The worrying impacts of various aspects of the Ucits V rules have been lessened by the European Union although what the final rules of this directive will contain remains to be seen.
The European vote allowing variable fund manager remuneration was not the only successful amendment to Ucits V rules earlier this month. According to the IMA several other worrisome sections of the directive were lessened, although what the final rules will contain remains to be seen.
Ucits V is the latest draft of European Union-wide rules governing funds with the objective of a single market and allowing them to be sold cross border. The latest version contains a number of elements that could impact advisers, investors and fund managers. Among these are rules on fund manager remuneration, sanctions and investor protection and the function of depositories.
Many in the industry have been gratified to see greater flexibility in manager remuneration allowed by the directive as there has been fear a cap would restrict asset management groups from hiring and/or retaining talented managers.
In response to the early July European vote on Ucits V, Daniel Godfrey, IMA chief executive, said: “The European Parliament has voted for proposals that drive true alignment between asset managers’ pay and the interests of our clients including; multi-year assessment for variable remuneration, to drive longer-term thinking; multi-year deferral, to enable clawback if things go wrong; and a requirement for asset managers not only to disclose their remuneration policies, but also to say how those policies meet the objective of aligning to client outcomes.”
While an important concession for the fund management industry, the problem has less to do with investor protection than other key parts of Ucits V that have also been amended. These include rules governing depositories.
According to Julie Patterson, director, authorised funds and tax, at the IMA, Ucits V has offered a welcome push to unify the rules on depositories on a EU-wide level. Currently there is effectively little more than a single sentence governing their role in safeguarding client assets, she says.
According to KPMG the problem of depositary duties was brought to the fore by the Lehman Brothers default and the Madoff fraud. The European Commission also wants to see the duties of depositories aligned with the rules imposed by the Alternative Investment Fund Managers Directive (AIFMD), it said.
True alignment between asset managers’ pay and the interests of clients
The EC’s text on Ucits V states: “The principal Ucits rule is that all assets of a Ucits fund must be entrusted to a depositary. This depositary shall, in accordance with national law, be liable for losses suffered as a result of a failure to perform its duties. The Ucits Directive, apart from employing a negligence-based standard, makes reference to national laws in respect of the precise contours of these duties. This reference leaves considerable scope for diverging interpretations regarding the scope of a depositary’s duties and the liability for the negligent performance thereof. As a result, different approaches have developed across the EU, leading to Ucits investors facing uneven levels of protection in different jurisdictions.”
However, there were several proposed rules in Ucits V that stood to negatively affect UK funds as a result of these new restrictions.
Key among these has been the actual definition of who can stand as a depository for an Ucits fund. The Commission proposed that only those entities that are banks or “investment firms” (eg brokers) could function in this capacity.
Patterson says this would have been problematic in the UK where many of the depositories are banks but others are specialist entities within banking groups that are themselves neither deposit takers nor investment firms. “Yet the rule, as it was written, would have allowed a broker or asset manager to be the depository.” This definition has now been amended to allow for the way the UK currently operates, Patterson says.
Another worrisome rule within the proposed directive has also been amended to ease its potential negative implications, one of which could have led to funds invested in non-EU assets move outside the Ucits framework altogether.
The draft rule stated that whatever jurisdiction in which a fund is invested a clear insolvency law opinion would be needed. This was intended to ensure depositories and custodians have a clear idea if something goes wrong the fund would be sure to get its money back, Patterson says. “A clear legal opinion is a very difficult thing to achieve in every developed country but harder still in many frontier countries,” she adds.
With the liability and due diligence in this area so high, the effect of such a rule would likely have been to push funds such as emerging market portfolios outside the Ucits framework, she posits.
The argument that such legal clarity regarding insolvency is unreasonable and there are other just as effective ways of ensuring investor protection appears now to have been somewhat successful. The Ucits V vote by the Parliament has passed an altered version of the depositories requirement with the additional words “makes adequate arrangements,” Patterson explains. While this has loosened the legal clarity requirement it is not yet certain as Ucits V still has further to go before the final rules are in place.
EU member states still need to see the final European Council text, and only once this has been received can a trilogue between the three entities – the Commission, the Parliament and the Council – begin, Patterson says. This, she adds, is unlikely to start until the autumn.
Potentially another proposal within the Ucits V directive could also prolong final approval. Although in the UK the regulator, the FCA, can impose sanctions on depositories if a rule breach occurs, it is not necessarily the case in all EU jurisdictions. The expansion of regulatory supervision in this area may require constitutional changes in some EU countries, Patterson says.
Without greater unification on regulator sanctions, UK investors may be impacted if they are invested in an offshore fund that subsequently experiences a problem. Without regulatory power to resolve such issues quickly or to impose sanction, such an investor could be left beholden to a foreign court.