ESMA published its Final Report on 28 November 2014, setting out its technical advice to the European Commission as to the content of delegated acts proposed to be adopted under UCITS V.

The technical advice covers:

  • The steps to be taken by any third party to which a UCITS depositary has delegated its safe-keeping duties to ensure that, in the event of such third party delegate’s insolvency, UCITS assets held in its custody are unavailable for distribution among, or realisation for the benefit of its creditors
  • The conditions for fulfilling the requirement that, in carrying out their respective duties, a UCITS’ management company (or the UCITS itself, where it has not appointed a management company) and the UCITS’ depositary must act independently

Insolvency protection

ESMA’s technical advice provides as follows:

All third-party delegates to whom UCITS assets are entrusted for safe-keeping will be required to:

  • Inform the relevant depositary about the applicable insolvency laws and jurisprudence that apply to the assets delegated to them for safekeeping
  • Maintain accurate and up-to-date records and accounts of UCITS’ assets they hold that readily establish the precise status of those assets vis-à-vis ownership, amount, location etc. and which accounts and records must be maintained such that they may be used as an audit trail
  • Provide the depositary with regular inventory statements of all UCITS assets held by the third party delegate for and on behalf of the depositary
  • Maintain appropriate arrangements to safeguard the UCITS’ rights in its assets and to minimise the risk of loss and misuse of such assets

In addition, ESMA’s advice provides that third party delegates, if safe-keeping UCITS assets outside of the EU, must make all reasonable efforts, including the receipt of independent legal advice, to verify that the applicable insolvency laws of the relevant jurisdiction:

  • Recognise the segregation of the UCITS’ assets from the third party’s own assets and from the assets of the depositary
  • Recognise that the UCITS’ segregated assets do not form part of the third party’s estate in the case of insolvency and are unavailable for distribution among or realisation for the benefit of its creditors

Such third party delegates must also ensure that the legal conditions ensuring or underpinning these requirements in the relevant non-EU jurisdiction are met both at the time of agreement with the depositary and for the duration of the delegation and must immediately inform the depositary in circumstances where any of the conditions in question cease to be met.

The depositary itself must in turn consider the following matters when selecting and appointing any third-party delegate to safe keep UCITS assets:

  • Any applicable legal requirements or market practices related to holding client assets that could adversely affect the UCITS’ rights either during the normal course of business or in the event of the third party delegate’s insolvency
  • The financial condition, expertise and market reputation of the third party delegate
  • Any protection or lack thereof attendant upon the regulatory status of the third party delegate

Where delegating functions to a third party located outside the EU, the depositary must additionally adopt the following measures:

  • It must make all reasonable efforts, including the receipt of independent legal advice, to understand the material effects of the contract with the third party on the UCITS’ rights in respect of its assets.
  • It must ensure that the contract with the third party delegate facilitates termination of the arrangement without undue delay, taking into account the best interests of the UCITS and its shareholders, in circumstances where the insolvency laws of the relevant non-EU jurisdiction cease to recognise the segregation of the UCITS’ assets in the event of the insolvency of the third party delegate.
  • In circumstances where the depositary becomes aware that the applicable insolvency laws no longer recognise the segregation of the UCITS’ assets in an insolvency situation, the depositary must immediately inform the UCITS/ManCo of such situation. On receipt of such information the UCITS/ManCo must immediately notify its competent authority and consider all appropriate measures, including disposal of the UCITS’ assets held by the third party delegate, taking into account the best interests of the UCITS and its shareholders.

It should also be noted that ESMA’s advice provides for exceptions whereby either the depositary or the non-EU third party would be absolved from the requirement to obtain independent legal advice in circumstances where the advice obtained by one or other of the parties is made available to the other and meets the relevant requirements.

Independence requirement

ESMA considers that the independence of the management company / self-managed investment company and the depositary (Relevant Parties), may be jeopardised by the existence of the following links between these parties:

  • Common management/supervision
  • Cross-shareholdings

Common management/supervision

ESMA’s advice includes rules preventing the management bodies of the Relevant Parties from having members in common and or from including employees of the other.

Cross – shareholdings

ESMA has, significantly, chosen not to adopt the more controversial of the two options proposed at consultation stage, being that Relevant Parties connected by a qualifying holding or included in the same group for the purpose of consolidated accounts would not be considered as independent from each other for the purpose of the UCITS V requirements.

Instead, ESMA’s technical advice permits UCITS management companies/investment companies to be considered independent of their depositaries despite being linked by ‘qualifying holdings’ or forming part of the same group provided certain additional safeguards, such as robust conflicts of interest procedures, are put in place. Additionally, in cases where the management company/investment company and the depositary are part of the same group for consolidated accounts purposes, at least one third of the members of the management bodies of both entities will be required to be independent of the group.

Next steps

Delegated Acts, otherwise known as “Level 2” measures will now be prepared by the European Commission taking into account ESMA’s advice. It is currently proposed that Level 2 measures implementing UCITS V will be formally adopted by the Commission by April 2015. UCITS V itself must be transposed into the national law of all Member States by 18 March 2016.