Amendments of Level 2 Regulations regarding safekeeping obligations for alternative investment funds (AIF) and UCITS depositaries
Commission delegated regulations (EU) 2018/1618 and (EU) 2018/1619, both of July 12, 2018 and regarding the safe keeping duties of depositaries, were published in the European Official Journal on October 30, 2018. The measures amend previous delegated regulations from 2013 and 2016 respectively.
The revised regulations impose stricter rules on depositaries delegating their safekeeping obligation applicable from April 1, 2020, giving institutions a grace period of 18 months to adapt their arrangements with third-party providers to which they have delegated their obligations.
Depositaries must review all delegation arrangements and negotiate amendments that ensure they can fulfil their oversight and due diligence obligations. The written agreement should notably enable the depositary to identify all entities within the custody chain.
They should also be able to verify that the quantity of identified financial instruments recorded in the financial instruments accounts opened in the depositary’s books in the name of the UCITS or alternative investment fund or in the name of the management company acting on the fund’s behalf matches the quantity held in custody by the third party for that fund as recorded in the financial instruments account in its books.
Depositaries must also verify that the quantity of identified financial instruments registered and held in a financial instruments account at the issuer’s Central Securities Depository or its agent, in the name of the third party on behalf of its clients, matches the quantity in the financial instruments accounts in the depositary’s books in the name of each of its fund clients or that of the management company.
The same requirements will apply between the third-party and any other contracted providers in the case of a further delegation of custody functions. The agreement between the depositary and the third party delegate must indicate whether sub-delegation is permitted and if so, under what conditions.
The delegated regulations clarify the frequency of reconciliations between the financial securities accounts and the records of the depositary of a UCITS or alternative fund client and the third party, or between the third parties, where the custody function has been delegated further down the custody chain.
Depositaries must also ensure and verify that the third party delegate complies with the segregation requirements laid down in point (iii) of Article 21(11)(d) of the Alternative Investment Fund Managers Directive (2011/61/EU).
Where the third party is located in a non-EU country, the depositary must obtain independent legal advice confirming that the applicable insolvency law recognises the segregation of the assets of the depositary’s clients from the assets of the third party to which custody functions have been delegated in accordance with Article 21(11) of the AIFMD, the assets of the third party’s other clients and those held by the third party for the depositary’s own account; that the assets of the depositary’s fund clients do not form part of the third party’s estate in the event of insolvency; and that the assets of the fund clients are not available to the third-party’s creditors or realised for their benefit.
Managers of alternative and UCITS funds will be required to check whether amendments to their existing depositary agreements will be necessary.
The full text of the delegated regulations are available in English at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018R1618&from=EN and at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018R1619&from=EN for (EU) 2018/1619.
CSSF circular 18/698 on authorisation and organisation of Luxembourg investment fund managers
On 23 August 2018, the CSSF issued a Circular 18/698 relating to the authorisation and organisation of investment fund managers incorporated under Luxembourg law, repealing and replacing CSSF Circular 12/456.
The circular applies to UCITS management companies authorised under Chapter 15 of Luxembourg’s investment fund legislation of 2010, management companies authorised under Chapter 16 or branches of management companies authorised under Chapter 17 of the 2010 law, self-managed UCITS, alternative investment fund managers authorised under chapter 2 of the AIFMD implementation legislation of July 12, 2013, and self-managed alternative investment funds under Article 4(1)(b) of the AIFMD law. However, it does not apply to sub-threshold registered alternative investment fund managers using the exemption under Article 3(2) of the 2013 law.
The circular seeks to standardise and codify the practical approach adopted by the CSSF up to now in its supervision process as well as to reflect the new legislation introduced in the years since the regulator’s previous circular in this regard.
The repealed Circular 12/456 was not been directly applicable, for instance, to alternative investment fund managers, even though the CSSF required AIFMs to comply with its provisions. Publication of the new circular has clarified this situation and established a unified and comprehensive set of rules for all market participants within the scope of the circular.
Circular 18/698 sets out the conditions necessary to obtain and maintain the authorisation of the investment fund manager relating to aspects including its ownership, own funds, governance, central administration, internal organisation, external audit and exchange of the information between relevant parties.
It additionally sets out specific conditions applicable to investment fund managers providing accessory services such as discretionary portfolio management or providing services via EU passporting arrangements.
The provisions of the new circular became applicable from the date of publication of the circular and all investment fund managers in scope should adapt their operating models accordingly without delay. We are available to discuss any questions you might have in this regard.
CSSF Circular 18/698 can be accessed here.
Marketing AIFs : New draft of AIFMD update eases pre-marketing requirements
The European Commission has put forward amendments to the 2011 Alternative Investment Fund Managers Directive (AIFMD) that includes clarifying and setting out uniform rules on what constitutes ‘pre-marketing’ activity, a topic that has been an area of controversy since the directive came into force in 2013. However, the rules have been eased in a fresh draft following criticism from the alternative fund industry.
The Commission published a draft directive in March 2018 amending both the UCITS and AIFMD regimes governing the cross-border distribution of retail and alternative collective investment funds, as well as a proposed regulation on facilitating cross-border fund distribution, as part of a legislative package designed to help complete its Capital Markets Union project.
The legislation aims to make possible pre-marketing of alternative funds in EU member states where it is not currently permitted. However, the proposal sparked controversy because in some cases AIFMs would find themselves subject to more restrictive rules than in the past, especially under regulators such as the UK’s Financial Conduct Authority or Luxembourg’s Financial Sector Supervisory Authority (CSSF) that have been accommodating toward pre-marketing under the existing, less prescriptive AIFMD requirements.
Differences of interpretation of marketing
At present, an EU alternative investment fund manager must notify its home regulator of its intention to market an EU-domiciled alternative fund either in its home jurisdiction or another EU member state. While the directive provides a definition of ‘marketing’, interpretations of this in practice vary from one country to another.
Some EU members treat any initial contact with a prospective investor as marketing, while others allow a degree of pre-marketing contact without the requirements of the AIFMD being triggered. The proposed directive would incorporate a definition of pre-marketing into the AIFMD and to specify the conditions under which it is permitted.
Under the Commission’s original draft, pre-marketing was defined as the direct or indirect provision of information on investment strategies or investment ideas by or on behalf of an AIFM to professional investors domiciled or registered in the EU, to ascertain their interest in a fund that has not yet been established.
Threat to existing investment practice
This activity would in the future be permitted throughout the EU, without any requirement on AIFMs to notify regulators when they did so. However, the Commission’s proposal excluded information that relates or refers to an existing fund, enables investors to commit to acquisition of units or shares of a fund, or that amounts to a prospectus, constitutional documents of a future AIF, offering documents, subscription forms or other documents that would enable investors to take an investment decision.
The draft proposed that where a professional investor subscribes to a fund established following pre-marketing activity, this would be considered the result of marketing, as would be the case for funds managed or marketed by an EU AIFM that had engaged in pre-marketing of a not-yet-established AIF with similar features.
The Commission’s proposals came under criticism from industry practitioners and advisers. They noted that by not permitting the circulation of fund documentation in draft form to investors without a marketing authorisation, the revised rules would require significant changes from existing practice for alternative investment funds.
Sounding out the market
It would further complicate the process of dealing with investors in jurisdictions whose domestic private placement regimes already entail a longer investment process. In some cases, it could oblige AIFMs to comply with the marketing passport conditions before a final decision to establish a fund had been made.
The issues raised regarding the original proposal appear to have been taken into account in a revised version of the legislation published by the EU Council on June 15, which is seen as significantly closer to the more liberal interpretation of AIFMD marketing authorisation requirements adopted by member states that are centres of the asset management and fund sectors.
The changes would permit AIFMs to sound out the market of prospective professional investors before documents are finalised ahead of a fund’s launch, the point at which AIFMs would probably be deemed to be carrying out marketing activities requiring authorisation or notification under the AIFMD.
Non-binding documentation
Under the revised conditions for pre-marketing, investors would not be able to subscribe to the prospective fund, and indeed no subscription documents would be available. Any constitutional and offering documents of not-yet-established AIFs would be in draft form only, would not constitute an offer, and would have to state clearly that they were incomplete, subject to change and were not to be relied upon. AIFMs would be required to document market-sounding activities, including details on when and where they were carried out, and be ready to share these with regulators on request.
If the Council’s proposals become law, EU and EEA member states that currently do not permit any pre-marketing activity would be required to allow managers to hold initial discussions with investors and test market appetite for their proposed fund before obtaining a marketing passport or submit notifications under the AIFMD rules governing national private placement regimes.
The Council’s amendments also state that any subscription to an AIF within 18 months of pre-marketing that either referred to the AIF or was established as a result of pre-marketing will be considered to be the result of marketing and subject to notification/authorisation, a new approach that would rule out reliance on reverse solicitation in certain circumstances.
Discontinuing marketing
Other amendments to the AIFMD proposed by the Council include changes to measures setting out the procedures and conditions for AIFMs seeking to discontinue marketing activities in a particular member state. In the Commission’s original draft, firms could simply notify other EEA regulators for which they had marketing authorisation for a particular fund that they no longer wish to market, cutting their costs on reporting and fees – but only if the jurisdiction was home to fewer than 10 investors in the funds with shares or units representing less than 1% of the fund’s assets.
AIFMs were also obliged to offer to repurchase units from investors in these jurisdictions, even if the fund was closed ended and not permitted to make redemptions. In the compromise proposals, the threshold is 5% of assets with an unlimited number of investors, and closed-ended AIFs are not required to repurchase investors’ shares or units.
The legislation also states that while an AIFM authorised to market units or shares of AIFs to retail investors in a particular member state must offer facilities locally to investors to make subscriptions or payments and to repurchase or redeem shares or units, they do not need to establish a physical presence there but can use electronic or other distance communication.
For further information, please contact Olivier Sciales at oliviersciales@cs-avocats.lu
Latest update of ESMA Q&A on information to be provided in AIFMD notification procedure
The European Securities and Markets Authority published on October 4 the latest edition of its Questions and Answers document regarding the application of the AIFMD and its implementing measures in order to promote standardised supervisory approaches and practices, incorporating a new question 5 in section IV of the Q&A regarding notification of alternative investment fund managers.
ESMA clarifies that the AIFM must identify all compartments of an umbrella alternative investment fund in the notification it makes when intending to manage an EU umbrella AIF on a cross-border basis through a management passport under Article 33 of the Alternative Investment Fund Managers Directive.
In the notification, the AIFM must identify the umbrella fund as well as the name and investment strategy of its sub-funds to facilitate administrative procedures in its home and host member states. Any change in the composition of an umbrella AIF managed on a cross-border basis must be notified to the appropriate regulators as required by Article 33(6) of the AIFMD.
The new version of ESMA’s AIFMD Q&A is available in English at: https://www.esma.europa.eu/sites/default/files/library/esma34-32-352_qa_aifmd.pdf
CSSF issues circular on governance and organisation of non-UCITS fund depositaries
Luxembourg’s financial regulator, the Commission de Surveillance du Secteur Financier, published on August 23 CSSF Circular 18/697 on organisational requirements applicable to depositaries of funds that are not subject to the UCITS rules set out in Part I of the investment fund legislation of December 17, 2010 and to their branches.
The circular amends Circular CSSF 16/644 regarding the provisions applicable to banks acting as UCITS depositaries under Part I of the 2010 legislation or their management companies, as well as Circular IML 91/75 (in turn amended by Circular CSSF 05/177) regarding the revision and remodelling of the rules governing Luxembourg funds under the law of March 30, 1988.
The new circular, which will come into force on January 1, 2019, is applicable to all non-UCITS Luxembourg depositaries, as well as EU banks and investment firms or their branches that are currently providing depositary services in Luxembourg, or intend to apply for an authorisation to do so in the future, to three categories of non-retail funds.
These comprise alternative investment funds managed by an authorised management company or alternative investment fund manager; Luxembourg Part II funds managed by a fully authorised or registered AIFM that stipulate in their constitutive documents that they are not distributed to retail investors established in Luxembourg; and specialised investment funds (SIFs) and risk capital investment vehicles (SICARs) that do not qualify as AIFs or that do so and are managed by a registered AIFM.
Most of the rules set out in the circular supplement the AIFMD transposition legislation of July 12, 2013 and the Commission’s level 2 delegated regulation (EU) 231/2013 regarding depositaries, clarifying the organisational requirements of the categories of depositary covered.
These include the eligibility criteria for AIF depositaries, segregation rules, depositary rights of pledges, and the rules to be followed when providing services to funds that invest in assets including real estate, private equity, tangible assets and financial derivatives.
The circular also requires the alternative fund to ensure that on its appointment and on an ongoing basis the depositary has access without undue delay to all the relevant information it needs to comply with its obligations regarding depositary services for the AIF in question.
If the AIFM is not established in Luxembourg, the depositary must conclude a written agreement with it setting out the flow of information necessary for it to perform its functions, notably regarding the safekeeping of assets, monitoring of the fund, and the legislative, regulatory and administrative provisions applicable to the depositary. The parties to the contract appointing the depositary may agree that all or part of the information required may be transmitted electronically.
The full text of the circular (in French) is available at http://www.cssf.lu/fileadmin/files/Lois_reglements/Circulaires/Hors_blanchiment_terrorisme/cssf18_697.pdf
CSSF sets out more restrictive policy on UCITS investment in non-UCITS funds
Luxembourg’s Financial Sector Supervisory Authority (CSSF) has announced changes to its policy regarding investment by UCITS funds in non-UCITS undertakings for collective investment, amending the guidance contained in its Frequently Asked Questions document addressing the law of December 17, 2010 on undertakings for collective investment.
In the interests of convergence at EU level regarding the UCITS regime, the CSSF now says that UCITS may no longer invest in other UCIs and those that have done so are required to divest their holdings as soon as possible, unless the eligibility of each target fund has been confirmed specifically through case-by-case analysis.
Point 1.4 of the FAQs previously stated that non-UCITS ETFs were eligible investments for UCITS funds if they effectively complied with all criteria of Articles 2(2) and 41(1)(e) of the 2010 legislation, event if the offering documents of non-UCITS ETFs contain provisions regarding investment that are not equivalent to the requirements applicable to UCITS.
However, the CSSF says that given the specific characteristics of each non-UCITS ETF, merely the existence of a system of compliance control, or written confirmation from the ETF or the manager of the fund’s eligibility, is no longer acceptable.
The regulator says that for a non-UCITS ETF to be accepted for investment by a UCITS, an eligibility analysis must be carried out in each case, and the UCITS must continuously monitor that the investment rules applied by the ETF are equivalent to those applicable to UCITS.
The CSSF emphasises that to be eligible under article 50(1)(e) of the UCITS directive, non-UCITS funds must be prohibited from investing in illiquid assets such as commodities and real estate, in conformity with Article 1(2)(a) of the UCITS directive.
They must also be bound by rules on asset segregation, borrowing, lending, and uncovered sales of transferable securities and money market instruments that are equivalent to the requirements under article 50(1)(e)(ii) of the UCITS directive. Simple compliance in practice is no longer considered sufficient.
The non-UCITS fund’s rules or instrument of incorporation must also include a provision stipulating that no more than 10% of its assets in aggregate can be invested in UCITS or other UCIs in compliance with article 50(1)(e)(iv) of the UCITS directive. Again, mere compliance in practice is not sufficient.
As a result, UCITS funds subject to the 2010 legislation that have invested in non-UCITS on the basis of the policy previously set out in Point 1.4 of the FAQs must disinvest from these funds as soon as possible, subject to the best interests of the investors. The CSSF says it will contact fund managers that have invested in such UCIs to check compliance with the new policy by March 31, 2018. In addition, new investments in such funds is no longer allowed unless the new requirements are fulfilled.
The version of the CSSF’s Frequently Asked Questions regarding Luxembourg’s legislation of December 17, 2010 relating to undertakings for collective investment, updated on January 5, 2018, may be viewed at http://www.cssf.lu/fileadmin/files/Metier_OPC/FAQ/FAQ_Law_17_December_2010_050118.pdf
ESMA issues new updates to UCITS and AIFMD Q&As
The European Securities and Markets Authority has issued fresh updates on October 5 to its Questions and Answers documents containing guidance on and interpretation of the EU’s Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers Directive (AIFMD) regimes.
ESMA says the Q&A documents aim to promote common supervisory approaches and practices in the practical application of the various UCITS directives and the AIFMD through responses to questions posed by industry members and regulators themselves.
Reporting on securities financing transactions and total return swaps
The UCITS Q&A deals with areas including master-feeder structures, investment restrictions, UCITS Key Investor Information Documents, guidelines on exchange-traded funds, exchange of information between regulators, risk measurement and OTC derivatives. The latest update concerns periodic reporting by UCITS and AIFs to investors on the use of securities financing transactions (SFTs) and total return swaps under Article 13 of the EU’s 2015 Securities Financing Transaction Regulation.
Article 13 of the regulation requires UCITS management companies, UCITS investment companies and AIFMs to inform investors on the use they make of SFTs and total return swaps in annual and half-yearly (for UCITS only) reports. ESMA says this data should be reported based on a snapshot at the end of the reporting period, with the exceptions of data on reuse of collateral and on the return and cost for each type of SFT and total return swaps.
Disclosure of remuneration by AIFM’s portfolio or risk management delegate
The AIFMD Q&A covers remuneration, notification of alternative investment funds and their managers, reporting to national regulators, services covered by MiFID, depositaries, calculation of leverage, delegation, calculation of assets under management, additional own funds, and scope of the authorisation requirement, as well as the impact of the EMIR regulation. The new version also includes the same comments on Securities Financing Transaction Regulation reporting, as well as the application of remuneration disclosure requirements to staff of an entity conducting portfolio or risk management under delegation from an AIFM, and the manner of such disclosure in annual reports.
ESMA says the remuneration-related disclosure requirements under Article 22(2)(e) of the AIFMD also apply to employees of such an entity, and that AIFMs may ensure compliance in one of two ways. Where the delegated entity is subject to regulatory requirements on remuneration disclosure for its staff that are equally as effective as those stipulated under the AIFMD, the AIFM should use the information disclosed by the delegate to meet its obligations under Article 22(e) of the AIFMD and Article 107 of the AIFMD Level 2 Regulation.
In other cases, contractual arrangements should be concluded that enable the AIFM to receive, and disclose in annual reports for the relevant AIFs that it manages, at least information on the total fixed and variable remuneration for the financial year paid by the AIF and/or the AIFM to the identified staff of the delegate, the number of beneficiaries and where relevant, carried interest, that is linked to the delegated portfolio.
The disclosure should be made on a prorated basis for the share of the AIF’s assets that is managed by the delegated entity’s identified staff. In both situations, the disclosure may be provided on an aggregate basis, as a total amount for all delegates of the AIFM in relation to the AIF in question.
Inclusion in annual report
ESMA says the information stipulated in Article 22(2)(e) and (f) of the AIFMD may not be disclosed in the annual report through a link to a document containing the information, but must be included in the annual report itself, although additional information in other documents may be referred to.
ESMA’s Q&A document on application of the UCITS regime may be consulted at https://www.esma.europa.eu/sites/default/files/library/esma34-43-392_qa_ucits_directive.pdf, and the AIFMD Q&A at https://www.esma.europa.eu/sites/default/files/library/esma34-32-352_qa_aifmd.pdf.
CSSF guidance on PRIIPs KID for Luxembourg alternative investment funds
In the latest update of its Frequently Asked Questions document on the legislation governing alternative investment fund managers, published on July 6, 2017, Luxembourg financial regulator CSSF has addressed issues raised by the introduction in January 2018 of the European Union’s regulation on Packaged Retail and Insurance-based Investment Products and its requirement for such products to provide investors with a Key Information Document.
Exemption for UCITS KIID
The CSSF says manufacturers of Luxembourg AIFs whose units are being advised on, offered to or sold to retail investors must have a PRIIPs KID in place from January 1, 2018, unless they benefit from a two-year exemption under article 32(2) of the PRIIPs Regulation by having issued a UCITS Key Investor Information Document before that date.
The exemption is subject to the UCITS KIID being issued for each retail share class of the sub-funds of the Luxembourg AIF, and that its offering document has been amended to reference the distribution of a KIID to all retail investors considering an investment in the fund. The offering document must also mention that the KIID will be published on the website of the AIF’s registered or authorised AIFM and is available upon request in paper form.
Additional sub-funds or share classes of such an AIF launched after January 1, 2018 may also benefit from the exemption. All AIFs must have a PRIIPs KID in place by January 1, 2020 (unless this deadline is pushed back by the European Commission).
Indication of professional investor exclusivity
The CSSF makes clear that the PRIIPs Regulation does not apply to manufacturers of and persons advising on or selling Luxembourg AIFs whose units are advised on, offered or sold solely to professional investors. However, the regulator strongly urges AIFs in this situation to amend their offering documents before January 1, 2018 to include a reference to the fact that they are restricted to professional investors and therefore no PRIIPs KID will be issued. As an alternative, the CSSF will accept a signed self-assessment form stipulating that AIF’s shares or units may be subscribed or acquired exclusively by professional investors.
Non-EU and existing retail investors
A PRIIPs KID does not have to be provided to retail investors outside the EU and European Economic Area unless the regulations of the country in which marketing takes place provide otherwise, nor is one required for existing retail investors of a Luxembourg AIF if its units are not being advised on, offered or sold to any new retail investors.
A KID does need to be provided to existing retail investors of a Luxembourg AIF that wish to make additional investments after January 1, but not where periodic subscriptions are being made under a regular savings plan, unless a change is made to the subscription arrangements and a new subscription form is required.
Timing of KID delivery
PRIIPs KIDs should be provided to retail investors by persons advising on or selling units of Luxembourg AIFs “in good time” before the investors are bound by any contract or offer relating to the subscription of units, free of charge and in paper form, using another durable medium or by means of a website (a PRIIP manufacturer must always publish the KID on its website). The KID should be made available in at least one official language of each EU member state where the AIF is being offered or sold.
Filing of KID final version
The CSSF says it requires exclusively the notification of the final version of a KID; there is no obligation of notifying any draft versions. Despite the above, the final version of KID will not be certified by the regulator. It must be filed according to the instructions in circulars CSSF 08/371 and CSSF11/509 using the nomenclature described at: http://www.cssf.lu/fileadmin/files/Metier_OPC/Transmission_electronique_des_documents__PRIIPs_KID_.pdf
Other PRIIPs guidance
The CSSF’s update on AIFs and PRIIPs follows just after the publication on July 4 of a Questions and Answers document (https://esas-joint-committee.europa.eu/Publications/Consultations/Questions%20and%20answers%20on%20the%20PRIIPs%20KID.pdf) from the European Supervisory Authorities’ joint committee covering the presentation, content and review of the KID, including the methodologies underpinning the risk, reward and costs information.
At the same time the European Commission adopted and released guidelines (http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52017XC0707(02)&from=EN) on application of the PRIIPs Regulation that are designed to ease implementation of the new rules by minimising as far as possible the scope for differences in interpretation between EU member states. It includes clarification in areas including territorial application, running offers and ‘real time’ KIDs.
The latest version of the CSSF FAQ on the Luxembourg law of July 12, 2013 on alternative investment fund managers and the European Commission’s AIFMD level 2 regulation is available at http://www.cssf.lu/fileadmin/files/AIFM/FAQ_AIFMD.pdf.
ESMA sets out new rules for UCITS share classes
On January 30, 2017 the European Securities and Markets Authority issued an opinion on the minimum principles that management companies must apply when establishing different UCITS share classes. The opinion is aimed at ensuring a harmonised approach throughout the EU, where different national approaches have been observed up to now.
The opinion is addressed to national regulators including Luxembourg’s Commission de Surveillance du Secteur Financier (CSSF), which has already endorsed it in a press release on February 13. The CSSF expects Luxembourg-domiciled UCITS management companies to take any necessary measures to comply with the transitional provisions set out in the opinion, and any new UCITS share classes created will have to comply with the principles.
ESMA says share classes that are not compliant with the principles may continue to exist, but should close to investment from new investors within six months of the opinion’s publication, that is, by July 30, 2017, and to additional investment from existing investors within 18 months of publication, by July 30, 2018.
ESMA sets out four principles regarding the establishment of UCITS share classes:
1. Common investment objective
Multiple share classes of the same UCITS should have a common investment objective reflected by a common pool of assets. ESMA considers that hedging arrangements at share class level, apart from currency risk hedging, are not compatible with the requirement for a UCITS to have a common investment objective. Therefore strategies that seek to protect investors from certain types of risk should be set up as separate UCITS or sub-funds. The authority says this is because the use of derivative overlays for a particular share class could result in that share class having an individual risk profile and therefore an investment objective that is no longer in line with the objective of the UCITS or sub-fund.
2. Non-contagion
UCITS management companies should implement procedures to minimise the risk that features specific to a single share class could have a potentially adverse impact on other share classes of the same UCITS or sub-fund. The risk of contagion or spill-over is particularly high where the UCITS concludes derivative contracts. In such cases these risks should be mitigated and monitored, and borne only by investors in the particular share class. Any administrative costs arising from the need for additional risk management should be borne only by investors in that share class.
3. Pre-determination
All features of a particular share class should be pre-determined before the UCITS is established, including currency risk hedging.
4. Transparency
Where there is a choice between two or more share classes, differences between them should be disclosed to investors through the UCITS prospectus. The management company should have an updated list of share classes readily available and implement appropriate stress tests.
The full text of the opinion may be accessed here.
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Luxembourg regulator updates rules for UCITS depositaries
Luxembourg’s Financial Sector Supervisory Authority (CSSF) has issued on October 11, 2016 Circular 16/644, which sets out revised rules applicable to all Luxembourg credit institutions acting as depositary banks for UCITS funds as well as to all Luxembourg UCITS, including self-managed funds, and/or their management companies.
The circular sets out regulatory requirements clarifying rules under the updated Luxembourg investment fund law implementing the UCITS V directive, which came into force on June 1, and the European Commission’s Level 2 delegated regulation EU2016/438 regarding the obligations of depositaries, as well as various other matters.
For the most part the rules detailed in the CSSF circular are supplementary to the revised UCITS regime, providing clarification in areas such as the organisational requirements relating to the chain of custody and detailing the duties and responsibilities of the designated UCITS depositary and any sub-custodians, as well as the depositary’s responsibility for monitoring financial flows.
The circular covers eligibility criteria for UCITS depositaries, including human resources and technical capabilities, the process of regulatory approval by the CSSF, the contract designating a depositary, governance and organisational issues such as managing conflicts of interest, internal procedures regarding the depositary function, organisational matters regarding the safekeeping of assets, depositary functions in the case of assets that are not subject to safekeeping, due diligence regarding investment in other funds, the depositary’s right of access to information required to fulfil its responsibilities, collateral management, the depositary’s responsibilities regarding exchange-traded and OTC derivatives, reconciliation procedures, and business continuity management.
Further guidance is expected to be issued shortly by the CSSF on the degree of independence of a depositary in relation to a UCITS structured as an open-ended investment company (SICAV) managed by a Chapter 15 management company, as analysts have indentified a lack of detail in the circular on this matter.
Most of the requirements set out in the circular are general to the UCITS V regime. However, it includes guidance specific to Luxembourg regarding the requirement for asset segregation below the depositary level regarding sub-custodians and entities at lower levels to which depositary duties are delegated.
According to the previously applicable CSSF Circular 14/587, which the new circular replaces, sub-custodians may use omnibus accounts for all client assets managed collectively within UCITS and alternative investment funds subject to the Alternative Investment Fund Managers Directive, as long as accounts can always be clearly identified as belonging to clients whose assets are managed collectively.
For sub-custodians below the first level of delegation, the CSSF does not require omnibus accounts to be dedicated to UCITS depositary or collective investment fund clients, an approach that eases requirements for Luxembourg-based UCITS depositaries and may presage similar Europe-wide guidance in the future from the European Securities and Markets Authority.
The CSSF circular, which is available only in French, came into force on October 13. It can be accessed by going to the following link: CSSF circular 166/44.
