Report contents:

  1. Introduction
  2. Depositary liability for loss of financial instruments
  3. Distribution of assets on depositary insolvency
  4. Sanctions
  5. Whistleblowing
  6. How we can assist

1. Introduction

HM Treasury (“HMT”) has published a consultation (the “Consultation”) in order to conclude the UK’s implementation of UCITS V. This follows the Financial Conduct Authority’s (“FCA”) recent consultation paper (“CP15/27”) on its proposed rule changes for implementing UCITS V in the UK. Our recent report on CP15/27 can be read here.

The areas considered by the Consultation are:

  1. depositary liability for loss of financial instruments held in custody;
  2. distribution of assets upon insolvency; 
  3. sanctions; and
  4. whistleblowing.

The Consultation also appends a draft statutory instrument, the “Undertakings for Collective Investment in Transferable Securities Regulations 2016” (the “Instrument”). The Instrument amends the Financial Services and Markets Act 2000 (“FSMA”), the Undertakings for Collective Investment in Transferable Securities Regulations 2011 (the “UCITS Regulations”) and a number of other legislative acts to give effect to the requirements of UCITS V.

The Consultation is open for responses until midnight on 17 December 2015.

2. Depositary liability for loss of financial instruments

The principal matter the Instrument addresses is the UCITS V requirements on liability of depositaries, which broadly mirrors the equivalent requirements on depositaries of alternative investment funds (“AIFs”) under Directive 2011/61 (“AIFMD”).

Under UCITS V a depositary is liable to the UCITS and its unitholders for:

  • the loss of financial instruments held (either by the depositary or a third party) in custody; and 
  • other losses suffered as a result of the depositary’s negligent or intentional failure to properly fulfil its obligations under the Directive.

The Directive also provides that liability of a UCITS depositary to the UCITS or the unitholders of the UCITS is not affected by:

  • any delegation by the depositary of its custody functions; or
  • any exclusion or limitation by agreement of, or any contractual provision that purports to exclude or limit, the depositary’s liability for losses. Any such provision or agreement will be void.

HMT has proposed implementing these UCITS V provisions by taking a “copy-out approach”, whereby the language of UCITS V is replicated to ensure there is no “gold-plating” of its provisions. This broadly replicates the FCA’s approach in CP15/27 to transposing UCITS V into the Handbook

HMT predicts that the practical impact of this change, together with the other changes implementing the UCITS V depositary requirements, to be moderate. Its rationale is that the UCITS V requirements are broadly in line with those already in place under AIFMD. Specifically in relation to depositaries, HMT expects that the UCITS V proposals will have a narrow impact in the UK. This is because 10 of the 11 firms authorised to act as depositaries of UCITS in the UK are also depositaries of AIFs. HMT therefore considers that, to the extent the UCITS V Level 2 measures fall in line with the AIFMD level 2 measures in Regulation 231/2013, most firms will already have most of the required systems, procedures and organisational arrangements in place.

HMT’s position perhaps fails to appreciate the practical issues posed by UCITS V for UCITS managers and depositaries. While UCITS V may not require substantial changes to systems and procedures which have already been updated in respect of AIFMD, potentially significant changes will nonetheless be required to fund documentation. UCITS constituted as authorised unit trusts will for the first time be required to have depositary agreements in place, while UCITS constituted as OEICs will need to make significant amendments to their depositary agreements. Prospectus amendments will also be required.

Further, UCITS managers who exclusively manage UCITS funds will not have not already been through the AIFMD compliance process. The UCITS V requirements will represent a significant shift in operating model for these managers. In addition, UCITS depositaries may increase their costs to compensate for the increased risk they take on as a result of the UCITS V depositary liability requirements. Finally, UCITS depositaries may also scrutinise more closely the markets in which they operate, which could lead to some markets becoming inaccessible for practical purposes if depositaries conclude that operating in those jurisdictions is not worth the risk.

3. Distribution of assets on depositary insolvency

UCITS V requires Member States to ensure that in the event of the insolvency of the depositary and/or any third party custodian that is located in the EU, the assets of a UCITS held in custody are unavailable for distribution among, or realisation for the benefit of, creditors of such depositary and/or third party. HMT does not propose to make any legislative changes to implement these requirements in the UK. HMT’s view is that only those financial instruments that are actually held in custody at the point of insolvency are captured. On that basis, existing UK domestic legislation (including the FCA’s rules) should operate to ensure in any event that such assets are protected from creditor distribution upon the insolvency of a UK depositary.

Under UCITS V financial instruments of the UCITS must be registered in segregated accounts in the name of the UCITS or the management company so that they can be clearly identified as belonging to the UCITS at all times. HMT considers that the existing UK  framework for depositaries and trustees of collective investment schemes, together with the rules proposed by the FCA in CP15/27 will address these requirements, and that no specific legislative implementation measure is required to transpose the UCITS V provisions relating to depositary or third party insolvency.

4. Sanctions

Under UCITS V Member States are required to impose administrative sanctions and other measures for breaches of the national measures implementing the UCITS Directive. These sanctions must be “effective, proportionate and dissuasive” and apply to members of management body of UCITS, its management company and the depositary. Administrative penalties must include:

  • a public statement identifying the person responsible for the breach;
  • cease and desist orders in respect of infringing conduct;
  • a permanent or temporary ban from fund management;
  • suspension or withdrawal of authorisation;
  • fines of:
    • for legal persons such as companies, a  maximum of at least €5million or 10% of annual turnover, or alternatively at least twice the amount of the benefit gained by the infringement;
    • for natural persons (i.e. individuals), a maximum of at least €5m, or alternatively at least twice the amount of the benefit gained by the infringement.

HMT expects the implementation of the sanctions requirements to have a minimal impact on the UK fund management industry, as HMT considers that the sanctions available under UK legislation already go beyond the level of sanctions required under the UCITS Directive. Nonetheless, HMT propose some minor amendments to the existing provisions of FSMA to clarify that breaches of the national legislation transposing the UCITS Directive trigger the FCA’s existing sanctions.

5. Whistleblowing

The Instrument does not impose any new requirements regarding whistleblowing by employees of UCITS investment companies, management companies or depositaries to the FCA or other domestic authorities. HMT therefore appears to have taken the view that the whistleblowing requirements under UCITS V are addressed by:

  • existing UK legislation (principally under Part IVA of the Employment Rights Act 1996); 
  • current FCA rules (Chapter 18 SYSC); and
  • the new rules proposed by the FCA in CP15/27 (which require UCITS management companies and depositaries to adopt procedures to allow their employees to report any actual or potential breach of the domestic measures implementing the UCITS Directive internally through a specific and autonomous channel).

The Instrument does however amend existing whistleblowing legislation to protect disclosures to the European Securities and Markets Authority (“ESMA”). This is required by UCITS V, which broadly requires Member States to ensure that the reporting by employees of infringements of the national measures implementing UCITS V will not infringe any contractual, legal, regulatory or administrative restriction and the employee in question shall not be subject to any liability for such reporting. The Public Interest Disclosure (Prescribed Persons) Order 2014 (the “PID Order”) sets out those persons to whom information may be disclosed by workers during their employment under section 43F of the ERA so as to be a protected disclosure. The Instrument purports to amend the Schedule to the PID Order to provide that such disclosures may be made to ESMA in respect of matters relating to the compliance with the UCITS Directive. As such, disclosures to ESMA complying with the requirements of the ERA will be protected disclosures.