Finnish response to the Commission s working document constituting a consultation on the UCITS depositary function

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1 MINISTRY OF FINANCE Finland Helsinki, 21 September 2009 Finnish response to the Commission s working document constituting a consultation on the UCITS depositary function General remarks We welcome the Commission s initiative to examine the issues concerning the UCITS depositary function. It is important to clarify the duties and obligations of depositaries EU-area wide. The new UCITS Directive 2009/65/EC encourages and facilitates operations cross-border. A management company will be able to manage funds in other Member States than in its home Member State. Yet, a depositary must have its registered office or it must be established in the UCITS home Member State. These situations raise new challenges that underline the importance of more harmonised rules concerning the depositaries. As mentioned in the Consultation paper, the existing divergence of duties means an unlevel playing field and different level of investor protection within the common UCITS framework. We think that the regulation on obligations and duties of the UCITS depositary could be developed according to the lines of the Directive 2006/73/EC (MiFID implementing measures) concerning outsourcing and safeguarding of client assets. In addition, the depositary liabilities of the UCITS Directive and of the proposed AIFM Directive ought to be revisited with each other. However, a further evaluation of the issue requires an analysed impact study on the benefits of the possible amendments concerning the UCITS depositary function and the costs caused by those amendments, which can be significant. We look forward to having this analysis. The views stated in our reply are coordinated within the Finnish government and with market participants. I. DEPOSITARY S DUTIES A. Safe-keeping duties Question 1) Do you agree that the safe-keeping (and administration) duties of depositaries should be clarified? Question 2) Do you agree these duties should be clarified for each class of assets eligible to the UCITS portfolio? Question 3) Are there any other appropriate approaches? 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? Question 5) Is there some specificity that may be applicable to the custody functions of a UCITS depositary that should be taken into account? Question 1, 2 and 4: Yes, we agree. It is very important to clarify what safe-keeping means. For example, OTC or listed derivative contracts are financial instruments (MiFID definition) but it is impossible to safe-keep a derivative contract. Only the complying and execution of contract can be monitored. This is why functions relating to the safe-keeping should be defined separately for each class of assets eligible for being held in UCITS portfolio.

2 2 We welcome the idea that specific rules on safekeeping and custody take into account whether assets are held directly registered or held in omnibus nominee accounts. Consultation paper does not define a common horizontal and functional approach. However, a common approach across jurisdictions and all types of funds would enhance transparency and reduce uncertainties. Due to increasing variety of new instruments, a guideline (to be up-to-dated) for various asset classes could be beneficial both to the management companies as well as to the depositaries. Question 3 and 5: In general, we are open on these issues. As the Commission notes, UCITS eligible financial products are increasingly complex and are often registered outside the EU in third countries. Therefore, it is important that the chosen approach could work well in global safe-keeping chains of custodians. A depositary must be able to hold assets in the way those assets can legally be hold under the law of the relevant jurisdiction and the holding is fundamentally affected by where the assets are located and the intermediaries in the custody chain. B. Supervisory duties Question 6) Do you agree that the existing supervisory duties of the UCITS depositary should be clarified? According to the Consultation paper, there are diverging interpretations on the principles of the article 22(3) of the UCITS Directive. Taking into account the new UCITS Directive 2009/65/EC, it would be problematic if the duties of the UCITS depositary are interpreted differently in different Member States, in particular, in the management company s home Member State and in the UCITS home Member State. We believe it is necessary to clarify the duties of the UCITS depositary in this respect. Question 7) If so, what clarification do you suggest? According to the Directive, a depositary has to ensure various things. Supervisory duties are the tasks referring to compliance controls with those referring to the safe-keeping function. It is important to clarify, what does this being assured mean in the practice. One ought to explore here the practical experience of the supervisory authorities. Question 8) To what extent does the list of supervisory duties need to be extended? In our opinion, the depositary s obligations when delegating its functions to a third party ought to be regulated by more detailed requirements. One could require that depositaries exercise due skill, care and diligence when entering into, managing or terminating any arrangement when delegating safekeeping of assets to a third party as in paragraph 2 of article 14 of the Commission Directive 2006/73/EC (implementing measures of the MiFID), which relates to investment firms obligations when outsourcing their certain functions or services. It should always be adhering to the general principle, that depositary has suitable record keeping arrangements in place and order to ascertain the location of the assets of the fund. Question 9) Do you agree that the 'only one depositary' requirement should be clarified? The exact content and relation of this question to prevailing market practices is unclear. It is enquired whether the assets of the UCITS funds could only be entrusted to one depositary. According to the existing Directive, a common fund s/a unit trust s/ an investment company s assets must be entrusted to a depositary for safekeeping. We understand that the assets of a fund must be entrusted to one depositary, which in our view is a prerequisite that the depositary actually is able to take care of its obligations. According to our experience, there is no need to require that all funds of one management company ought to be entrusted to one depositary although this is at the moment a practice. In addition,

3 3 we believe that after the new UCITS Directive s coming into force this kind of requirement would not work in such situations where a management company manages common funds in different Member States and in third countries. II Responsibility Regime A. Liability regime in case of improper performance Question 10) Do you think that the risks related to improper performance have been correctly identified? We have no experience of our own of a situation where a depositary would have lost the assets entrusted to it for safekeeping. In the Consultation paper one has specified the issue of liability regime in case of improper performance. On the basis of this specification we think that the risks related to improper performance could be better identified in the Directive. Question 11) Do you foresee other situations where a risk associated with improper performance of the depositary duties might materialise? We have so far not figured out any. The question can be answered once the functions are clarified. 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 subcustodian's assets, should be introduced? Yes, we agree. One ought to require that UCITS assets have to be kept separate from the depositary s and sub-custodian s assets and also from other common funds assets to the appropriate extent equivalent to articles on safeguarding and depositing of client assets of the Directive 2006/73/EC (implementing measures of MiFID). 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? We do not agree. We do not support any amendment of article 9 of the UCITS Directive (article 24 of the new UCITS Directive). We do not support an enactment of a strict liability of a depositary as a consequence of cases where it seems that a depositary has not complied even with the existing legislation and a competent authority has not supervised. Question 14) What adjustments to the liability regime associated to the custody duties of the UCITS depositary would be appropriate and under what conditions? We see no reason to any adjustments. B. Liability regime of depositaries in cases of delegation 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, we agree. It is impossible for a depositary to keep all UCITS assets in its own custody, in particular, in case of foreign assets. The term depositary covers two functions: safe-keeping of the UCITS assets and performing a certain control on the management company. This means that there is no subdepositary but only a sub-custodian. This means that clarification of the functions of the depositary

4 should include the issue of custodian delegation, which would clarify the conditions under which the UCITS depositary shall be able to delegate its custodian function to a third party. 4 Question 16) Under which conditions should the depositary be allowed to delegate the performance of its duties to a third party? We think one should introduce to the appropriate extent the same model as in article 14 of the Commission Directive 2006/73/EC (implementing measures of the MiFID). Question 17) Do you agree that the depositary should be subject to additional on-going due diligence requirements when delegating the performance of its duties to a third party? Yes, we agree. In addition, it might be relevant that the proposed duties would include a requirement of account segregation in sub-custodians. Holding securities in segregated form could make the real allocation of UCITS assets more reliable and would also enhance investor protection. C. Default (bankrupty) 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? We do not share the idea. We are opposed to such compulsory regulation, according to which professional clients like UCITS would be included to the scope of the investor compensation scheme. This kind of requirement would be against the present paragraph 2 of article 4 of the ICSD. Question 19) Do you agree that UCITS holders should also benefit from compensation if their custodian defaults and these assets are lost? In our opinion, it would be necessary to examine whether non-professional UCITS unit holders ought to be protected by the compensation schemes. It should be analyzed which arguments are in favour or against protecting non-professional investors in UCITS against the risk that, in the event of default, a management company is not able to return to investors the monies belonging to them. At least in theory, the risk is the same in the case where a management company is carrying out common fund activity as in the case where a management company or an investment firm is providing investment services. This need for a compensation scheme might be an important issue, in spite of the fact that the assets of the UCITS are kept separately by the custodian. Also investment firms are obliged to keep their customers funds separately. III. ORGANISATIONAL REQUIREMENTS Question 20) Do you agree that the general organisation requirements that are applicable to a UCITS depositary should be clarified? Question 21) If so, to what extent? Question 22) Do you agree that requirements on conflicts of interest applicable to UCITS depositaries should be clarified? Question 23) If so, to what extent? Yes, we agree. We support the idea to take the MiFID where applicable to a starting point concerning organisational requirements and requirements on conflict of interest applicable to a depositary. In our legislation the requirements of a depositary authorisation are already to a great extent equivalent to the requirements of an authorisation of an investment firm. In Finland, credit institutions and investment firms are eligible to act as UCITS depositaries.

5 5 IV. ELIGIBLE DEPOSITARY INSTITUTIONS A. The type of eligible institution 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, we agree. As mentioned in the Consultation paper, the Commission currently prepares a legislative proposal for intermediated securities. In general, we support the idea that the same institutions would be able to offer the service of safekeeping under the forthcoming legislation and the UCITS Directive 2009/65/EC. Question 25) Do you agree that only institutions subject to the CDR should be eligible to act as UCITS depositaries? Question 26) If not, which types of institutions should be eligible to act as UCITS depositaries, and why? We agree that institutions subject to the CRD should be eligible to act as UCITS depositaries. In addition, one ought to accept as eligible a limited company, which has been authorised under national law by a competent authority to carry out custodial activity provided that it fulfils to the appropriate extent the same requirements as an authorised investment firm. For example, Central Securities Depositaries albeit they are not credit institutions may have an important role as sub-custodians for UCITS depositaries. V. SUPERVISION ISSUES: A. Supervision by auditors 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? We find the question unclear. Under it one refers to article 20 of the Directive 2006/73/EC (implementing measures of the MiFID), which concerns an investment firm and the adequacy of the investment firm s arrangements under section 3 of the Directive. With the question it is unclear whether similar kind additional auditing requirements should be imposed to a management company or to a depositary? In this issue, one could start with an analysis whether an audit of the accounts of the depositary is comprehensive enough in this respect. B. Supervision by national regulators Question 28) Do you agree that UCITS depositaries should be subject to a specific 'depositary' approval by national regulators? Yes we agree. 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? Yes, we agree. However, we think it is quite ambitious to talk about an EU passport for UCITS depositaries although we do not totally exclude the idea. An EU passport would require abovementioned further harmonisation of legislation in the EU area.

6 VI. OTHER INVESTORS PROTECTION ISSUES A. Calculation of the net asset value of the UCITS shares and units by an independent valuator 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? Question 31) If so, what should be the applicable conditions for an entity to be eligible to act as an UCITS Valuator? We do not support the idea on an independent valuator for UCITS, the assets of which can be invested exclusively into liquid financial assets. An independent valuator is proposed in the AIFM Directive, where the question of a valuation of AIF assets can be a more complex issue than under the UCITS. The question on an independent valuator is complicated in that proposal too. 6