INTRODUCTION SPECIFIC REPLIES. Box 1 ADEPO

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1 ADEPO REPLIES BY THE AGRUPACIÓN ESPAÑOLA DE DEPOSITARIOS DE INSTITUCIONES DE INVERSIÓN COLECTIVA Y FONDOS DE PENSIONES (ADEPO) TO THE EUROPEAN COMMISSION S CONSULTATION REGARDING THE DUTIES OF UCITS DEPOSITARIES AND UCITS MANAGER S REMUNERATIONS INTRODUCTION ADEPO welcomes and takes a positive view of the opportunity and specific content of the DOCUMENT drawn up by the European Committee. ADEPO is a Spanish association of mutual and pension funds depositaries currently formed by BBVA, BANCO POPULAR, BANCO SABADELL, BANCO SANTANDER, BNP-PARIBAS, CECA,CAJA MADRID, RBS-DEXIA Y LA CAIXA. Given the specific scope of our Association we are limiting ourselves to respond the questions dealing with the depositaries regime. Our position is in some way predetermined by our responses to the Commission Consultation of 2009 regarding the duties of depositaries and by the final solutions incorporated to the Alternative Investment Fund Managers Directive (AIFM). Although we still have doubts about the correctness of some of the rules that said Directive incorporates, we don t consider now opportune to defend different rules for UCITS depositaries, because UCITS clients are normally less sophisticated than AIF ones and consistently demand a higher level of protection. Future UCITS legislation should be aligned with the approach of the AIMF Directive, but never incorporating more stringent solutions. SPECIFIC REPLIES Box 1 It is necessary to define what activities and responsibilities are related to the notion of "safekeeping" of assets. 1

2 ADEPO fully agrees with the idea of defining and precising the notion of safekeeping. In this point, as in many others, we do defend a clear alignment with the approach of the AIFM Directive. Box 2 It is envisaged to complete articles 22 and 32 of the UCITS Directive in a way which is consistent with the approach in the AIFM Directive, in order to: Distinguish safekeeping duties between (1) custody duties relating to financial instruments (such as securities) that can be held in custody by the depositary and (2) asset monitoring duties relating to the remaining types of assets. A reference to the custody of physical assets, such as real estate or commodities, is not necessary because such assets are currently not eligible for holding within a UCITS portfolio;27 Supplement the requirements on custody duties with a segregation requirement, so that any financial instruments on the depositary's book held for a UCITS can be distinguished from the depositary's own assets and at all times be identified as belonging to that UCITS; such a requirement would confer an additional layer of protection for investors should the depositary default; Equip the depositary with a view over all the assets of the UCITS, cash included.28 The directive should more explicitly make clear that no cash account associated with the funds' transactions can be opened outside of the depositary's acknowledgement, with a view to avoiding the possibility of fraudulent cash transfers; Introduce new implementing measures in the mentioned Articles defining detailed conditions for performing depositary monitoring and custody functions, including (i) the type of financial instruments that shall be included in the scope of the depositary's custody duties; (ii) the conditions under which the depositary may exercise its custody duties over financial instruments registered with a central security depositary; and (iii) the conditions under which the depositary shall monitor financial instruments issued in a nominative form and registered with an issuer or a registrar. ADEPO agrees with the approach. We should distinguish between: a) Financial instruments than can be held in custody and b) other assets just to be monitored. a) Financial instrument than can be held in custody: -Instruments that can be physically delivered, these having very little importance in Spain. Instruments that can be registered in the depositary s book: - Listed securities. In Spain these instruments are registered through a two levels system, the Central Registry managed by IBERCLEAR (Spanish CSD, as first level), which keeps the securities balances of the participants entities, and a detailed registry managed by the 2

3 participants entities (second level) where securities are listed by holder's name. In this scenario depositaries can be members or not of the system. -Non listed securities represented through a book entry system (with a single level ). -Units of collective investments vehicles acquired through platforms. Most financial instruments which can be held in custody are finally those which are registered with a CSD, either directly or through a chain of intermediaries, in this scenario: - The CSD and the various intermediaries (i.e., participant entity at the relevant CSD) should all be regulated entities. - The depositary is in most cases able to choose the intermediaries selected for the holding of financial instruments according to stringent criteria which ensure that these entities have the appropriate expertise and provides all the financial and professional guarantees to carry out their duties, - The depositary carries out periodic reviews on the sub-custodian network to validate that they keep to apply these criteria on an ongoing basis. With regard to the segregation of assets, the following rules should be complied with: -Specific accounts are opened in the name of the UCITS in the books of the depositary to book the assets and separate them from assets held by the depositary on its own account and by other investors, - Where a depositary uses a sub-custodian, the segregation of the assets is effective when the depositary s own assets are segregated from the ones of its clients. In the books of the subcustodian, the depositary will open one account where the assets held by the depositary on its own account are recorded and one or several other accounts where the assets of the depositary s clients are registered. There is no need to have one account per UCITS in the books of the sub-custodian. This principle is to be replicated all along the intermediaries chain whether several intermediaries are used This principle also applies for the accounts opened in the CSD s books where the assets are ultimately registered. b) Other assets just to be monitored: 3

4 - Units of collective investment vehicles, held with a register (managed or not by the manager). - Derivative contracts. - Shares and other instruments issued in a nominative form or registered by the issuer itself or a register. - Structured products. - Cash placed on deposit with other entity. In those cases where the assets cannot be kept in custody by the depositary, it can only develop its safekeeping duties as an inventory (through a 'mirror record' or a 'position keeping' record) so as to have an overview of all the assets of the fund. As depositaries may experience difficulties in getting access to accurate and up-to-date information in a timely manner (for example the confirmation of derivative transactions), UCIT (i.e., UCIT Manager) should be liable for providing the depositary with the accurate information. As regards to the segregation issue, depositaries (and sub-custodians appointed by the depositaries) should meet at any time the requirements set out in articles 16 and 17 of the Commission Directive 2006/73/EC implementing MIFID. Rules should impose segregation requirements so as to protect the UCITS assets from being commingled, not only of the depositary's own assets but also of the assets held on behalf of its clients. Moreover the depositary should be able to have a view of all the assets, cash included. Depositaries should implement the internal controls necessary to guarantee the necessary account segregation in order to clearly assure that in no case depositary s own cash is kept in the same accounts opened in the name of the UCITS. Finally ADEPO is very supportive of future implementing legislation in this area where very refined solutions are specially necessary. 4

5 Box 3 It is envisaged to achieve a higher degree of consistency in the oversight duties to be performed by UCITS depositaries: the oversight duties related to UCITS with a corporate form should be aligned with those to be performed in respect to UCITS with a common fund form (article 22). ADEPO agrees with the proposal, there are no reasons to maintain different regimes. Box 4 It is envisaged to introduce implementing measures that will clarify further the scope of each listed supervisory duty, for example the methodology to be used for the calculation of the Net Asset Value of the UCITS. We want to emphasize that depositary s supervisory duties consist in performing independent controls which are designed to check that the management company has developed the appropriate operational processes and procedures to comply with the Directive s provisions and has put in place an efficient internal control system. Under these conditions, the depositary should not be required to perform some tasks which are under the management company responsibility and/or to duplicate controls which are already discharged by the management company. To that end, implementing measures relating to the depositary s supervisory duties could be introduced to clarify that supervisory duties: - consist in making some verifications and not in performing tasks under the responsibility of the management company, - are to be performed on a ex-post basis and not ex-ante, - may be performed on a punctual basis and not systematically, - may be performed through various methods which are appropriate for independent controls (e.g. review of samples, regular reconciliations, review of procedures ). Some flexibility should be always left to the depositary to adapt its controls to the organisational structure of 5

6 the management company and to local laws which apply in the country where the fund is domiciled. Once said that, we are supportive of a achieving a high degree of harmonization, comprising at least the following areas: - Controlling that investments are made under market conditions (clear in the case of listed securities with liquid markets). - Compliance with limits and ratios. Abiding with the investment policy reflected in the prospectus. - Supervision of the procedures established for calculating the net asset value and verifying the calculation of the net asset value. - Registration of participants, recourse to transfer agents, commercialisation and use of marketing platforms. - Rules on subscriptions and redemptions. - Rules on drawing of funds relating to investments. In the two latter cases, the regulation should highlight the role of the depositary as centralising the movements of cash and as the controller of the UCITS bank accounts. Box 5 It is envisaged to restrict more explicitly the delegation of the depositary task to the safekeeping duties and that the conditions and requirements upon which a UCITS depositary may entrust its safekeeping duties to a third party should be aligned with those under the AIFM Directive. It is also envisaged to require additional information for UCITS investors be published (for example in the prospectus) where a network of sub-custodians is to be used. Such information would specify the risk that such a sub-depositary network might fail or default, and how this risk can be dealt with. Finally, implementing measures are envisaged in order to detail the depositary's initial and on going due diligence duties, including those that apply to the selection and appointment of a sub-custodian. We agree with all the Commission s suggestions. Solutions adopted by AIFM Directive are sufficient enough and we do not see any need of further requirements. 6

7 Box 6 It is envisaged that the depositary liability regime might be clarified in case of a UCITS suffering losses as a result of a depositary's negligence or intentional failure to perform its duties. ADEPO agrees with this proposal. Box 7 It is envisaged to clarify the UCITS depositary liability regime in case of loss of assets. Accordingly, the UCITS depositary shall be under the obligation to return the financial instruments of the identical type or of the corresponding amount to the UCITS. No further discharge of liability in case of loss of assets is envisaged, except in case of force majeure. Implementing measures should be introduced, as necessary, to clarify all necessary underlying technical aspects, for example to identify the circumstances under which assets may be lost. ADEPO considers that depositary s liability regime should be aligned totally- with solutions finally adopted by the AIFM Directive. Although we have some doubts about said solutions any shift would be completely inconsistent, given that UCITS funds are normally destined to retail clients. On top of secondary legislation would be completely necessary. We also want to give the Commission some input with respect to the concept of loss and mention some cases force majeure. Concept of loss: ADEPO considers that the loss of a financial instrument should not be assumed simply because the assets of the UCIT are not immediately available for the investors. Legally speaking, a financial instrument should be considered as permanently lost only where at least one of the following conditions occurs: - the financial instrument does no longer exist or did never exist, - the rights over the financial instruments were suspended or terminated. 7

8 Under these conditions, a financial instrument cannot be deemed as lost if: -it is temporarily unavailable as a result of legal and/or regulatory proceedings. This typically happens in the case of a sub-custodian s insolvency. Provided that the assets were correctly segregated before, the depositary will get them back entirely but only after the insolvency procedure will be finalised, -there is a loss in the market value of the financial instrument. The loss of value of a financial instrument results from a pure market risk taken by the UCIT. As a consequence the depositary cannot bear that risk. In any case, the loss should be declared by a judicial or regulatory authority which acknowledges that the financial instruments have been definitively lost. This issue is also considered in the draft Securities Law Directive (SLD). Therefore any solution finally adopted in the future legislation should be in line with the final version of the SLD. Cases of force majeure ( external events going beyond reasonable control ). - Loss or destruction of physical financial instruments. - Instrument sold or transferred to other holder without order from the manager(specially when the third party holder is acting with good faith ). - The instrument is de-registered because finally it is not received. - The instrument is de-registered because the UCITS Manager s instructions where not sent and there is not force majeur. - Legal deprivation (not temporally) of the core rights/faculties inherent to the financial instrument due to Civil Law reasons. - Situations under which legal capability to dispose of the instrument has been lost in a permanent/long standing fashion. Box 8 As already provided under art. 22 and art. 32 of the UCITS directive, it is envisaged to maintain the rule according to which the depositary's liability is not affected if it has entrusted to a third party al or some of its safekeeping tasks. As a result, the depositary faces the same level of liability, should the UCITS assets be lost by a sub-custodian. Moreover, it is envisaged that the legislative proposal should clarify the fact that if assets are lost, the UCITS depositary liability regime has the general obligation to return the financial 8

9 instruments of the identical type or of the corresponding amount to the UCITS with no delay. As mentioned above, no further discharge of liability (either regulatory or contractual) in case of loss of assets by a sub custodian shall be envisaged, except in case of "force majeure". ADEPO disagrees with Commission s hints to reinforce and make more stringent for UCITS depositaries solutions already envisaged in the AIFM Directive. More specifically, the restitution of assets should be done without undue delay and not just with no delay, since a minimum delay is unavoidable because of technical and legal reasons. On top of that, the (very limited) contractual possibility for the depositary to be discharged of its liability according to the AIMFD Directive should be maintained and in general- the regime envisaged in the latter should be respected. Box 9 It is envisaged to clarify that the depositary should carry the burden of demonstrating that it has duly performed its duties. Although ADEPO is not very convinced on this point we do accept the change on consistency grounds with the AIMF Directive. Box 10 It is suggested to align the rights of UCITS investors, so that both share- and unit-holders are able to invoke claims relating to the liabilities of depositaries, either directly or indirectly (through the management company), depending on the legal nature of the relationship between the depositary, the management company and the unit-holders. Finally, implementing measures should also be introduced in order to encourage a high degree of harmonisation, for example to detail the conditions and procedures under which shareholders may directly use their rights towards a UCITS depositary. 9

10 We fully agree with the Commission s proposal. Box 11 It is suggested to introduce an exhaustive list of entities that should UCITS depositories, aligned with the AIFM Directive list. Such credit institutions authorised MiFID firms which also provide safe-keeping and administration of financial instruments, depositary institutions (by means of a grandfathering clause). ADEPO agrees with the proposal. Box 12 It is envisaged that a provision is introduced into the UCITS Directive creating a commitment to assess and re-examine the need to address depositary passport issues, to be undertaken a few years after the new UCITS depositary framework has come into force. ADEPO disagrees with the proposal. In our opinion, even if a perfect harmonisation of the depositary s framework had been achieved, no passport facility should be granted to depositaries since the oversight function requires a clear proximity to the UCITS fund. Box 13 Differences between national supervisors' scope of competencies lead to an uneven supervisory framework, suggesting that such competences might be better harmonised. In the Commission's view, this remains a key issue to be addressed in order to fully achieve due levels of harmonisation in practice for the depositary function at the Community level. ADEPO clearly backs the proposal. Box 14 The introduction of a requirement for an annual certification of the assets held in custody by the depositary would clarify the true existence of such entrusted assets. This annual certification could be performed by the depositary's auditors. Details related to any such requirement might need to be further defined in implementing measures or technical standards as appropriate. 10

11 We don t think a genuine certification of assets is necessary. The audits and controls required in banking regulations on grounds of prudential reasons and the specific ones in the MIFID on custody activity are more than sufficient. Box 15 It is suggested to delete articles 32 (4) and 32 (5) of the UCITS Directive n 2009/65/EC. We agree with this initiative. Box 16 It is suggested that the requirement for a single depositary per UCITS should be clarified (without prejudice to Article 113(2) of the UCITS Directive n 2009/65/EC). ADEPO also agrees with this proposal. Box 17 It is suggested to: - Introduce for UCITS depositaries similar rules of conduct as in the AIFM Directive, in addition to the already existing rules stated in the article 22 and 32 of the UCITS Directive; - Introduce implementing measures in order to encourage a higher degree of harmonisation and consistency between the organisational requirements applicable to all functions of the UCITS depositary (safekeeping as well as oversight) and, where appropriate, the existing MiFID requirements. ADEPO agrees with both proposals. Box 18 It is suggested to amend existing requirements concerning the disclose of information to the competent authorities, on their request, in such a way that any information, obtained by a depositary while carrying out its duties, should be made available to its competent authorities if such information may be necessary for these authorities. 11

12 Implementing measures should also be introduced in order to, for example to detail the conditions and procedures under which UCITS depositaries shall exchange information with their supervisors. ADEPO agrees with the proposal. More specifically and regarding organisational requirements, the latter should encompass at least: - Minimum capital requirements. - Experience and capacity of directors (in custody matters). - Organisation/internal controls. - Possibility of performing duties (administrative) through delegation by the management company and other entities (without ever jeopardising the duty of supervision). The harmonisation we wish to see in the field of duties and organisation, together with high levels of exigency, and, above all, of the responsibility of the depositaries, would prompt a rise in costs. From the standpoint of consistency, the European regulation should also address this point, insisting on transparency and expressly ruling out the solution of putting legal limits on depositary commissions. Box 19 It is suggested that the requirements set out in Article 23(5) and Article 33(5) of the UCITS Directive and their corresponding implementing measures should also apply to a situation where the management company home Member State is also a UCITS home Member State. It appears opportune to require the UCITS depositary to follow conduct of business rules which would oblige a depositary to act honestly, fairly, professionally, independently and in the interest of the UCITS and investors of the UCITS. Furthermore, the depositary should be required to establish appropriate policy for identification, management, monitoring and disclosure of the conflict of interests which may arise when a depositary carries out activities with regard to the UCITS. ADEPO agrees with the need of a written contract regardless the depositary and the manager location, but we do not see the need of imposing a standardized format at European level. Separately, we fully endorse other considerations in Box 19 referred to conduct of business rules and conflicts of interest. 12

13 Gregorio Arranz ADEPO Secretary General 13