BNY Mellon response to WORKING DOCUMENT OF THE COMMISSION SERVICES (DG MARKT) CONSULTATION PAPER ON THE UCITS DEPOSITARY FUNCTION

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1 BNY Mellon response to WORKING DOCUMENT OF THE COMMISSION SERVICES (DG MARKT) CONSULTATION PAPER ON THE UCITS DEPOSITARY FUNCTION Responses provided in boxes foreseen. The present document constitutes a questionnaire designed by the services of the Directorate General Internal Market and Services. Its aim is to obtain information from Member States, market participants and other stakeholders, particularly investors, on the necessity to improve the EU-wide legal framework applying to UCITS depositaries. 1. INTRODUCTION Since the creation of the regime for Undertakings for Collective Investment in Transferable Securities (UCITS) in 1985, depositary institutions have played a crucial role in the European funds' industry. According to Directive 85/611/EEC (UCITS Directive), the designation of a depositary is a condition for the approval of UCITS. The function of the depositary is to be an institution in which investors can place their trust for keeping their savings safe, and also to be an institution that can play an essential role in balancing the management company's prerogatives, to ensure that investors' interests are at the centre of the industry and duly respected. UCITS depositaries are expected to act with the highest professional skills and prudential standards. This is a key element to maintain the high level of confidence that investors have always placed in the UCITS label.1 Over the years, the UCITS regulatory model has become the benchmark for fund regulation and it is the cornerstone of a fully integrated European fund market. Since 1985, the regulatory principle applicable to the depositary function has been considered as sufficiently robust and well-understood, such that it did not require further harmonisation. Indeed, the existing UCITS model has in general proven to be very resilient and solid since the outset of the financial crisis. From the investors' perspective, the market risk associated with their UCITS investments is the only acceptable risk they should have to bear. But since 1985, the European asset management industry has changed. Financial products now eligible for UCITS portfolios are more complex and are often registered outside the EU in third countries and emerging markets jurisdictions. More recently the Madoff fraud and the Lehman default2 have revealed the existence of new forms of risk associated with the depositary function. These cases have shown that to some degree Member States differ in their understanding of the Directive's principles as regards the exact nature of the duties of depositaries and the scope of their liability. 1 At end March 2009, the European depositary industry was entrusted with over EUR 4,5 billion worth of UCITS assets. 2 The Lehman default has impacted non UCITS funds which were, according to their national regime and as far as the duties and liability of the depositary are concerned, under very similar regulatory requirements as UCITS funds. 2

2 Most importantly, the Madoff fraud and the Lehman default have underlined the lack of a level playing field in the protection offered to UCITS investors across Europe. In April 2009, the Commission made a Proposal for a Directive on Alternative Investment Funds Managers (AIFM). This proposal aims at organising a regulatory regime for investment products that are mainly structured for professional investors. It imposes a requirement that an alternative fund appoints an institution to safe-keep its assets. The proposed regime applicable to alternative fund depositaries would differ from the UCITS Directive because it details the depositary s safe-keeping duties, and imposes new eligibility conditions upon institutions willing to act as AIF depositaries. Under the proposed AIFM Directive, AIF depositary liabilities have been strengthened to include an inversion of the burden of proof, and there are clear provisions not only on delegation but also on the conditions under which assets can be entrusted to depositaries outside the EU. These constraints have been introduced in order to provide a better and more transparent regulation of the entity holding the assets and to enable an appropriate level of investor protection in general. As announced by Commissioner McCreevy on 28 May 2009, the level of protection offered by the AIFM Directive proposal should be extended to UCITS funds. It is evidently not appropriate to have a less stringent approach for retail investors than for professional investors. These new developments therefore require a re-examination of the adequacy and effectiveness of the UCITS regulatory framework applicable to depositaries, with a view to increasing the level of the protection of the UCITS investors, at least to the level of protection offered to professional investors. This public consultation will play an important role in identifying and shaping the European response to strengthening the UCITS depositary sector. The issues are wideranging and have implications for depositaries, investors, auditors, asset managers and regulators alike. The consultation also covers issues not directly linked with the depositaries duties but of particular relevance for ensuring an increased level of investor protection within the UCITS framework (for example valuation). The responses to and conclusions from this consultation will serve as a basis for the Commission to take appropriate initiatives to ensure that the fundamental principles enshrined in the Directive are upheld. * * *

3 I. DEPOSITARY S DUTIES A. Safe-keeping duties According to Article 22(1) of the amended UCITS Directive : a common fund s assets must be entrusted to a depositary for safe-keeping. The UCITS Directive does not define the meaning of safe-keeping. At national level, approaches differ as to what exactly a depositary is expected to do when it is entrusted with the task of safe-keeping the funds assets. This has a direct impact on the liability of the depositary, for instance vis-à-vis the unit-holders and shareholders, especially when the depositary relies on third parties to perform some of its duties. These divergences of interpretation between Member States can lead to an uneven level of protection offered to UCITS investors across Europe. Clarifying the depositary 3 3 A relevant public consultation was conducted very recently on this subject; it was closed on the 11th of June duties for safe-keeping of assets would allow investors to clearly identify what the depositary s liabilities are, even where assets are transferred to global sub- custodians. To clarify the depositary's safe-keeping liabilities, it seems essential to firstly clarify what the depositary operational safe-keeping duties actually are, for each class of asset eligible for being held within a UCITS portfolio. For example, the AIFM Directive proposal provides: ( ) the AIFM shall ensure that a depositary is appointed to fulfil, where relevant, the following tasks: (a) receive all payments made by investors when subscribing units or shares of an AIF managed by the AIFM and book them on behalf of the AIFM in a segregated account; (b) safe-keep any financial instruments which belong to the AIF; (c) verify whether the AIF or the AIFM on behalf of the AIF has obtained the ownership of all other assets the AIF invests in." The AIFM Directive proposal introduces the overall concept of identifying and separating funds' assets within a segregated account. It also makes a more detailed distinction between general safe-keeping duties in regards financial instruments and other duties of the depositary, such as an obligation to verify the AIF's ownership in relation to assets that are not on custody. Similar detailed approaches to the safe-keeping duties have been implemented by some Member States. They aim at identifying what the custody duties are and the other general safe-keeping duties of the depositaries, depending on the specificity of each asset class eligible for the fund s portfolio (for instance listed financial instruments, OTC financial instruments and deposits). The same approach could be undertaken and further harmonised at EU level. For example, for a UCITS depositary, safe-keeping implies different duties depending on whether the asset can or cannot be registered in the depositary's book (e.g. where the assets are kept 'in custody' by the depositary). In considering the need for specific rules on safekeeping and custody, we need to take into account the various types of assets concerned and any existing or future EU legislative measure that might affect them. For instance, for indirectly held securities ("book-entry securities") which would include shares in companies and bonds, the services of the Commission are preparing a proposal for an appropriate legislative measure which will address some of those specific issues3.

4 Depending on the type of assets eligible for the fund's portfolio, UCITS depositaries would have to comply with the following requirements: (i) For listed financial instruments: (which can be kept in 'custody') requirements could be introduced to ensure that the UCITS depositary complies with European custody regulation, based on the conclusions of the work undertaken by the Commission. (ii) For other eligible assets that cannot be kept in custody in the UCITS depositary's book (such as OTC contracts, or financial instruments held in nominee accounts on issuers books or Central Securities Depositaries), the operational duties could also be given in further detail. 4 Question 1) Do you agree that the safe-keeping (and administration) duties of depositaries should be clarified? Yes. The Commission has linked the definition of the depositary function for Alternative Investment Funds to the depositary function for UCITS funds. This approach suggests that the commission proposes equivalence between investor protection for AIF and UCITS investors (As announced by Commissioner McCreevy on 28 May 2009). The Commission should clarify why the level of investor protection for professional investors should be the same as for retail investors. The Commission should clearly define the risks which investors should be protected from and how the depositary can best contribute to the mitigation of those risks, without increasing the overall cost to the fund (and reduce the return on investors savings). Furthermore, a furthre definition of safe keeping is required. Some jurisdictions, e.g. Ireland, interpret safe keeping beyond the pure deposit of securities. It is therefore important to define the ultimate purpose of the safe keeping function. Question 2) Do you agree these duties should be clarified for each class of assets eligible to the UCITS portfolio? The safe keeping function should be tailored to the legal nature of each asset type. It is therefore reasonable to break down the duties of the depositaries by asset class, or asset classes, broadly defined as: Listed financial instruments, held directly by the depositary or through sub-custodians, selected and supervised by the depositary.

5 Other eligible assets, not held by the depository or entities selected and supervised by the depositary but held by counterparties selected by the UCITS s board of directors or its management company. These assets are typically governed by bilateral agreements, which do not include the depositary. Other eligible assets include: Third party cash products (FX, term deposits, loans, repos) OTC derivatives Listed derivatives held through clearing brokers Funds not held in ICSDs Other assets held through prime brokers, lending and collateral agents The duties should differ per asset class, although there should be a common philosophy across asset classes. This approach would ensure that depositaries have guidance on current asset classes and that the regulation can foresee additional, to be determined, asset classes. Question 3) Are there any other appropriate approaches? UNIDROIT and the Legal Certainty Group s work in the definition of securities and securities accounts should be considered. The role of all players should be considered. And, complementary to the clarification of duties per asset class, there should be a clarification of the duties of where a prime broker is used. This clarification should apply to the triangular relationship between investment manager, depositary, and prime broker (or equivalent). Question 4) Do you agree to a common horizontal and functional approach of the custody duties on the listed financial instruments, to be applied to UCITS depositaries? This consultation paper does not define the common horizontal and functional approach. But, a common approach, across jurisdictions, would enhance transparency and reduce uncertainties for the depositaries. Question 5) Is there some specificity that may be applicable to the custody functions of a UCITS depositary that should be taken into account? Yes. Local civil and administrative laws may have to be taken into consideration.

6 B. Supervisory duties Article 22 (3) of the UCITS Directive stipulates that a "Depositary shall: ensure that the sale, issue, re-purchase, redemption and cancellation of units effected on behalf of a common fund or by a management company are carried out in accordance with the law and the fund rules; ensure that the value of units is calculated in accordance with the law and the fund rules; carry out the instructions of the management company, unless they conflict with the law or the fund rules; ensure that in transactions involving a common fund's assets any consideration is remitted to it within the usual time limits; ensure that a common fund's income is applied in accordance with the law and the fund rules." In practice, Member States have diverging interpretations of these principles. For example some Member States require the Net Asset Value of the UCITS to be recalculated by the depositary, whereas others only require test controls. A global revision of depositary duties could also therefore clarify what the UCITS depositary supervisory specified role and duties actually entail. This could also be an opportunity to more clearly determine that at EU level all the assets of UCITS funds can only be entrusted to one depositary. This would allow the UCITS depositary to have an exhaustive and complete overview of the funds' assets and therefore be in a proper position to perform its supervisory duties (such as to control that the fund respects the applicable regulatory ratios). Question 6) Do you agree that the existing supervisory duties of the UCITS depositary should be clarified? Yes. A clarification of duties would result in a further harmonisation of those duties across the EU. A harmonisation would, in turn, bring investors more equal investment protection regardless of the domicile of the fund in which they have invested. A harmonisation may also reduce overall cost to the industry as true pan-eu providers of depositary services may emerge (potentially enabling a EU passport for depositaries). The Commission should also clarify how the supervisory duties should be performed and which supervisory duties are outside the scope of depositary s responsibilities. It is particularly important that the duties of the depositary are further clarified for other eligible assets, i.e. those assets that are not held by the depository or entities selected and supervised by the depositary. Those assets include:

7 Third party cash products (FX, term deposits, loans, repos) OTC derivatives Listed derivatives held through clearing brokers Funds not held in ICSDs Other assets held through prime brokers, lending and collateral agents Question 7) If so, what clarification do you suggest? A further clarification of all duties under article 22 (3) of the UCITS directive would be desirable. The objective of the clarifications should be to avoid (or reduce) the scope for divergent interpretations in different member states. The example mentioned where some member states require the Net Asset Value of the UCITS to be recalculated by the depository is one of the areas where a clarification could have largest impact. We do not believe that the depositary should be required to recalculate the Net Asset Value, but rather that the appropriate processes and procedures are in place and enforced to perform a correct calculation. A full recalculation introduces extra costs, both for the recalculation itself, and for the required reconciliation effort between the original NAV and the recalculated NAV. Further clarification is also required to identify whether any pre-trade assessments are required and if Investment and Borrowing monitoring can be delegated to the depositary. Question 8) To what extent does the list of supervisory duties need to be extended? The test of whether supervisory duties have been clarified in sufficient amount of detail and in appropriate scope is whether there is still room for material divergence in the interpretation between member states. Any extension of supervisory duties should be weighed against the benefit to the investor. Question 9) Do you agree that the 'only one depositary' requirement should be clarified? Yes. The only one depositary requirement is not clear. Both the safekeeping of financial instruments and the operational duties for other eligible assets should be defined by asset and by institution performing the duty if different from the one depositary (delegated, prime broker, etc.)

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9 II. RESPONSIBILITY REGIME Investors may face a risk associated to the depositary function if (1) the depositary fails to perform its duties ('improper performance') and (2) if the depositary defaults. When the depositary fails to perform its safe-keeping or its supervisory duties, it raises the question as to the regime of liability that should be applicable in relation to the losses. A. Liability regime in case of improper performance 1. Identification of the associated risks a) Loss of assets The regime of liability should depend on the risk that can materialise in case of wrong performance of custody duties. This risk will differ for each class of eligible assets. The main risk that can materialise where the depositary is acting as a custodian is to lose these assets.4 This can arise: - At depositary level - if the UCITS assets are not duly registered and segregated on the depositary's books, the financial instruments can not be identified and duly reattributed to the UCITS; - In the case of sub-delegation: If the UCITS assets are not segregated on the subcontractors books (global and local sub-custodians), the funds assets can not be identified and reattributed to the fund. Another risk may arise if a sub-custodian becomes insolvent such that investors are not able to claim back their assets. b) Improper performance of the safe-keeping duties for assets which cannot be held in custody Different safe-keeping duties apply to eligible assets that cannot per se be kept in custody by the depositary (such as derivative contracts). Provided that the depositary does not keep the assets in custody, it may not have an exhaustive view over all the assets that the fund may have invested in. In such cases, the risk is that no appropriate entity has a global view over the fund s assets so that false assumptions can be made regarding the real scope of the fund s portfolio. c) Improper performance of supervisory duties Several risks can materialise at this stage. One of the most predominant is where the fund s portfolio is mis-valued, leading to the mis-calculation of the value at which shares and units are issued and redeemed.

10 Question 10) Do you think that the risks related to improper performance have been correctly identified? No. The distinction between A (liability regime in case of improper performance) and B (liability regime in cases of delegation) seems unclear - the loss of assets under A, where the commission refers to sub-custodians, considers the situation where the depositary delegates to a sub-custodian, and should hence need to fall under B if the commission were to follow the divide between A and B consistently. The view on segregated accounts in A.1.a seems a bit simplistic, as well as the reference to bankruptcy of the sub-custodian. In any event, even in an omnibus situation, client assets in deposit are segregated from proprietary assets, and client assets are off balance sheet. Also CSD's (or ICSD's) are a part of the chain, and so are transfer agents; and very clearly these can go bust as well. However the depositary has no option of selecting in which CSD to hold a given security. Note the 40 act in the US does address the use of CSD's and holding foreign securities in rules 17 f 5 and 17 f 7. The definition in A.1.b does not define safekeeping duties for assets not held in custody. The fund's books and records should reflect the full positions and the depositary has access to those. Assets like cash, or securities delivered to counterparties as collateral, are perfectly custodisable with the depositary, but have been delivered out as per fund manager's instruction, acting in accordance with stated investment policy of the fund. Also note there is a counterparty risk on brokers in the settlement cycle. The definition in A.1.c seems to imply that the depositary liable for any error made by the fund accountant. Is that what is meant? Question 11) Do you foresee other situations where a risk associated with improper performance of the depositary duties might materialise? No. Question 12) Do you agree that safeguards against the risk associated with the improper performance of depositary duties, such as requiring that UCITS assets be segregated from the depositary s and sub-custodian's assets, should be introduced? It depends on the risk. Loss of assets - no. We believe that whilst the risks have been correctly identified, appropriate safeguards are already in place to mitigate the risks. The assets are generally only fully segregated on sub-contractors books in the markets of investment where such segregation is required. A comparison between the safety of assets in markets where a full segregation is required and those markets where such segregation is not required would not reveal any discernable difference in the safety of the UCITS s assets. The segregation of assets is fully ensured (and audited) at the level of the depositary.

11 Improper performance of the safe-keeping duties for assets which cannot be held in custody yes. Whilst an only one depositary approach may be too restrictive, we believe that additional safeguards could be introduced in this space, for example a direct reporting requirement for all sub-depositaries to report positions into an independent Net Asset Value calculation agent. This reporting would underlie the supervision of the main depository. Improper performance of supervisory duties yes. We believe regulation should be introduced to create a Net Asset Value Calculation Agent which is fully separated from the investment management process. The depositary should maintain full oversight of the Net Asset Value Calculation Agent. 4 Listed financial instruments are registered in the depositary s books4. They are assets in bearer form, neither registered in the issuer nor its Central Security Depositary s books. 2. Liability regime: Unconditional performance v obligation of means a) Diverging regime of liability Improper performance of the regulatory duties of the depositary, such as the supervisory obligation, implies that the depositary faces civil and/or administrative liability. Member States positions as to the liability of the depositary diverge where financial instruments are kept in custody. If the instruments cannot be identified and returned to their true owner, some Member States consider it legitimate for the owner of the assets (e.g. the UCITS) to be entitled to claim for immediate full compensation. For these Member States, this compensation regime is an essential element in maintaining investor confidence in global financial markets. For other Member States, the safekeeping duties consist in merely exercising due diligence over the assets. Therefore, a potential harmonisation of the regime of liability in case of loss of assets raises the question of whether a UCITS fund should be entitled to full and direct compensation. The potential harmonisation of the regime of liability associated with safe-keeping duties will also have a clear impact on the nature of the responsibility of the depositary where a third party is used to perform its duties. b) The burden of proof The amended UCITS Directive 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 obligations or its improper performance of them. Liability to unit-holders may be invoked 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.

12 According to the recently proposed AIFM Directive: The depositary shall be liable to the AIFM and the investors of the AIF for any losses suffered by them as a result of its failure to perform its obligations pursuant to this Directive.". As far as safekeeping is concerned, the AIFM Directive proposal also adds: "In case of any loss of financial instruments which the depositary safe-keeps, the depositary can only discharge itself of its liability if it can prove that it could not have avoided the loss which has occurred.». The liability regime applicable to the AIFM depositary has been strengthened compared to the UCITS provisions, to the extent that it inverts the burden of proof in favour of the investors. Question 13) Do you agree there should be a general clarification of the liability regime applicable to the UCITS depositary in cases of improper performance of custody duties? Yes. As with the safe-keeping and supervisory duties, we believe that a clarification of the liability regime will bring more transparency and consistency across EU member states. Question 14) What adjustments to the liability regime associated to the custody duties of the UCITS depositary would be appropriate and under what conditions? Full restitution of assets. We do not believe that a framework, which requires a full restitution from the main depositary, is workable. It would introduce significant extra cost in the fund servicing value chain that ultimately would reduce returns for investors and the attractiveness of funds as investment vehicles. We acknowledge that investors want to reduce a counterparty's risk and that sub-custodians should be able to return the fund assets to their owners. We believe that the role of the depositary in relation to differing asset classes and fund structures should be considered in detail prior to any revisions being made to the existing position. The burden of proof. In principle, the burden of proof could lie with the depository. But, the appropriateness of the burden of proof principle would depend on the nature of the depositary's obligations.

13 B. Liability regime of depositaries in cases of delegation 1. The Depositary liability upon delegating its functions to a third party The UCITS Directive states that "A depositary s liability as referred to in Article 24 shall not be affected by the fact that it has entrusted to a third party all or some of the assets in its safe-keeping. The proposed AIFM Directive uses the same approach and the liability of the funds depositary remains identical, irrespective of the fact that the funds depositary may use local sub-custodians or sub-contractors. In practice, the consequences of this liability principle imply that the regime and the responsibility vis-à-vis the UCITS and its unit and shareholders, remain identical for the depositary irrespective of delegation. This means that the depositary has the same unconditional obligation of restitution, or the same obligation to perform due diligence duties, even when the assets are held by a sub-custodian. To that end, the clarification of the liability regime of the depositary is an essential step in order to establish what responsibility the depositary faces prima facie when its duties are sub-delegated to a third party. 2. Conditions applicable in case of delegation of the depositary duties The Madoff and the Lehman cases have revealed that the risks associated to the use of local sub-custody networks are not negligible. This is because the sub delegation of the depositary creates an additional risk of third party failures to perform or third party defaults. The UCITS Directive does not elaborate on the conditions applicable to the delegation of depositary activities by the depositary. Therefore, additional safeguards might be introduced in order to define conditions on the basis of which depositary activities can be entrusted to a third party. Such additional constraints could consist of: - limitations as to the types of activities, which may be delegated by the depositary; - limitations as to the nature of the sub-depositary or its location, to ensure that the sub-depositary is subject to appropriate or equivalent levels of regulation and supervision, for example the AIFM Directive proposal states that Depositaries may [only] delegate their tasks to other depositaries "; - give details of the due diligence that would be expected of the depositary in selecting, appointing and reviewing on a regular basis any sub-depositaries. - limitations on any right to 're-use' the funds assets by the sub-depositary; - requirements for information to unit-holders about the possibility that the funds may have a sub-depositary, the risks incurred in case of the failure or default of the subdepositary and how the risks can be mitigated.

14 Question 15) Do you agree that the conditions upon which the UCITS depositary shall be able to delegate its duties to a third party should be clarified? Yes. Although the clarifications required are less pertinent to listed financial instruments than other eligible assets. Question 16) Under which conditions should the depositary be allowed to delegate the performance of its duties to a third party? Clarification is required in order to define delegation. Could delegation include decisions on appointing a prime broker, a repo counterparty etc.? These delegations imply asset movements and counterparty risk, but are triggered by the investment policy, not by the depositary deciding to delegate. Perhaps better disclosure to investors is needed, so they can decide for themselves if they want to bear that risk. Question 17) Do you agree that the depositary should be subject to additional ongoing due diligence requirements when delegating the performance of its duties to a third party? The on going due diligence requirements for the delegation of duties regarding listed financial instruments is well established. That is, where the depositary has a contractual relationship with its sub-depositary. However, depending on the proposed depositary framework for other eligible assets, additional due diligence requirements may be appropriate where assets are held through counterparties appointed directly by the UCITS board of directors or its management company.

15 C. Default (bankruptcy) The Investor Compensation Schemes Directive (Directive 1997/9/EC) aims to protect investors against the risk of losses in the event of an investment firm's inability to repay money or return assets held on behalf of its clients. Under this Directive (the 'ISCD'), national compensation schemes are only required to cover investment firm defaults for clients whom have been provided with a financial service. A review of existing EU legislation has been recently launched to examine whether existing or equivalent compensation or guarantee schemes (which apply to securities or bank deposit holders) may be extended to UCITS Holders.5 The call for evidence for this review has posed the question whether UCITS should fall within the scope of the ISCD where assets have been lost by a depositary, including where there has been improper performance of duties by the depositary (or a sub-depositary). The debate might be further focused on the possibility to limit the extension of compensation or guarantee schemes, whether or not the custody service is associated to the provision of a financial service, to only cover: - the UCITS, in cases of depositary default (bankruptcy); - UCITS holders, in cases of default by the institution the UCITS holders chose to keep their units or shares within the UCITS. The services of the Commission are considering reviewing the ISCD in order to allow (i) UCITS to benefit from compensation schemes on the default of the depositary, and (ii) UCITS holders to benefit from compensation schemes in case of their custodian's default. Question 18) Do you share the Commission services approach to reviewing the ICSD, to allow UCITS to benefit from a compensation scheme where the depositary defaults? No. Market risk should not be covered by a compensation scheme. A compensation scheme will result in higher cost and lower returns for investors. Funds are investment products and should carry explicit health warnings. In that sense, funds are different from deposits that should be the only insured placement in order to give investors a safe haven. Question 19) Do you agree that UCITS holders should also benefit from compensation if their custodian defaults and these assets are lost? No. Most custodised assets are not on the balance sheet of the custodians and will usually not be impacted by the custodians default. Compensation would therefore equally require an insurance, which will ultimately have to be borne by the investor.

16 III. ORGANISATIONAL REQUIREMENTS The amended UCITS Directive does not include detailed rules on organisational matters for depositaries. There are no specific organisational constraints that are applicable to the UCITS depositary function (a compliance officer, Chinese walls, distinction between safe-keeping and supervisory team etc.). Differences in the organisational requirements set by national regulations also depend on the institutions that are eligible for depositary business. On the rules applicable to conflicts of interest, the amended UCITS Directive only sets principles of separation and ethical independence between the fund manager and the depositary. In particular, Article 25 of the amended 85/611/EEC UCITS Directive - which reproduces the existing Article 10 of Directive 85/611/EEC provides that: no single company shall act as both Management Company and depositary ( ) in the context of their respective roles the management company and the depositary shall act independently and solely in the interest of the unit-holders. Depositaries may face situations where they can no longer ensure that they act solely and exclusively in the interest of unit-holders. A global revision of depositary duties could for instance be an opportunity to clarify at Community level, when and under what conditions a depositary can provide other financial services to a UCITS. The organisational requirements found within MiFID could, where these are appropriate, serve as the starting point for implementing similar organisation rules for UCITS depositaries, with the aim of creating as much consistency as possible. Question 20) Do you agree that the general organisation requirements that are applicable to a UCITS depositary should be clarified? Yes. Question 21) If so, to what extent? The clarification should be detailed enough to introduce consistency across member states. Consistency between UCITS and MiFID should be sought, wherever appropriate. That consistency should aim to reduce overall regulatory complexity. And, the general organisation requirements should take into account the fact that UCITS invest in other eligible assets as well as listed financial instruments. Question 22) Do you agree that requirements on conflicts of interest applicable to UCITS depositaries should be clarified? Yes. Question 23) If so, to what extent?

17 The requirements on conflicts of interest should harmonize the organisational requirements set by national regulations. The requirements should also become equivalent across the EU, regardless of the institution eligible to conduct depositary business. The requirements are likely to include safekeeping and other supervisory duties.

18 IV. ELIGIBLE DEPOSITARY INSTITUTIONS A. The type of eligible institution According to the existing Article 8(2) of UCITS Directive, a depositary must be an institution which is subject to public control. In the amended version of the UCITS Directive,6 this provision has been replaced by the following provision: A depositary shall be an institution which is subject to prudential regulation and on-going supervision, which aims at restricting the type on institution eligible to act as a UCITS depositary. Today, the type of institutions acting as UCITS depositaries are very heterogeneous. Credit institutions, investment firms, public institutions such as central banks, insurance companies, private institutions can all act as a UCITS depositary, sometimes according to additional national regulatory requirements. Clarifying the conditions under which an entity may be eligible to act as a UCITS depositary would enable investors to identify more precisely the group of relevant institutions that would offer all the necessary operational and asset guarantees to fulfil the UCITS depositary functions. The AIFM Directive Proposal requires that "The depositary shall be a credit institution having its registered office in the Community and be authorised in accordance with Directive 2006/48/EC of the European Parliament and Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions". The Capital Requirements Directive applies to credit institutions.7 It means that credit institutions acting as AIFM depositaries are subject to capital requirements for the operational risks of safe-keeping services they provide. This condition on the eligibility can also provide the investors with the additional comfort that their savings are kept by an institution which is regulated and supervised with a sound organisational structure and professional experience in securities and cash settlements. Question 24) Do you agree that there is a need for clarifying the type of institutions that should be eligible to act as UCITS depositaries? Yes Question 25) Do you agree that only institutions subject to the CDR should be eligible to act as UCITS depositaries? No In the UK and in Ireland the depository bank function is usually fulfilled by trust companies, which are not credit institutions subject to the CRD directive. What is critical is to ensure that the role, responsibilities and liabilities of depositaries are defined consistently, independent of the fact that the entity is subject or not to CRD.

19 Question 26) If not, which types of institutions should be eligible to act as UCITS depositaries, and why? Institutions eligible should fulfil Article 23(2) of the amended Directive and be an institution which is subject to prudential regulation and on-going supervision

20 V. SUPERVISION ISSUES: A. Supervision by auditors The Securities and Exchange Commission, the US regulator, has recently launched a consultation on additional requirements to be imposed on broker-dealers that hold their clients assets. One of the consultation proposals focuses on an annual revision of the service providers' accounts by independent and registered auditors. The EU legal framework under the Markets in Financial Instruments Directive8 imposes similar obligations on credit institutions and investment firms holding clients assets. Member States have already implemented such measures. An annual certification by independent and publically registered auditors may provide further improvements on the level of investor protection where a UCITS entrusts its assets to a depositary. Question 27) Do you agree that additional auditing requirements should be imposed, such as an annual certification of the depositary's accounts by independent auditors? The depository function is, as such, already audited. Additional audit requirements are likely to be most relevant for institutions appointed directly by the UCITS board of directors or its management company, i.e. those who are entrusted with other eligible assets.

21 B. Supervision by national regulators The global review of depositary functions raises the question of whether depositaries should be formally approved by a relevant national regulator. Regulatory approval is not required under the UCITS Directive. The Markets in Financial Instruments Directive9 considers these services as ancillary to investment services; thus when intermediaries are authorised under MiFID, they are also supervised for the associated ancillary services. Some countries already require depositaries to hold an approval for performing safekeeping or banking duties. However, as noted, a regulatory approval of the depositary function (safe-keeping and supervisory duties) is not a requirement under the UCITS Directive. Question 28) Do you agree that UCITS depositaries should be subject to a specific 'depositary' approval by national regulators? No. An authorisation as authorised ancillary service under MiFID should be sufficient. Question 29) Do you believe that there is need to promote further harmonisation of the supervision and cooperation by European regulators of depositary activities? What are your views on the creation of an EU passport for UCITS depositaries? We are of the opinion that harmonisation of registration and supervision of Depositories activities is a prerequisite to the possible expansion of EU passport rules to depositories activities. We strongly endorse the creation of a EU passport for UCITS depositaries. Most of the questions raised in this consultation paper prompt further clarification of the role of the depositary. This clarification would reduce the scope for differences when transposing the directive into national legislation and therefore create an equivalence of duties in all EU member states. An equivalence of duties across member states paves the way for a passporting of the depositary function. Several of the considered measures discussed in this consultation paper will introduce additional cost into the depository process. This cost will ultimately be borne by investors in the shape of lower returns on their savings. A depositary passport would counteract some of the implied process cost increases as providers of depositary services would generate pan-european scale. A depositary passport would also break down one of the last national barriers in the fund servicing industry (assuming that the management company passport can be implemented efficiently).

22 VI. OTHER INVESTORS PROTECTION ISSUES A. Calculation of the net asset value of the UCITS shares and units by an independent valuator Appointing an independent valuator may improve the level of investor protection to the extent that it ensures an accurate and objective valuation of the assets of the UCITS portfolio. Given that assets which are eligible for a UCITS portfolio, have over the years become increasingly complex, the calculation of the net asset value of the fund today may often require more elaborate and precise organisational and functional skills. Question 30) As far as the UCITS portfolio and UCITS units or shares are concerned, do you agree that their value should be assessed by an independent valuator? Yes, we agree that UCITS net asset value should be calculated by an entity that is independent from the investment manager. This does however not mean that the UCITS board of directors (or its management company) and its pricing committee can relinquish all obligations regarding valuation. The depositary s role should not be that of the independent valuator. The depositary should rather provide oversight of the work performed by the independent valuator. This oversight does not require the depository bank to replicate valuation performed by the valuator, i.e. the valuation should not be duplicated. Question 31) If so, what should be the applicable conditions for an entity to be eligible to act as an UCITS Valuator? The valuator should be a regulated entity

23 VII. CONCLUDING REMARKS In many respects, the existing safeguards have withstood the economic pressures unleashed by the financial turmoil. However, the size and severity of recent fraud cases has triggered dynamics which have revealed some possible fragilities in the operating models of UCITS depositaries. An absence of a level playing field in the protection offered to UCITS investors has also emerged, specifically where a depositary fails to perform its duties. This warrants closer regulatory oversight. The Commission expects this consultation exercise to lead to the development of a set of informed and evidence-based views on the range of issues addressed in this paper. This will permit a better appreciation of how European policy towards UCITS depositaries should best evolve. Responses to the consultation are requested by 15th September Responses can be addressed to markt-depositary-consultation@ec.europa.eu