EUROPE: CESR publishes UCITS Depositary Functions Review

Tuesday September 29 2009

CESR has published its response to the European Commission `s consultation on the UCITS depositary function. The European Commission had mandated CESR to review the manner in which Member States have implemented the relevant provisions of the UCITS Directive, and evaluate how responsibilities and liabilities of depositaries are defined having regard to national law.

CESR has published the results, despite the fact that they had last month confirmed to Funds-Axis that this request had been “de-prioritised” in order to allow them to respond to more urgent deadlines.

The mandate, which came after the Madoff Scandal had brought to light the differences between Member States with regards to their implementation of UCITS Depositary Rules, prompted CESR to conduct a survey/mapping exercise on the rules which are applied at national level with respect to the liabilities and responsibilities of depositaries, including in the case of sub-custody of the UCITS ` assets.

29 Members responded to the survey and the responses confirmed that Members have implemented and interpreted the requirements of the UCITS Directive in relation to depositaries in divergent ways.

In regards to the liability regime of UCITS Depositaries, all Members base their requirements on Article 24 of the UCITS IV Directive which states that :”A depositary shall, in accordance with the national law of the UCITS home Member state, be liable to the management company and the unit-holders for any loss suffered by them as a result of its unjustifiable failure to perform its obligations or its improper performance of them.”

Concerning the liability regime in case of sub-custody, CESR findings show that a third of the CESR Member impose “an obligation of result” meaning depositories are “liable vis-à-vis to the investors” and must restore assets if a failure occurs at a third-party. Another third impose an “obligation of means” which means that a depositary is liable to investors only if it has “failed to perform its obligation vis-à-vis the third-party”. Seven Members do not make a distinction between an obligation of means and an obligation of result.

CESR has in its response made specific recommendations on the definition of safekeeping. CESR proposes for a definition which contains two broad elements, namely overall control of assets and segregation.

For overall control it would mean that the assets could not be transferred by the manager/management company without prior knowledge or consent of the depositary. On segregation, meanwhile, CESR sees merit in imposing explicit controls on re-hypothecation and clarifying that the sub-custodian should also be obliged to put in place proper segregation arrangements.

Furthermore, CESR makes a number of suggestions on the criteria that should be satisfied before a UCITS can entrust the UCITS ` assets to a third party. These include that the third party be subject to supervision by a public authority in its own jurisdiction; that the presence of the relevant assets be verified on a regular basis by an independent auditor; that the sub-custodian have an adequate and proportionate organisational structure; and that the depositary itself be required to keep adequate records and documentation of its delegation.

CESR has also used this opportunity to raise concern regarding the application of certain elements of the Alternative Investment Fund Managers (AIFM) Directive to the UCITS sphere as regards depositaries. CESR stressed that Members do not feel that the AIFM provisions as currently drafted, and which are in any case subject to change, represent a sound basis for the requirements that should apply to UCITS depositaries.

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