The role of the Luxembourg depositary under UCITS V

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Funds Europe
March 2011

The European Commission launched a Consultation on the UCITS depositary function and on the UCITS managers’ remuneration on 14 December 2010. One of the objectives of the consultation is to better clarify the UCITS’ depositary function which was last reviewed at EU level in 1985. The Commission is aiming to improve investor protection by developing a solid, harmonized EU framework for depositaries. The challenges for depositaries will be to understand and prepare for the implications of their redefined role.

Retail and institutional investors often choose UCITS investment funds to invest their savings. As noted in the European Commission Feedback Statement - Summary of Responses to UCITS Depositaries Consultation Paper, the depositary is an institution in which investors can place their trust for keeping their savings (investment fund assets) safe. The Commission has initiated its review to ensure, in particular, that investors can be confident that they will not face losses associated with the safekeeping of their assets.

Specifically, the consultation paper proposes to clarify the roles of the depositary, and also the related liability regime. Furthermore, the Commission would like to ensure that there is overall consistency between the legislation applicable to the depositaries of UCITS and that applicable to the depositaries of alternative investment funds, laid down in the Alternative Investment Managers Directive.

Overall, the depositary has two main roles: i) oversight and monitoring and ii) safekeeping, often referred to as custody.

Regarding the oversight duties, the Commission proposes to further clarify the scope of UCITS depositary supervisory duties, such as those over the calculation of the Net Asset Value (NAV).

Overall, depositaries have two types of safekeeping tasks: those related to financial instruments (such as shares) that can be held in custody and monitoring other types of assets (such as cash deposits). The proposal aims to clarify the scope of these safekeeping duties. In order to ensure that the UCITS assets are fully protected, the proposal also requires segregation of financial instruments held on behalf of a UCITS from the depositary's own assets at all times.

The depositary may delegate all or part of its safekeeping tasks to a sub-custodian. The proposal elaborates on the conditions applicable to the delegation of depositary activities, inter alia, requiring the depositary to demonstrate that there is an objective reason for the delegation and clarifying the depositary's diligence duties relating to selecting, appointing and ongoing monitoring of a sub-custodian.

On the depositary liability regime, the proposal clarifies that the depositary is liable in cases of loss suffered by UCITS as a result of a depositary's negligent or intentional failure to perform its duties or in case of loss of assets. The depositary will be obliged to return financial instruments of an identical type or of a corresponding amount to the UCITS (except in case of “force majeure”). It is proposed that the same level of liability will apply to the depositary where safekeeping tasks have been entrusted to a sub-custodian. The Commission suggests that the depositary should, in future, carry the burden of demonstrating that it has complied with its obligations in a situation where failure to perform its duties is alleged.

It is widely acknowledged that the proposal will result in increased investor protection through the strengthening of the depositary’s role, the clarification of depositary oversight responsibilities and the extension of depositary liability. Such increased protection may, however, come at an additional cost to investors.