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.

UCITS V regulation on depositaries’ obligations comes into force

The Commission’s delegated regulation (EU) 2016/438 of December 17, 2015, which updates the UCITS regime provisions on the obligations of depositaries, has taken effect as of October 13. The UCITS V Level 2 regulation sets out detailed uniform rules in particular regarding the duties of the depositaries of UCITS funds.

The regulation lays down requirements regarding depositaries’ duties, delegation arrangements and the liability regime for UCITS assets under custody, designed to provide a high level of investor protection.

Written agreement

To ensure that the depositary performs its duties properly, the regulation provides a detailed list of all the elements to be included in the written depositary contract. It should notably provide adequate detail on the categories of financial instruments in which the UCITS may invest and the geographical regions where investments may be made.

In addition, the contract should set out the escalation procedure to be followed should any discrepancies be detected, including notification of the management company or investment company, and provide for termination of the agreement as a last resort if the depositary believes the required level of investment protection is not ensured.

Depositary’s duties

The regulation states that as a rule, the depositary must perform four types of duty. With regard to oversight, it must ensure consistency between the number of shares or units issued and the subscription proceeds received, ensure that appropriate valuation policies and procedures for the assets of the UCITS are effectively implemented, verify the fund’s compliance with applicable law and regulations as well as its rules and instruments of incorporation, and check that its income is calculated accurately.

As part of its cash monitoring duties, the depositary must maintain a clear overview of all inflows and outflows of cash and maintain periodically updated procedures for monitoring of the UCITS’ cash flows. It should also ensure that all payments made by investors for subscription to the shares or units of the UCITS have been received and booked in one or more cash accounts.

Its safekeeping duties include keeping in custody all financial instruments held by the UCITS that may be registered or held in an account directly or indirectly in the name of the depositary or a third party to which safekeeping functions are delegated. For assets that are not financial instruments subject to custody, such as certain derivatives or cash deposits, the depositary must verify and maintain records of their ownership.

The due diligence duties of the depositary entail implementing and applying a due diligence procedure for the selection and ongoing monitoring of any third party to which safekeeping functions are delegated. The depositary’s obligations correspond to those applicable both to the UCITS itself and to its management company.

Liability for losses

The depositary is liable in the event of loss of a financial instrument held in custody by the depositary itself or by a third party to which safekeeping has been delegated, unless the depositary can demonstrate, by according to a list of conditions, that the loss has resulted from an external event beyond its reasonable control and whose consequences would have been unavoidable despite all reasonable efforts to the contrary.

Operational independence

To ensure the protection of investors, the management company or investment company and the depositary must be operationally independent. Any existing or arising group link between them must be addressed with appropriate policies and procedures.

The measures set out in the Commission’s delegated regulation update the depositary rules in line with the most recent iteration of the retail fund regime, UCITS V, while bringing the UCITS requirements into line with those applicable to alternative funds and their depositaries under the 2011 Alternative Investment Fund Managers Directive.

UCITS V legislation to come into force in Luxembourg in June

Luxembourg’s Chamber of Deputies has approved legislation incorporating the European Union’s UCITS V directive into national law, following a legislative odyssey lasting just over nine months. Bill of law no. 6845 amends the grand duchy’s fund legislation of December 17, 2010, which transposed UCITS IV, and was finalised by publication on May 12 in the Mémorial, the country’s official journal, as the Law of May 10, 2016, the day it was signed by Grand Duke Henri. The legislation will come into force at the beginning of June.

The main changes brought by the new legislation affect depositary functions, remuneration policies and sanctions applicable to the management of UCITS funds, bringing the UCITS regime into line with that governing alternative funds.

It enshrines the responsibility of depositaries for the assets they oversee, sets out rules to ensure that remuneration structures do not incentivise portfolio managers or other key employees to take inappropriate risks, and sets out a framework of sanctions for breach of the rules.

In addition, the law makes non-UCITS funds established under Part II of the fund legislation also subject to the UCITS V depositary requirements, rather than the rules applicable to alternative fund managers under Luxembourg’s law of July 12, 2013, which transposed the Alternative Investment Fund Managers Directive, or those set out in Circular 91/75 issued by the grand duchy’s financial regulator, the Financial Sector Advisory Authority (CSSF).

Part II funds are now subject to the more stringent UCITS depository rules irrespective of whether the assets overseen by their managers are above or below the threshold set out in the AIFMD. The Law of May 10, 2016 also amends the 2013 legislation by requiring an independent audit of alternative investment fund managers’ accounting documents and providing clarification on rules governing the provision of non-core services on a cross-border basis.

The passage of the Luxembourg law follows the issue by the European Commission on March 24 of a level 2 delegated regulation supplementing the UCITS V directive. The key provisions include:

• The regulation sets out minimum requirements for written agreements between the investment company or management company and the depositary for each fund run by the management company.
• It adds details regarding duties of the depositary including oversight, cash monitoring, safekeeping of custody and other assets, due diligence in selecting and appointing third parties, and segregation and insolvency protection of UCITS assets when delegating custody. The insolvency protection requirement, new to EU fund rules, requires the depositary to obtain legal assurance that in the event of insolvency of a third-country custodian, the UCITS assets may not be used to pay the custodian’s creditors.
• The regulation defines the conditions and circumstances, first set out in the AIFMD, in which financial instruments held in custody are considered lost and what constitutes a force majeure event that would relieve the depositary of liability.
• It clarifies independence requirements for management companies, investment companies, and depositaries, including rules on composition of the management body of the management or investment company as well as the depositary and any sub-custodians. Additional rules apply when an ownership link exists between the management or investment company and the depositary.

The Commission’s delegated regulation came into force on April 12 and will be applicable from October 13 this year.

The full text of the Law of May 10, 2016 can be viewed at:
The Commission’s delegated regulation is available at:

Luxembourg moves ahead with UCITS V adoption

Luxembourg is pushing ahead with legislation to adopt the UCITS V directive into national law. Bill no. 6845, transposing Directive 2014/91/EU of July 23, 2014, was approved by the cabinet on July 10 and placed before parliament on August 5. It is expected to be debated and adopted during the fourth quarter of the year.

The legislation amends directive 2009/65/EC (UCITS IV) on co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities with regard to depositary functions, remuneration policies and sanctions.

The Luxembourg bill contains significant amendments to the investment funds law on December 17, 2010 on undertakings of collective investment and the law of July 12, 2013, adopting into the national law the EU’s Alternative Investment Fund Managers Directive. The AIFMD is the source of many of the UCITS V provisions and one of the new directive’s main aims is to bring the two regimes into line regarding depositary rules, remuneration and sanctions provisions.

The preamble to the legislation states that its main purposes are to define clearly the tasks and responsibilities of UCITS depositaries, including clarification of their responsibility for safekeeping of assets, set out rules on remuneration policies designed to curb incentives for excessive risk-taking by portfolio managers and others, and harmonise administrative penalties for breaches of the rules applicable to both funds and their managers.

The bill, which faithfully follows the language of the UCITS V directive, also proposes separate changes to the December 2010 legislation, notably to apply the UCITS V depositary rules to non-UCITS funds established under Part II of the Luxembourg fund law. At present the depositary rules applicable to Part II funds are those set out in CSSF Circular 91/75 if the fund’s assets are below the AIFMD threshold.

It also introduces additional amendments to the 2013 AIFMD implementation law, requiring alternative managers to have their accounts audited by a certified auditor, as is now the case for UCITS management companies.

In addition, authorised AIFMs may henceforth provide non-core investment services, such as discretionary individual portfolio management or investment advice, on a cross-border basis subject to the notification requirements. This amendment implements changes to the AIFMD introduced by the MiFID II directive of May 15, 2014.

UCITS V - CSSF circular 15/608

On March 23 the Luxembourg Financial Supervisory Authority issued CSSF Circular 15/608, addressed to all banks acting as depositaries of UCITS funds under the grand duchy’s investment funds legislation of December 17, 2010 as well as to all Luxembourg funds or their management company, regarding a change in the deadline for compliance with the regulator’s earlier Circular 14/587 as well as advance notice of future modifications.

Given that the rules regarding UCITS depositaries as modified by the UCITS V directive (which also covers remuneration rules and sanctions) are due to be transposed by EU member states at the latest by March 18, 2016, and that the depositary provisions of the directive will be fleshed out by delegated legislation that may not be issued until the third quarter of this year, the CSSF has ruled that funds, depositaries and managers will have until March 18 of next year to become compliant.

The change is set out in an amended paragraph 187 of Circular 14/587, while also states that chapter E of the venerable Luxembourg Monetary Institute circular IML 91/75 will cease to apply from that date.

The CSSF has also given notice that in due course it will implement a further change to Circular 14/587 in order to adapt it to the depositary measures set out in UCITS V and its Level II measures. This amendment will also take effect on March 18, 2016.

ESMA issues final report on UCITS V delegated acts

On November 28 the European Securities and Markets Authority issued its final report to the European Commission regarding two delegated acts on depositary requirements that must be issued to complement the primary legislative text of the UCITS V directive.
The report, drawn up in response to a request from the Commission on July 3 for technical advice, was issued following a period of consultation with the industry, which closed on October 24, on a preliminary draft of ESMA’s advice.
ESMA received 60 responses to the consultation paper from asset managers, depositary banks, industry groups, consumer representatives, public authorities and a law firm, as well as an academic and one individual.
In their feedback, the asset management industry associations regretted the short deadline for responses to the consultation, arguing that this would compromise what should be an objective exercise allowing the Commission to justify its policy choices according to its internal impact assessment guidelines. In fact ESMA did delay its submission to the commission, for which the original deadline was October 15.
Respondents also insisted that it was important to ensure that the Level 2 delegated legislation issued by the Commission would be applied in the same way throughout the EU, requiring national regulators to refrain from ‘gold-plating’ the measures with additional requirements in their jurisdictions, and urged that consistency be ensured between the UCITS delegated acts and their AIFMD counterparts.
The new depositary requirements are designed to broadly align the provisions of the UCITS regime with those of the Alternative Investment Fund Managers Directive regarding the rules on depositaries’ duties, delegation, eligibility to act as custodian, and liability.
In addition to the rules governing depositaries set out in the AIFMD, UCITS V contains additional requirements relating to the insolvency protection of fund assets in cases where the depositary delegates safekeeping duties to a third party, and the requirement for the management company and depositary to act independently of each other.
UCITS V stipulates that any third party to which custody is delegated by the depositary must take all necessary steps to ensure that in the event of the third-party custodian’s insolvency, the fund assets it holds should not be available for distribution to or realisation on behalf of its creditors.
The consultation paper proposes measures, arrangements and tasks to be undertaken by the third-party custodian, as well as measures to be implemented by the depositary, to be included in the Commission’s legislation.
Some respondents cautioned that the protection offered by segregation of assets was at the mercy of any developments in insolvency laws and jurisprudence, and that based on past experience, the laws of many jurisdictions do not ensure the return of clients assets without hindrance or delay, or even guarantee that they will not be treated as part of the insolvent estate of the third-party custodian.
They urged ESMA and the Commission to support harmonisation at international level, through IOSCO, of insolvency laws in third-country jurisdictions to ensure effective asset segregation and protection. ESMA says that since this is not part of its mandate, it would be more appropriate for IOSCO or the Commission to take the lead.
UCITS V also stipulates that in carrying out their respective functions, the management company (and investment company) and the depositary should act independently and solely in the interest of the UCITS fund and its investors.
The Commission’s depositary acts should set out how this independence requirement is to be ensured. The report identifies common management and/or supervision and cross-shareholdings between the management and depositary entities as links that could threaten their independence and recommends measures to address these risks.
ESMA says it will now work closely with the Commission to help it adapt the technical advice into formal delegated legislation. The report can be consulted in its entirety at: Please also see our previous article on this topic at 

ESMA consults on depositary requirements under UCITS V

The European Securities and Markets Authority has issued a consultation paper seeking feedback from asset management industry members on its draft advice to the European Commission regarding depositary requirements under the forthcoming UCITS V directive.
The paper has been drawn up in response to a provisional request from the Commission on July 3 seeking technical advice on the content of two delegated acts on depositaries that the Commission is called on to issue to complement the primary UCITS V legislative text.
The new depositary requirements are designed to broadly align the provisions of the UCITS regime with those of the Alternative Investment Fund Managers Directive regarding the rules on depositaries’ duties, delegation, eligibility to act as custodian, and liability.
The requirement for delegated acts on depositaries from the Commission under UCITS V are broadly in line with that applicable to the AIFMD, for which ESMA provided technical advice to the Commission in 2011.
However, UCITS V includes two further stipulations relating to the insolvency protection of UCITS fund assets when the depositary delegates safekeeping duties to a third party, and the requirement for the management company and depositary to act independently of each other.
UCITS V provides that in the event of delegation of custody by the depositary, the third-party custodian should take all necessary steps to ensure that in the event of its insolvency, the UCITS assets it holds are not liable to be distributed to or realised for the benefit of the custodian’s creditors.
The Commission is empowered to adopt delegated acts specifying the steps to be taken by the custodian in this regard. The consultation paper proposes measures, arrangements and tasks to be undertaken by the third-party custodian, as well as measures to be implemented by the depositary.
Regarding the independence requirement, UCITS V stipulates that in carrying out their respective functions, the management company (and investment company) and the depositary should act independently and solely in the interest of the UCITS fund and its investors.
The Commission is empowered to adopt delegated acts specifying how this independence is to be ensured. The consultation paper identifies common management and/or supervision and cross-shareholdings between the management and depositary entities as links that could call independence into question.
The consultation paper can be consulted at ESMA will consider the feedback it has received before submitting its technical advice to the Commission by the end of November.

Countdown approaches for UCITS V implementation

The approval of the UCITS V directive by the European Parliament shortly before its dissolution for elections last month has ensured that the latest iteration of the European legislative framework for the cross-border marketing and distribution of retail investment funds will not be held hostage to second thoughts by the new membership of the assembly.
The directive approved by the parliament in plenary session on April 15 is relatively limited in scope, covering depositary functions, remuneration policies and sanctions. More fundamental changes may come in the future from what will become UCITS VI.
This measure, which is still at the preliminary discussion stage, could rethink the expansion of the range of assets eligible for investment by UCITS funds launched by the UCITS III directive in 2002.
First, though, the UCITS V legislative process must be completed. First the European Council on behalf of EU member states must approve the version of the text agreed by the parliament, which is expected to be a relatively straightforward process.
Following technical finalisation of the text to revise drafting errors and omissions and add details such as timelines, as well as translation into the EU’s official languages, the directive is expected to be published in the EU Official Journal around September or October.
It will enter into force 20 days following the date of publication, after which member states will have 18 months to transpose it into national law. In Luxembourg’s case, this will involve amendment of the existing law on collective investment schemes of December 17, 2010, by which UCITS IV was adopted. The likely go-live date should therefore be some time during the second quarter of 2016.
In the meantime, the European Securities and Markets Authority is expected to issue guidelines toward the end of this year, in particular offering help in interpreting aspects of the directive’s provisions on manager remuneration, one of three areas addressed by UCITS V along with the role of the fund’s depositary and harmonisation of regulatory sanctions regimes.
Together the changes in these areas are intended to enhance investor protection, increase the degree of standardisation in the way the UCITS rules are applied by regulators across Europe, and align the rules to a greater degree with those applicable under the Alternative Investment Fund Managers Directive, although various differences remain between the retail and alternative fund regimes.
The role of the depositary is a cornerstone of the UCITS investor protection provisions. Up to now, the EU legislation simply required each UCITS to have an independent depositary and contained just a few sentences on the depositary’s role.
In some member states, the brief text of the directive was copied wholesale into national law, leaving plenty of leeway for differences in local regulators’ interpretation of the rules. That now changes because the UCITS V depositary measures contain several pages of rules.
The draft directive imposes limitations on the kinds of entity that are eligible to perform the role of a depositary to national central banks, credit institutions and regulated firms with sufficient capital and adequate infrastructure.
The depositary holds for safekeeping the assets in which a UCITS invests, protecting the ownership rights of the fund and its investors and carrying out various oversight functions. In turn, segregation mechanisms protect the fund’s assets in the event of the depositary’s bankruptcy.
It is argues that even before any changes of the eligible asset rules is introduced in UCITS VI, the depository requirements in UCITS V may have the practical effect of imposing more conservative management policies toward assets and strategies because of the detailed rules setting out the depositaries’ responsibility for oversight of compliance with the rules.
This is enforced by the depositary’s strict liability for loss of assets, which could make institutions less willing to tolerate the holding of assets or following of investment strategies that might be perceived as breaching the UCITS rules.
In line with the provisions of the AIFMD, UCITS V will require that remuneration practices affecting all ‘risk-takers’ involved in managing UCITS funds do not encourage excessive risk-taking and instead promote sound and effective risk management.
The forthcoming directive will stipulate that at least 50% of any variable remuneration (i.e. bonuses) consists of shares or units of the UCITS concerned, or equivalent instruments, unless the management of UCITS accounts for less than 50% of the total portfolio managed by the management company, in which case the minimum of 50% does not apply.
The directive also seeks to ensure more effective and harmonised administrative sanctions, including action under criminal law, which is covered by co-operation between national authorities.
The financial crisis revealed differences in the way national regulators addressed breaches of the UCITS rules. The changes set out minimum administrative sanctioning powers that all member states must make available to their respective regulators.
The stipulated sanctions run from public naming and shaming and regulatory orders to cease the conduct in question to financial penalties applicable to both individuals and companies, suspension or withdrawal of the licence of the UCITS management company, and temporary or permanent bans on individual managers of the management company or investment manager.