On 18 December 2015, the European Commission published the long-awaited official draft of the UCITS V Level 2 Regulation. The Level 2 Regulation relates to depositary issues only and there are very few substantive changes between the official draft and the draft leaked in mid 2015. The draft Level 2 Regulation supplements the Level 1 Directive provisions regarding certain requirements imposed on the depositary, namely:
- The minimum contents of the contract between the management company/UCITS and the depositary (the official draft deletes the requirement set out in the leaked draft that the depositary agreement must actually state that the depositary’s liability shall not be affected by any delegation of its safe-keeping functions).
- The duties and obligations of the depositary namely safe-keeping, custody and ownership verification, record-keeping, cash monitoring and oversight.
- Due diligence and asset segregation obligations of depositaries when appointing delegates to perform safe-keeping duties. The official draft includes a provision, not in the leaked draft, requiring the depositary put in place a decision-making process for choosing third parties to whom it may delegate the safekeeping function. These processes should be based on objective pre-defined criteria and meet the sole interest of the UCITS and the investors of the UCITS. As the depositary is already subject to rigorous obligations in the context of the selection and ongoing monitoring of delegates, this new requirement is not particularly onerous.
- The conditions and circumstances in which the depositary will and will not bear responsibility when financial instruments held in custody are considered to be lost by a depositary or third party.
- Steps to be taken by a third country delegate or third country sub-delegate of the depositary to ensure that in the event of insolvency of the delegate/sub-delegate, assets held in its custody are unavailable for distribution or realisation for the benefit of its creditors.
- The conditions for fulfilling the requirement that the management company and depositary must act independently and solely in the interests of the unitholders. The official draft includes a provision, not in the leaked draft, that where the management company/fund appoints a depositary to which it has a link or group link, (i.e. 10% or more of the capital or voting rights or exercises a significant influence over management), it must keep documentary evidence of an assessment comparing the merits of a depositary with a link/group link with the merits of an independent depositary, together with a report describing the way in which the appointment meets the objective pre-defined criteria and is in the sole interest of the UCITS and its investors. The costs, expertise, financial standing and quality of service provided by all of the depositaries assessed must be taken into account in carrying out this assessment.
If neither the Council of the EU or the Parliament object to the proposed Level 2 Regulation, it will be published in the Official Journal of the EU and enter into force 20 days following that publication (due to occur in March 2016). The Regulation is due to apply 6 months after the date of its entry into force meaning that there will be a divergence between the application date of the UCITS V Level 1 measures (18 March 2016) and the Level 2 Regulation. It is anticipated that, in many instances, both depositaries and management companies/UCITS will strive to take account of the Level 2 Regulation when putting in place arrangements for compliance with Level 1.
It is anticipated that the Central Bank will shortly issue its draft form for the content of UCITS V Depositary Agreements incorporating the draft Level 2 requirements.