Directive 2014/91/EU (“UCITS V”) came into force on 17 September 2014 and makes certain changes to Directive 2009/65/EC (the “UCITS Directive”), which sets out the re-stated regulatory regime applicable to undertakings for collective investment in transferable securities (“UCITS”). UCITS V makes changes to the recast UCITS Directive in relation to the following areas:
- Remuneration; and
The main policy goal underlying UCITS V is to (arguably belatedly) enhance the protections afforded to investors in UCITS funds as part of the overall European-level response to perceived structural problems in the financial sector since the 2008 financial crisis, and particularly since the Madoff fraud. Its entry into force will align, to a large extent, the protections afforded to UCITS investors with those afforded to (predominantly professional) investors in alternative investment funds (“AIFs”) under the Alternative Investment Fund Managers Directive (“AIFMD”).
As with AIFMD, much of the detailed provision regarding the requirements of UCITS V will be set out in additional legislation at EU level, which are referred to as “Level 2 measures”. The Level 2 measures are expected to take the form of an EU regulation, as was the case for AIFMD. As EU regulations are directly-effective in the UK from the date they enter into force, if the Level 2 measures are contained in a regulation they will not require separate transposition into UK law. At the time of writing the Level 2 measures have not been published.
In addition to the Level 2 measures, the European Securities and Markets Authority (“ESMA”) is currently consulting on draft guidelines on sound remuneration policies under the UCITS Directive and AIFMD (the “ESMA Guidelines”). Once finalised, the ESMA Guidelines will provide additional information on how the remuneration requirements of UCITS V should be interpreted and applied. This consultation is open for responses until 23 October 2015, and ESMA has said it proposes to issue final guidelines in early Q1 2016.
At a national level, EU Member States have until 18 March 2016 to transpose UCITS V into national law. On 3 September 2015 the UK’s Financial Conduct Authority (“FCA”) published a consultation paper (“CP15/27”) setting out its current proposed changes to the FCA’s rules for the purposes of implementing UCITS V in the UK. HM Treasury is also due to publish its own consultation on the implementation of UCITS V in the near future, although at the time of writing this has not been published.
This note considers the requirements of UCITS V and the FCA’s proposals for its transposition into UK law, and in particular where its proposals on UCITS V differ from those in relation to AIFMD.
The FCA estimates that the rules will affect about 150 firms as managers, with there being around 2,300 UCITS schemes authorised in the UK (though this includes sub-funds as well).
The FCA’s approach
In general terms, the FCA’s approach to transposition of UCITS V into UK law has been to adopt the same approach as for AIFMD; that is, to broadly transpose the UCITS V requirements without gold-plating them. This is however subject to certain exceptions where additional requirements are already in place or alternatively where the FCA believes that they are justifiable.
In relation to remuneration, the FCA has proposed a new chapter 19E of its Systems and Controls Sourcebook (“SYSC”) which will contain the rules implementing the UCITS V remuneration requirements (the “UCITS Remuneration Code” or the “Code”). This follows the approach taken in respect of AIFMD, for which the remuneration requirements for managers of AIFs (“AIFMs”) are set out in SYSC 19B (the “AIFM Remuneration Code”). The draft UCITS Remuneration Code applies to a UK UCITS management company managing a UK or EEA UCITS scheme.
The FCA’s approach in relation to depositaries has been to amend chapter 6.6A of its Collective Investment Schemes Sourcebook (“COLL”) to include the requirements on UCITS managers in relation to depositaries, and create a new chapter 6.6B containing the specific requirements on UCITS depositaries themselves. This is a slightly different approach to that taken in relation to the equivalent requirements under AIFMD, under which all requirements regarding depositaries were set out in chapter 3.11 of the FCA’s Investment Funds Sourcebook (“FUND”). However, despite this subtle difference in approach, the requirements of the depositary regimes under UCITS V and AIFMD are broadly similar, and this is reflected in the FCA’s draft rules.
The FCA has not addressed the issue of sanctions in CP15/27, and it is expected that this will be addressed in the awaited HM Treasury consultation referred to above.
The principal components of the UCITS V depositary regime relate to standards of conduct, eligibility criteria, oversight duties, liability and delegation. The rules relating to UCITS depositaries have not changed since the introduction of UCITS in 1985, and so it could be said that a readjustment is overdue. The FCA’s draft rules relating to depositaries apply to a depositary of a UK UCITS scheme managed by a UK or EEA UCITS management company. Many of the detailed requirements regarding UCITS depositaries are not addressed in the FCA’s draft rules, as the FCA expects these to be contained in the Level 2 measures.
Standards of conduct
UCITS V requires that UCITS managers appoint a single depositary in respect of each UCITS that they manage, with whom they must have a written contract. In practice this is not a new requirement in the UK for managers of open-ended investment companies (“OEICs”) but it will be in respect of UK authorised unit trusts (“AUTs”).
The depositary, together with the UCITS manager, will also be held to a particular standard of conduct, namely acting “honestly, fairly, professionally, independently and solely in the interests of the UCITS and the investors of the UCITS”.
The requirement for the UCITS manager and depositary to act “solely” in the interests of the UCITS and its investors represents a more stringent requirement than under the equivalent provision under AIFMD, which requires AIFMs and depositaries to act “in the interests of the AIF and the investors of the AIF”. It is however in line with the current requirement under COLL that a depositary of an authorised fund, when acting in its capacity as depositary, must act solely in the interests of the unitholders.
Under UCITS V, only certain specified classes of institution will be eligible to be UCITS depositaries, namely national central banks, credit institutions and other legal entities authorised to carry out UCITS depositary activities, the latter of which must be subject to prudential regulation and supervision and meet certain minimum operational requirements (which the FCA refers to as “non-bank depositaries”). The FCA’s draft rules also require non-bank depositaries to comply with certain minimum organisational requirements which are not explicitly required of AIF depositaries.
The FCA’s view is that, under the existing financial regulatory regime in the UK, the categories of firm which are not national central banks or credit institutions which are capable of meeting the requirements to be a UCITS depositary are, broadly, investment firms under the MiFID regime and investment firms which meet specific new capital resource requirements under its rules.
Regarding non-bank depositaries, the FCA proposes to impose an own-funds requirement of £4 million on all non-bank depositaries, in line with the current own-funds requirements for certain depositary firms under the FCA’s rules. This requirement is more stringent than the effective requirement under UCITS V for €730,000 of own funds for depositaries, and is one of the few instances of the FCA “gold-plating” the UCITS V requirements. The FCA also proposes to make certain amendments to the applicable rules to clarify how such own-funds are computed and impose new prudential reporting requirements to allow the FCA to monitor compliance with the applicable prudential rules.
Finally, it may be helpful to note that the FCA’s draft rules provide for a transitional period under which a UCITS management company may retain until 18 March 2018 a depositary which is yet to comply with certain of the eligibility requirements under the draft rules, broadly the prudential and organisational requirements applicable to non-bank depositaries. These transitional provisions do however only apply in respect of depositaries appointed before 18 March 2016.
Depositary oversight obligations
With the objective of ensuring a minimum level of protection for investors in UCITS, UCITS V places a number of oversight obligations on the depositary. Broadly, these obligations relate to cash monitoring, safekeeping of financial instruments and safekeeping of other assets, and include (in the UK context):
- carrying out the instructions of the UCITS manager except to the extent they conflict with applicable law, the instrument constituting the UCITS, the prospectus and COLL 5 (Investment and borrowing powers);
- ensuring dealing in and valuation of units and the application of the income of the UCITS is done in accordance with applicable law, the instrument constituting the UCITS and the prospectus, in addition to COLL 6.2 (Dealing) and 6.3 (Valuation and pricing);
- ensuring any consideration owed to a UCITS in relation to a transaction is remitted to the UCITS within usual time limits;
- ensuring the UCITS’s cash flows are properly monitored, in particular that payments from or on behalf of investors have been received and that all cash of the UCITS has been booked into cash accounts which are (i) opened in the name of the UCITS, its management company or the depositary acting on behalf of the UCITS, (ii) opened with a bank or qualifying money market fund and (iii) maintained in accordance with certain requirements under the Markets in Financial Instruments Directive (“MiFID”) regulatory regime; and
- ensuring that, where a cash account is in the name of the depositary acting on behalf of the UCITS, such cash is kept segregated from the cash of the depositary and the account provider.
The FCA’s draft rules on oversight broadly follow the equivalent rules on AIF depositaries under FUND. However, there are two principal departures under the FCA’s draft COLL rules from the AIFMD position on oversight.
First, and potentially onerously, UCITS V places a requirement on UCITS depositaries to provide UCITS managers on a regular basis a comprehensive inventory of assets of the UCITS to which they provide services. It should be noted that this requirement does not just relate to assets over which the depositary has custody or which it physically holds, but all assets of the UCITS in question, which may require depositaries to broaden the scope of their oversight processes. UCITS depositaries should consider how they propose to approach compliance with this requirement.
Secondly, depositaries are under UCITS V only permitted to reuse assets of UCITS schemes of which they have custody: (i) where such reuse is permitted under the rules regarding stock lending in COLL 5.4 and (ii) when they are carrying out the instructions of the UCITS management company on behalf of the UCITS. This is a more restrictive position than under the equivalent provision in FUND for AIF depositaries, which permits reuse of AIF assets by depositaries with the prior consent of the AIF or the AIFM acting on behalf of the AIF.
It should also be noted in the context of oversight that UCITS V makes a depositary liable for losses of financial instruments held in custody, except where it can show that the loss has arisen as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary. A depositary is also liable for all other losses suffered by a UCITS and its investors as a result of the depositary’s “negligent or intentional failure to properly fulfil its obligations” under UCITS V. These requirements mirror those under AIFMD. The FCA has stated that changes in legislation will be required to implement these requirements, which is outside of the FCA’s power as regulator. It is anticipated that these changes will be consulted on by HM Treasury in the near future. The equivalent requirements under AIFMD were transposed into UK law under the Alternative Investment Fund Managers Regulations 2013.
Delegation by the depositary
Just as UCITS V imposes obligations on UCITS depositaries, so it imposes limits on their ability to delegate those obligations to third parties. In particular, a UCITS depositary will not be permitted to delegate either its oversight of the day-to-day operations of the UCITS, for example oversight of dealing in and valuation of units, or its cash monitoring function. The only function that the depositary may delegate is that relating to safekeeping of UCITS assets. Also, in the context of a depositary’s liability considered above, UCITS V does not permit depositaries to contractually transfer their liability to delegates, as is permitted under AIFMD for AIF depositaries.
Even in relation to delegation of custodial functions, depositaries will be subject to a number of restrictions. The draft COLL 6.6B, reflecting the relevant UCITS V provision, provides that safekeeping functions may only be delegated where the depositary can demonstrate that there is an objective reason for the delegation, the delegation is not aimed at avoiding the requirements of the regime and the depositary has exercised and will continue to exercise all due skill, care and diligence in the appointment and periodic review of the delegate. The depositary must also ensure that the delegate meets certain organisational, prudential and custodial requirements, and that it complies with general obligations and prohibitions relating to the depositary under COLL 6.6B.
In the context of the depositary’s liability to the UCITS and its investors, as considered above, it should be noted that a UCITS depositary will not be able to contractually discharge such liability in respect of financial instruments for which custody has been delegated to a third party. This contrasts with the position under AIFMD, where a depositary may under certain circumstances discharge itself of liability where it delegates custody.
When delegating, UCITS depositaries must ensure that the delegate complies with the depositary’s requirements under its written contract with the UCITS management company. This is not an express requirement under the equivalent AIFMD provisions regarding delegation, although Article 89 of the AIFMD Level 2 Regulation requires depositaries to ensure certain standards are upheld by entities to which custody is delegated which may in practice be achieved through contractual obligations on the delegate. UCITS depositaries may therefore be required to put in place back-to-back contractual arrangements with any delegate to ensure that such delegate complies with the depositary’s own obligations under the written contract with the UCITS management company.
Finally, UCITS V makes no provision for reuse by a delegate of any UCITS assets for which custody has been delegated, a position replicated in the FCA’s draft rules. This is permitted under AIFMD but the depositary must ensure that the delegate does not make use of such assets unless it has both obtained the prior consent of the AIF or the AIFM acting on behalf of the AIF and given prior notice to the depositary. It appears that delegates may not, under the UCITS V regime, reuse assets for which custody has been delegated to them. It may be that this should be reflected in the contractual arrangements between depositary and delegate referred to above.
UCITS V imposes a set of codified remuneration rules upon UCITS management companies for the first time.
Remuneration within the financial services industry has been a hot topic with the European Commission for some time now, and it has attempted to address this across a number of sectors of the European financial services industry, principally through AIFMD, the Capital Requirements Directive (also referred to as “CRD IV”) and the Solvency II regime. The Commission’s perception is that remuneration paid to senior staff at financial institutions, including UCITS managers, has the potential to become disconnected from their performance and the performance of the businesses/funds they manage. This in turn has the potential to incentivise staff to adopt riskier behaviour in carrying out their professional duties in order to seek higher remuneration. The remuneration provisions of UCITS V are part of the Commission’s wider efforts to address this by seeking to realign the interests of certain senior classes of staff with the interests of the financial institutions/funds whose risk profiles their professional duties affect. The approach taken broadly follows those taken under AIFMD and CRD IV.
It is worth noting that the FCA estimates that two-thirds of the firms affected by UCITS V are already formally subject to codified remuneration requirements, for example banks and AIFMs, and some of the remaining one-third may already indirectly be subject to such requirements as subsidiaries. Accordingly, most firms will already be observing these rules in some for or other and so the incremental change may in many cases be smaller than when the CRD IV and AIFMD remuneration requirements came into operation.
This multiplicity of remuneration requirements raises the question of which remuneration guidelines should be complied with by firms which are subject to more than one, for example a UCITS manager which acts as an AIFM. The FCA expects these issues to be addressed by guidelines to be produced by ESMA and the European Banking Authority (“EBA”) regarding the CRD IV requirements and the final ESMA Guidelines.
Some firms, referred to by the FCA as “BIPRU firms”, are already subject to remuneration requirements under chapter 19C of SYSC. It is therefore worth noting the FCA’s draft guidance in the Code that a UK UCITS management company that is also a BIPRU firm will meet its obligations under SYSC 19C by complying with the Code.
The FCA’s current position is that firms will have to comply with the requirements of the UCITS Remuneration Code for new awards of variable remuneration from its first full performance period starting on or after 18 March 2016, although it appreciates that, when finalising its rules, it may have to review the proposed application dates in the light of the date of publication of the final ESMA guidelines. These dates may therefore be subject to change as the UCITS V implementation date draws closer.
The requirement for a remuneration policy
The UCITS Remuneration Code will require UK UCITS managers to establish, implement and maintain remuneration policies and practices which:
- are consistent with and promote sound and effective risk management;
- do not encourage risk taking which is inconsistent with the risk profiles of the UCITS’s constitutive document or prospectus;
- do not impair the manager’s compliance with its duty to act in the best interest of the UCITS it manages; and4.
- include fixed and variable components of remuneration.
Fixed remuneration” and “variable remuneration” are defined by the ESMA Guidelines respectively as “payments or benefits without consideration of any performance criteria”, and “additional payments or benefits depending on performance or, in certain cases, other contractual criteria”.
The FCA Handbook defines “remuneration” as any form of remuneration, including salaries, discretionary pension benefits and benefits of any kind, which is clearly an extremely broad definition intended to catch all forms of remuneration. The Code also states that “remuneration” includes payments made by a seconding organisation, which is not subject to the Code, to a secondee in respect of their employment by a UCITS management company which is subject to the Code. This indicates that references to “remuneration” in the Code have a different meaning to the normal definition of that term under the FCA Handbook. The presumption is that the applicable definition is that given under UCITS V, although this is not stated explicitly.
The statement under the ESMA Guidelines as to what “remuneration” consists of is also broadly drafted, referring to “all forms of payments or benefits paid by the management company, any amount paid by the UCITS itself and any transfer of units or shares in the UCITS, in exchange for professional services rendered by the management company’s identified staff”.
It seems clear from these instances of broad drafting that the intention is for the net to be cast as wide as possible in respect of what the concept of “remuneration” encompasses. Returns from UCITS managers’ personal investment in funds on normal terms would not however be included.
The description of the staff to which the remuneration policies and practices should apply is also broadly drawn. The Code states that these must be applied to “UCITS Remuneration Code staff”, a term which includes staff whose professional activities have a material impact on the risk profiles of the management company or the UCITS. These must comprise senior management, risk takers, staff engaged in control functions and any employees receiving total remuneration that takes them into the same remuneration bracket as senior managers and risk takers.
However, it is important to note that not all employees will be caught by the Code and some may only be caught in part due to the mixed UCITS and non-UCITS nature of their duties – these are not rules for the entire fund manager workforce – though many of the underlying principles would be applicable anyway on a cautious view. Further, the rules on deferral, use of non-cash instruments and their retention and clawback (explored below) are not required to be applied to staff whose total remuneration comprises less than 33% variable remuneration and is less than £500,000 overall. For many firms, this means that the structural pay rules will not therefore be relevant.
The term “employee” in this context includes individuals “employed or appointed” by the UCITS manager under a services contract or otherwise or whose services are placed at the management company’s disposal and control. This would seem to capture individuals employed by a services company whose services are provided to a UCITS management company, or indeed secondees as noted above, and even consultants.
The Code requires UCITS management companies to ensure that variable remuneration is not paid through vehicles or methods that facilitate the avoidance of the requirements of the Code. Further, the ESMA Guidelines state that a manager has the primary responsibility for ensuring the remuneration requirements are not circumvented, including by the use of persons not considered “employees” from a legal point of view. The definition of “identified staff”, the term used in the ESMA Guidelines to refer to staff to whom remuneration policies must apply, includes categories of staff of entities to which investment management activities have been delegated by a UCITS management company, whose professional activities have a material impact on the risk profiles of the UCITS that the management company manages.
It therefore appears that UCITS management companies must in certain circumstances apply their remuneration policies in respect of individuals who they do not directly employ. It should be noted in this regard that the ESMA Guidelines state that the outsourcing of professional services to firms outside the scope of the UCITS Directive poses a risk of constituting avoidance of the UCITS V remuneration requirements, unless such firms are subject to remuneration requirements which are “equally as effective” as the UCITS V requirements. Where a delegate is not subject to such equally effective requirements, appropriate contractual arrangements must be put in place to ensure that the rules are not circumvented. An entity can be considered subject to equally effective remuneration requirements if both it and its identified staff are subject to the remuneration rules under either CRD IV or AIFMD. UCITS managers should therefore consider when putting in place outsourcing arrangements whether the delegate is subject to remuneration requirements under UCITS V, AIFMD or CRD IV.
If the delegate is not subject to such requirements, contractual provisions on remuneration should be included as part of those arrangements. Relevant contracts and policies therefore need to at least be reviewed in time for implementation, and may need amendment to include separate reporting and monitoring requirements.
The Code requires each UCITS management company, when establishing and applying its remuneration policy, to comply with a series of 15 stated remuneration principles.
UCITS management companies must comply with the principles in a way and to an extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities. As mentioned above, it is useful in this regard to note the FCA has proposed specific guidance in the Code to allow certain remuneration principles to be disapplied when the remuneration paid to an individual within the scope of the Code falls below certain minimum thresholds. The FCA has said it will finalise its guidance after the publication of the final ESMA Guidelines, likely to be early in Q1 2016. ESMA is understood to currently be discussing the issue of proportionality with both the EBA and European Commission.
We have set out below certain of the remuneration principles which are in our view particularly significant or noteworthy.
Remuneration Principle 1: Risk management
A UCITS management company must ensure that its remuneration policy is consistent with and promotes sound and effective risk management, and does not encourage risk taking which is inconsistent with the risk profiles or constitutive instrument of the UCITS it manages. This principle is the foundation of the European Commission’s approach to all remuneration requirements across the financial services industry and the equivalent remuneration principles relating to CRD IV and AIFMD and the FCA’s rules transposing them into UK regulation.
Remuneration Principle 3: Governance
The UCITS management company’s management body must review the general principles of the remuneration policy “at least annually”. While purely as a matter of language this represents a departure from the equivalent requirement under the AIFM Remuneration Code, which requires the general principles to be reviewed “periodically”, this does not necessarily entail a less frequent review. It is perhaps noteworthy in this regard that the elements of the ESMA Guidelines addressing this point replicate the sections of ESMA’s guidelines on the AIFMD remuneration requirements relating to periodic reviews.
This Principle also requires that a manager which is significant in terms of its size, the size of the UCITS it manages, the complexity of its internal organisation or the nature, scope and complexity of its activities establishes a remuneration committee. The committee must comprise only non-executive members of the management body and be constituted so as to enable it to exercise competent and independent judgment on remuneration policies and practices and the incentives created for managing risk.
The ESMA Guidelines state that when assessing whether or not a UCITS manager is significant, and therefore required to establish a remuneration committee, a UCITS manager should consider the cumulative presence of all these factors (i.e. its size, the size of the UCITS it manages, its internal complexity and the complexity of its activities). A manager which is significant in only one or two of these areas should not be required to set up a remuneration committee. The guidelines do also state however that the setting up of a committee should be considered, as a matter of good practice, even if the manager is not obliged to do so.
The ESMA Guidelines also give examples of elements to be taken into account when deciding whether or not to establish a remuneration committee, including assets under management, number of employees and whether the management company is also an AIFM. Examples are also given of management companies which may not need to establish a remuneration committee, including management companies whose UCITS portfolios do not exceed €1.25 billion in value and not having more than 50 employees, including those dedicated to the management of AIFs.
Finally, in a departure from the equivalent requirements on AIFMs under the AIFMD regime, the Code provides that the remuneration committee must when preparing its decisions take into account the long-term interest of investors and the public interest. It is not clear in the absence of specific guidance in what sense regard must be had to the public interest, but relevant factors may include the maintenance of the strength of the UCITS brand and the protection of the public from the consequences of excessively risky investment practices in pursuit of variable remuneration.
Remuneration Principle 5(a): Remuneration structures – assessment of performance
Unlike the equivalent principle applicable to AIFMs under the AIFM Remuneration Code, UCITS managers are required to ensure that where remuneration is performance-related, the total amount of remuneration takes into account the investment risks of the UCITS and the risks of the management company. These requirements follow on from the emphasis throughout the UCITS V remuneration provisions on ensuring remuneration does not reinforce or reward risky behaviour.
Remuneration Principle 5(c): Remuneration structures – fixed and variable components of total remuneration
UCITS managers are required to ensure that fixed and variable components of total remuneration are appropriately balanced and the fixed component is sufficiently high to allow a “fully flexible” variable remuneration policy, including the option to pay no variable remuneration at all. This principle is clearly aimed at making variable remuneration almost an optional extra, or to put it another way making a “bonus” exactly that, to be paid only in circumstances and to a level which are merited.
While this is not a new provision for the financial services industry, during the negotiation of the UCITS V text forceful representations were made by a number of EU Member States to impose a cap on variable pay.
Remuneration Principle 5(e): Remuneration structures – retained units, shares or other instruments
Subject to the legal structure of the UCITS and its constitutive instrument, a management company must ensure that a substantial portion, and in an event at least 50%, of variable remuneration must consist of, broadly, interests in the UCITS or instruments linked to the performance of the UCITS. The aim of this requirement is to align the interests of a UCITS’s senior staff with those of the UCITS itself so as to give them some “skin in the game” by linking their variable remuneration, for example bonuses, to the success of the UCITS. Such units must also be subject to a suitable further retention period after the staff member has become entitled to keep the remuneration (i.e. after the end of a deferral period) and an appropriate clawback policy.
In a departure from the equivalent principle under the AIFM Remuneration Code, the Code provides that, if the management of the UCITS accounts for less than 50% of the total portfolio managed by the management company, the minimum of 50% does not apply. However, the applicable guidance states that in such circumstances the management company should determine the percentage of variable remuneration that should consist of such interests or instruments to appropriately reflect the extent of the management of UCITS by the management company. If this is less than 50%, the management company should consider the use of other instruments to achieve the same alignment of interest. The FCA’s view is that at least 50% of variable remuneration should consist of the required interests/instruments. This has been put out for specific comment by the FCA.
Remuneration Principle 5(f): Remuneration structures – deferral
At least 40% of variable remuneration should be deferred over an appropriate period in the light of the recommended holding period for investors, and only be received on a pro rata basis. Such deferral should be for at least three years, contrasting with the requirement under the equivalent AIFM Remuneration Code requirement for deferral for at least three to five years, unless the lifecycle of the AIF is shorter.
For “particularly high amounts” at least 60% should be deferred. The applicable guidance provides that £500,000 should be considered a particularly high amount for these purposes but that managers should consider whether lesser amounts should be considered “particularly high”, taking into account for example whether there are significant differences within the variable remuneration paid to staff subject to the remuneration requirements.
Remuneration Principle 8: Personal investment strategies
UCITS management companies must require affected staff to undertake not to use personal hedging strategies or remuneration- or liability-related insurance to offset the risk alignment effects of the remuneration arrangements. The use of the term “undertake” in this context may require that such an undertaking would need to be built into the contractual framework between the employee and employer. It is worth noting in this regard that the AIFM Remuneration Code also imposes this requirement, in response to which some AIFs have included in their remuneration policies and practices a requirement on staff to provide an undertaking in these terms. Many firms have become accustomed to obtaining signed letters from employees agreeing to this as well as recognising the general importance of the AIFM Remuneration Code.
In line with other recent EU-level financial regulatory initiatives, for example AIFMD, UCITS V contains provisions regarding sanctions for non-compliance with applicable regulations and the establishment of whistle-blowing procedures to allow internal reporting of regulatory breaches. The aim of these provisions is to achieve a minimum harmonisation of sanctions for breaches available to national regulators and enforcement agencies. The FCA has not included provisions on these points in CP15/27 and it is expected that these will be addressed at a different stage of the transposition process.
However, unlike under AIFMD, UCITS V requires Member States to establish whistle-blowing procedures to encourage reporting of potential and actual breaches of relevant national provisions implementing UCITS V. To the extent legislative changes are required to implement these requirements, it is expected that this will be consulted on in the impending HM Treasury consultation.
The FCA does however note in CP15/27 that one UCITS V requirement in this area is for management companies and depositaries to adopt appropriate procedures for their employees to report, internally, any potential or actual breaches of the relevant rules governing UCITS. In this regard it proposes to insert specific provisions into the Handbook for management companies and for depositaries obliging UCITS management companies and depositaries respectively to have in place appropriate procedures to allow employees to report internally potential or actual breaches of the UK provisions transposing the Directive through a specific, independent and autonomous channel. UCITS managers and depositaries will need to consider how to implement this requirement in practice as part of their existing systems and controls procedures.
Required amendments to documentation
The FCA’s proposals to transpose the requirements of UCITS V will require UCITS managers and in some instances depositaries to amend certain of the documentation relating to UCITS schemes.
As a general point, amendments may be required to the trust deeds of AUTs to give effect to the UCITS V changes, including in particular giving authority to enter into the required written agreement with the depositary.
Further, the draft rules amend the provisions of COLL 4.2.5R, which sets out the required content for prospectuses of UCITS schemes. UCITS prospectuses are already required to include certain information on the depositary under COLL 4.2.5R(8). This information will under the proposed rules be expanded to include: (i) a description of any conflicts of interest that may arise between the depositary and the UCITS, the unitholders or the manager; and (ii) a description of any safekeeping function delegated by the depositary, together with a description of any conflicts of interest that may arise from that delegation and a list showing the identity of each delegate and sub-delegate. A statement that up-to-date information regarding the depositary will be provided on request must also be included.
The prospectus must also include the following information regarding the UCITS’s remuneration policy: (i) certain up-to-date details of the remuneration policy, (ii) a summary of the policy and (iii) a statement that up-to-date details of the policy are available by means of a website, with a link to the website in question, and that a paper copy will be made available free of charge on request.
The draft rules also require a UCITS scheme’s annual long report to set out certain information in relation to the remuneration policy of the scheme, including certain details of total remuneration paid, descriptions of how the remuneration and benefits have been calculated, the outcome of any annual review of the general principles of the remuneration policy and details of any material changes to the remuneration policy since the previous annual review was prepared.
Finally, in addition to identifying the scheme, key investor information documents (“KIIDs”) will be required to include a statement that certain details of the remuneration policy are available by means of a website, with a link to the website in question, and that a paper copy will be made available free of charge on request. While this may seem a relatively benign requirement, space is already at a premium in KIIDs and including the required detail on remuneration policies while retaining the other required information may present practical and presentational difficulties. It also remains to be seen whether regulators in other EU member states take the same approach as the FCA in relation to what form of statement on remuneration is acceptable, which may be relevant in the context of UCITS passporting.
To aid compliance with the new rules, the FCA’s proposed rules include transitional provisions which permit that required changes to prospectuses, annual reports and KIIDs need not be in place for 18 March 2016. Prospectuses issued before 18 March 2016 need not be updated until 30 September 2016; UCITS managers will be able to update the relevant information at the next planned update during this period. Annual reports relating to an annual accounting period ending before 18 March 2016 need not include the additional information required under the draft rules. Finally, KIIDs drawn up by a UCITS manager before 18 March 2016 need not be amended until the next annual review of the KIID falling after 18 March 2016.
While these transitional provisions are of course welcome, it should be borne in mind that financial services regulators in other EU member states may not follow the FCA’s approach in this regard. UCITS which passport into other EU member states may therefore be required to have compliant documentation in place from 18 March 2016, and UCITS managers should consider seeking local advice on this point.
Employees’ remuneration arrangements may also need to be amended. This can range from consideration of whether service contracts (and any side letters) are inconsistent with the requirements of the Code to imposing new requirements to defer particular forms of remuneration and the inclusion of retention and clawback arrangements. The Code does not override existing contractual arrangements, nor on past experience will the FCA expect remuneration already awarded to be changed to comply with the new rules. In most cases, the award of remuneration on a year-by-year basis is discretionary and so employers should be able to impose new arrangements. However, clearly there is also a practical need at the very least to discuss with those affected the proposals for compliance with the new requirements, which may require new employee remuneration structures.
Contractual documentation with third parties
In practice, the changes to the required functions of UCITS depositaries and their obligations will require in-force depositary agreements to be amended so as to be compliant or new depositary agreements to be put in place in respect of AUTs. Changes may also be required to any separate custody agreements to give effect to the proposed changes to the depositary’s safekeeping obligations.
It is also possible that investment management agreements (“IMAs”) may in some instances need to be amended in respect of remuneration arrangements, and in any event will need to be reviewed in the context of the requirements of UCITS V.
Compliant agreements will need to be in place for 18 March 2016. Given the FCA’s statement in CP15/27 that it intends to publish its Policy Statement setting out the final rules on UCITS V in early 2016, it appears that UCITS managers are likely to have minimal time to negotiate suitable amendments to affected agreements.