIF. So there has been a learning curve, but I think there will be less impact from Ucits V as we can leverage off AIFMD.
Gilson: I originally thought this would not be a very big issue for Ucits, though it was a big issue for AIFMD – certainly the discussions of where it could have led to. There are a lot of AIFs with some interesting structures, and so where you stop monitoring the cash is an interesting point.
But while AIFs could be traded heavily, many are in fact seldom traded. Ucits are on average traded much more frequently. So where it wasn’t an issue for a real estate AIF, for a global equity Ucits fund that is being traded all the time, there could be more of an issue because of the increased cash flows, even though processes are STP [straight-through processing]. Even now, when we reconcile cash from our front-office system to our back-office system, to our fund accountant, to our custodian, you get breaks that you have to deal with, and adding the depositary could create more work. It is probably the biggest issue that needs to be addressed sooner rather than later.
Olding: I wonder whether it’s going to open up a discussion around whether transfer agency collection accounts are in the fund or outside the fund and where the scope of responsibility changes. The UK, and now Ireland, is moving towards money rules around those accounts. I sense we’re going to get bitten by one or the other, if not both.
The volume through those accounts is huge and inevitably there will be a lot of reconciliation brokers to deal with and it might be a concern for the depositary if the perimeter of Ucits V covers that.
Stillabower: The reality is all roads lead to the depositary. There are some interesting scenarios under the AIFMD. Real estate funds have an independent auditor and an independent valuation process for buildings. Private equity is slightly different and because of the complexity of the valuation process, a lot of the accounting is done in-house. So in practice, a depositary is potentially carrying more liability if it is not actually doing the accounting. Depositaries will start to look at smaller clients and it may be thought they need more oversight if there is an absence of the larger, perhaps more automated processes, or experienced operational managers.
The Level 2 guidelines are going to come out with a very strict implementation timetable and the industry will band together and get everyone over the line for the date that’s required, and then there will be a process where we all stand back and look at what has been done. That is what is happening with AIFMD now: the depositaries are looking at where they are doing more replication work than they originally expected.
Funds Europe: What will Ucits V mean for the availability of independent directors? Most people said that there is an adequate supply and that there will be no impact on the supply of independent directors. Does the panel agree?
Moxham: The experience we’ve had in Luxembourg and in Ireland is that independent directors have been challenged to demonstrate proportionality of time. But that does not mean they cannot take on these new rules or that there will be any difficulty.
Gilson: There are undoubtedly enough people who want to become independent directors, but there is a lack of good quality independent directors. And this whole issue of time is absolutely critical. If directors have more than 10 directorships, that is now a problem for the regulators. You need a board that covers everything; you need to have people who understand investment, who understand investment risk, who understand compliance, who understand operations. And you don’t necessarily have a large supply of all of those types of directors in places like
Luxembourg and Ireland.
Olding: The quest for the offshore director who provides sensible challenges on the investment fund is one that will continue.
Gilson: Yes, and the obvious consequence is that those people are just going to charge more; one reason is because they can, and the other is because they only have 10 directorships now, where before they may have had 20 or more.
Stillabower: Basic economics say that the supply will become scarcer and cost could increase as a result. If, as a director, I’m making £30,000 per fund and I’m serving 10 funds, and now I can only serve five funds, I may well then charge £60,000 per fund. This is an area that needs attention if we are to avoid Ucits potentially creating a more costly model.
Funds Europe: So the increased sanctions won’t put people off?
Gilson: Clearly not. There are more and more people making themselves available but they’re not necessarily the right profile.
Funds Europe: How will the costs, rates, responsibilities and involvement of any directors change as a result of Ucits V? The survey said costs were expected to rise by the majority, but with the most qualified directors attracting a premium.
Olding: It is about more than being qualified. There is a sense that style and ability will be more important than experience.
Gilson: They have to understand their responsibility as a director and act in that way and not just agree and tick boxes.
Funds Europe: Will insurance be mandatory for all independent directors? Many of the respondents said it will be, about 52%, and many do not know, 43%. So what’s the panel’s answer to this 43% that don’t know?
Olding: Even now there’s a commercial imperative to ensure that the board has got Directors & Officers cover and our practice is to help organise that for the fund, but I’d be really surprised if they weren’t already insured.
Funds Europe: Many people wouldn’t know whether directors themselves would have this cover in place or whether the fund would cover it automatically. The survey showed that 41% do not know.
Moxham: The normal expectation from independent directors is that the fund will cover it.
Olding: When you take on a new director, that’s one of the burning questions that you end up discussing and most commonly the fund will cover it.
Funds Europe: How will Ucits V impact your remuneration policies? The survey had a mix of answers. 28% are waiting for Level 2 measures; 29% say they have addressed this under AIFMD II; 20% say new policies will be required; and 16% want a remuneration committee.
Moxham: The biggest challenge we have found is all the other remuneration issues that come with MiFID II, CRD IV and AIFMD. Ideally we need a global-type remuneration directive, so our challenge is probably to align the directives to have a global policy...
Olding: If you have one fund manager involved with an AIF, a Ucits fund and a segregated mandate for an insurance company, there are three different codes to compensate one individual. You need one process.
Moxham: Maybe that’s where people could start doing some work, identifying those staff that will be captured by the different codes and where you set the level. There is the whole question of proportionality as well and time, and also the level at which you make those decisions – at management, committee level or executive committee level.
Olding: This is clearly the most politically sensitive part of the directive and other directives that are coming through. There’s a need to make sure that you’re focused on the spirit of the directive, which is to rebuild trust in financial services. From our perspective, we’ve got a process we’re happy with. This time last year, we were a listed company and had to have listed company governance around remuneration and we had a reasonably good infrastructure around remuneration committees and processes to support that. Now we need to wait for the detail and then we can work out how strict it is.
Moxham: With Ucits V, the focus seems to be on creating the remunerating package within the shares of the fund, whereas AIFMD gave us the flexibility to take the parent company shares as well. We have to look at how we square that circle and come up with different policies to cover the various different components.
Funds Europe: Presumably managers don’t want their remuneration coming in different shares.
Olding: We have a situation where we’ve got a substantial liability-driven investment practice, and delivering fractions of units in someone else’s liability profile to a fund manager, it just makes no sense. You have to look for another currency.
Gilson: There was a huge amount of huffing and puffing on remuneration for AIFMD, and a lot of time was wasted because a lot of asset managers felt that their remuneration was in the spirit of the directive but not within the rules of the directive and there was a reluctance to actually move to the latter. For Ucits V, anyone who doesn’t have these remuneration committees or processes needs to start huffing and puffing sooner rather than later.
Funds Europe: Will changes to remuneration fit your choice of using the Ucits vehicle? 66% say they will continue to use Ucits funds and 9% say they will choose a range of investments in future. What options do these providers have if not Ucits?
Gilson: I’m not sure where they’re going to go.
Olding: [If you wanted to avoid the remuneration rules], you always have to be somewhere else because in Europe it’s either a Ucits or it’s an AIF and you’ve got the same remuneration rules either way. Whilst the Ucits products are not impacted by the remuneration rules today, the implementation of Ucits V will harmonise the remuneration approach with AIFMD and mean that both products are captured.
Stillabower: It’s quite clear that the intention of the rule is to capture anyone in Europe or selling into Europe.
Gilson: That 9% [choosing a range of investment vehicles] should be closer to 100%. And that’s sort of the point – the investor has made the big decision before they come into a fund. More needs to be done to address that issue. They are trying to do it with MiFID II but will not achieve that investor protection with Ucits V.
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