FSO Alert: EU finalizes UCITS V negotiations
Upgrade of remuneration and depositary requirements
In February 2014, the European Union reached a compromise agreement on “UCITS V” – a Directive upgrading the UCITS requirements on remuneration policies, the depositary, as well as sanctions. The new requirements will have a substantial impact on many UCITS management companies and their depositaries. Certain elements remain to be clarified, including the applicability of the remuneration requirements to delegated portfolio managers.
In July 2012, the European Commission issued a proposal for a Directive amending the UCITS Directive (Directive 2009/65/EU) as regards depositary functions, remuneration policies and sanctions, generally known as “UCITS V”.
Following 18 months of discussions, the European Parliament, the Council of the European Union and European Commission reached a compromise agreement on the “UCITS V” text in February 2014.
The proposed amendments to the UCITS Directive on depositary and remuneration are broadly in line with the provisions of the Alternative Investment Fund Managers (AIFM) Directive.
Management companies will be required to establish and apply remuneration policies and practices that:
- Are consistent with and promote sound and effective risk management and do not encourage risktaking which is inconsistent with the risk profiles, or constitutional documents, of the UCITS they manage
- Do not impair compliance with the management company’s duty to act in the best interest of the UCITS
The proposal covers requirements on:
- Remuneration policies and practices
- Remuneration principles to be complied with by managers
- Remuneration committee, for management companies which are significant in terms of their size or the size of the UCITS they manage, their internal organization and the nature, the scope and the complexity of their activities
- Disclosure in the prospectus, Key Investor Information (KII) Document and annual report
|Key UCITS V provisions on remuneration|
Categories of staff in scope
The remuneration policies and practices apply to those categories of staff, including senior management, risk takers, control functions and any employee receiving total remuneration that falls within the remuneration bracket of senior management and risk takers whose professional activitieshave a material impact on the risk profiles of the management companies or of the UCITS they manage.
The Board of Directors adopts the remuneration policy, reviews it at leastannually, and is responsible for its implementation. Members of the Board who are part of executive management are excluded from this Board role.
Performance related remuneration
Where remuneration is performance related, the total amount of remuneration must be based on a combination of the assessment of the performance of the individualand of the business unit or UCITS concerned and their risks and of the overall results of the managem ent company, taking into account financial as well as non-financial criteria.
|Variable remuneration in shares or units of the UCITS||A substantial portion, and in any event at least 50% of any variable remuneration consists of shares or units of the UCITS concerned, or equivalent ownership interests, or share-linked instruments or equivalent non-cash instruments with equally effective incentives.|
|Deferral of variable remuneration||At least 40% of the variable remuneration must be deferred over a period which is appropriate in view of the holding period recommended to the investors of the UCITS concerned and is correctly aligned with the nature ofthe risks of the UCITS in question, and at least three years; where variable remuneration component of a particularly high amount, at least 60% of the amount must be deferred.|
|Pre-investment disclosure|| |
The prospectus must include a summary of the remuneration policy. Both the prospectus and KII must include a statement that the following information is available on the website, and include a link to the website:
Alternatively, details of the up to date remuneration policy and the other aforementioned information may be disclosed in the prospectus.
|Annual disclosure|| |
The annual report of the UCITS must include information on:
ESMA is to issue guidelines on remuneration policies under UCITS V; these guidelines may, inter alia, clarify the applicability of the remuneration requirements to delegated portfolio managers.
The proposal covers:
- The appointment of the depositary, including the content of the contract
- Eligible entities
- Duties of the depositary:
- Safe-keeping of financial instruments and other assets, including provisions on the reuse of assets
- Cash flow monitoring
- Monitoring and oversight
- Provision of information to competent authorities
- Loss of financial instruments held in custody
- Other losses
- Delegation of safe-keeping:
- Conditions for delegation
- Delegation and liability
|Key UCITS V provisions on the depositary|
Cash flow monitoring
The depositary is required to ensure that the cash flows of the UCITS are properly monitored, and in particular that all payments made by or on behalf of investors upon the subscription of units of the UCITS have been received, and that all cash of the UCITS has been booked in cash accounts that meet the minimum conditions.
Safekeeping of financial instruments
The depositary is required to hold in custody all financial instruments that may be registered in a segregated financial instruments account opened in the depositary’s books and all financial instruments that can be physically delivered to the depositary.
Reuse of assets
The assets held in custody by the depositary may only be reused if:
|Delegation of safekeeping||The depositary can only delegate safekeeping tasks. It must demonstrate that there is an objective reason for the delegation and perform adequate initial due diligence and ongoing monitoring of the delegate.|
|Central securities depositaries (CSD)||If the UCITS entrusts the custody of securities to a CSD, this should be considered a delegation of custody function unless the CSD acts as the issuer of the securities concerned.|
|Protection of assets from bankruptcy of sub-custodian||The depositary must take all necessary steps to ensure that in the event of insolvency of the third party, assets of a UCITS held by the third party in custody are unavailable for distribution among or realisation for the benefit of creditors of the third party.|
|Liability||The depositary is liable to the UCITS and to the unit holders of the UCITS for the loss by the depositary or a third party to whom the custody of financial instruments held in custody has been delegated.|
|Inventory of assets|| |
The depositary is required to provide the management company or the investment company, on a regular basis, with a comprehensive inventory of all of the assets of the UCITS.
The text lists a number of cases where EU Member States must impose sanctions on the UCITS, its management company or depositary. Possible sanctions include:
- A public statement which identifies the person responsible and the nature of the breach
- Suspension or withdrawal of authorization
- Banning the persons responsible from exercising management functions in such companies
- Fines of at least €5m or an equivalent amount on a natural or legal person, or at least twice the amount of the benefit derived from the infringement
The agreed text must be voted by the European Parliament and approved by the Council of the European Union. A vote in the European Parliament may be scheduled before the European elections in May 2014. Member States have 18 months after the entry into force of the Directive to transpose it into national law.
How EY can help
EY supports management companies in the practical implementation of the remuneration guidelines including:
- A diagnostic to assess the impact of the remuneration requirements on the management company itself and the group structure, and proposing amendments, if relevant
- Supporting the identification of key staff, review and upgrade of remuneration policies and practices, including performance related remuneration, in line with UCITS V requirements
- Reviewing individual remuneration packages
- Supporting remuneration disclosures
EY assists depositaries and sub-custodians in the implementation of effective and compliant operating models under UCITS V. We offer:
- A diagnostic to assess readiness for UCITS V, provide an overview of opportunities and challenges, the options available and the amount of work associated with each
- Detailed gap analysis of the main strategic opportunities and operational challenges to meet the UCITS V requirements
- Assessment of the adequacy of the risk management process, delegation arrangements and sub-custody network management, and rehypothecation arrangements
- Development and implementation of an operational change program including:
- Updating of policies and procedures
- Articulating business requirements
- Specifying functional and IT requirements
- Review of pricing structures
- Training on depositary issues under UCITS V and AIFMD requirements
Download the FSO alert (pdf, 2mb).