UCITS V Update - Level 2 Regulation on depositary obligations

On December 17th 2015, the European Commission adopted the long-awaited awaited official draft of the Level 2 Regulation, supplementing Directive 2009/65/EC of July 13th 2009 (the “UCITS Directive”) as amended by Directive 2014/19/EU of July 23rd 2014 (the “UCITS V Directive”) (the “Regulation”), with regard to the obligations of UCITS depositaries.

"The aim of the Regulation is to ensure uniform and effective compliance with the UCITS Directive across EU Member States with regard to the rules applicable to UCITS depositaries."

In order to ensure consistency between the UCITS Directive and Directive 2011/61/EU, on alternative investment fund managers (the “AIFMD”), the provisions of the Regulation are as close as possible to the provisions contained in the Level 2 Regulation 231/2013 supplementing the AIFMD.

The aim of the Regulation is to ensure the highest protection of UCITS assets through the provision of precise and unequivocal rules on depositaries and third parties to whom the safekeeping functions have been delegated. By virtue of such rules, UCITS investors will enjoy the same level of protection across the EU when it comes to the safekeeping of their assets with a UCITS depositary.

More specifically, the Regulation sets out detailed rules for UCITS depositaries relating, inter alia, to:

  • contractual provisions to be included in depositary agreements;
  • general requirements on the depositaries’ oversight duties;
  • cash flow monitoring;
  • safekeeping duties with regard to assets held in custody;
  • ownership verification and record keeping duties with regards to other assets (such as derivatives contracts);
  • potential discharge of liability in case of loss of financial instruments held in custody;
  • initial and ongoing due diligence requirements regarding the selection of sub-depositaries; and
  • segregation of assets.

Furthermore, the Regulation sets out independence requirements at the level of the management company and the depositary.  Thus, it is proposed that no person may be a member of the management body of the management company and a member of the management body of the depositary at the same time.

The Regulation also sets out rules on conflicts of interests in order to ensure that a UCITS asset manager and a UCITS depositary act independently. However, according to the principle of proportionality, more incisive measures, such as the requirement of a strict structural separation between an asset manager and its depositary are discarded in favour of less incisive, but equally efficient, requirements as to the independence of management boards of both entities. Equally, in relation to the “insolvency proofing” of assets in case of delegation to a third party, the strict requirement of an independent legal opinion is mitigated by allowing the sharing of such opinions between several members of an industry federation.

The Regulation will now be reviewed by the Council of the EU and the European Parliament. If the EU institutions  do not raise any objections, the Regulation will be published in the Official Journal of the EU. The Regulation shall enter into force 20 days following the day of its publication and shall apply directly in all Member States 6 months after its entry into force without the need for transposing legislation.