Consultation of the EU Commission Services on the UCITS Depositary Function

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1 BVI Eschenheimer Anlage 28 D Frankfurt am Main European Commission Directorate General Internal Market and Services B-1049 Brussels Belgium Bundesverband Investment und Asset Management e.v. By Frankfurt, 15 September 2009 Consultation of the EU Commission Services on the UCITS Depositary Function Dear Sir or Madam, BVI 1 is grateful for the opportunity to participate in the EU-Consultation on the UCITS Depositary Function. The background of the Madoff fraud case given, the Consultation of the EU Commission Services on the UCITS depositary function (the Consultation ) can be considered as a big step forward towards monitoring investor protection with regard to investment funds harmonised across the EU. We therefore welcome the project of a comprehensive analysis of all aspects involved in the safe-keeping of UCITS assets. However, we consider it as an unfortunate fact that almost all aspects touched in the course of the Consultation also concern the safe-keeping of assets of so-called alternative investment funds in the meaning of the scheduled AIFM Directive. 1 BVI Bundesverband Investment und Asset Management e. V. represent the interest of the German investment fund and asset management industry. Its 88 members manage currently assets of EUR 1.6 trillion both in mutual funds and mandates. For more information, please visit BVI is filed in the EU register of interest representatives ( ). Director General: Stefan Seip Managing Director: Rüdiger H. Päsler Rudolf Siebel Eschenheimer Anlage 28 D Frankfurt am Main Postfach D Frankfurt am Main Phone: Fax: info@bvi.de

2 page 2 of 14, letter of 15 September 2009 Since the EU Commission obviously contemplates a transfer of regulations contained in the draft of the AIFM Directive on the UCITS depositary function, it would have made more sense in our opinion to carry out the Consultation before the presentation of the draft of corresponding regulations in the AIFM Directive. The draft of the AIFM Directive already being under discussion, we are afraid that the results of the Consultation may not be sufficiently reflected in the course of the intended regulation of AIFM any more. However, we consider it as important to achieve a convergence with the UCITS Directive as far as ever possible. From our point of view, the UCITS regime should also serve as benchmark for AIF, since it is an established and internationally acknowledged legal framework. As regards the point of time of the Consultation, we furthermore consider it as questionable that results of the announced review of the implementation of the UCITS Directive on the national level are not yet available. Ultimately, the necessity of harmonisation of investor protection on EU level can be assessed on the basis of the above referenced information. Furthermore, we are still without any detailed results on the actual events around the Madoff fraud case. We cannot understand the Commission s assessment that in this context new risks in connection with depositaries had materialized. Rather, according to our present knowledge, fundamental principles contained in the UCITS Directive were violated in particular with regard to the separation of asset management on the one hand and asset custody on the other hand. Sufficient results and findings as a material starting point of the Consultation would have been most helpful for the evaluation of possible new regulatory approaches.

3 page 3 of 14, letter of 15 September 2009 In more detail: I. Depositary s Duties A. Safe-keeping duties 1. Do you agree that the safe-keeping (and administration) duties of depositaries should be clarified? A clarification of the depositaries duties and tasks in the course of safekeeping of UCITS assets is necessary. The scope of such duties and tasks does not arise in sufficient clarity from the UCITS Directive. 2. Do you agree these duties should be clarified for each class of assets eligible to the UCITS portfolio? 3. Are there any other appropriate approaches? We consider such approach as helpful, as far as this is required by differences related to the various types of assets or, as the case may be, the type of custody. In this context, the Commission makes reference to the approach of the proposed AIFM Directive (Art. 17), which differentiates between the safekeeping of financial instruments and verifying whether the AIF or the AIFM on behalf of the AIF has obtained the ownership of all other assets. This approach again does not clarify the depositaries duties and tasks. For example, OTC derivatives are considered as financial instruments in the meaning of the MiFID. However, it remains unclear e.g., what kind of safekeeping duties the depositary should have in case of OTC derivatives. The same set of problems arises in the cases where the depositaries have to safe-keep merely claims arising from contracts. On the other hand, we see the risk that the requirements on the depositary may be overvalued. A general duty to verify the acquisition of legal title might be too extensive, in particular where no acquisition of rights in rem is concerned but rather contractual claims.

4 page 4 of 14, letter of 15 September 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? 5. Is there some specificity that may be applicable to the custody functions of a UCITS depositary that should be taken into account? In principle, we welcome an extensive harmonisation of the depositaries duties and tasks related to the safe-keeping of assets eligible for custody. The depositary of a UCITS constitutes one of the keystones within the frame provided by the UCITS Directive. Where the UCITS depositary performs the tasks incumbent on him, he acts exclusively in the interest of the fund unit holders. This fact given, it is justified to refer to a specific custody relationship to which specific requirements apply. One of these requirements is that the depositary, in the performance of his duties and tasks, has to continuously safeguard that the assets are safely kept in custody. B. Supervisory duties 6. Do you agree that existing supervisory duties of the UCITS depositary should be clarified? To the extent that the supervisory duties of depositaries laid down in the UCITS Directive have caused diverging interpretations in the various Member States, a clarification of these duties on EU level seems welcome in principle. We on our part are unable to assess to what extent this is the case, since the results of the review by the Commission are not yet known or not yet available, as the case may be. As an example for the above, the Commission quotes a deviating procedure of the Member States for the calculation of the UCITS unit value. Some national laws would require an additional calculation by the depositary further to the calculation by the investment company. Under other laws, however, a mere supervision by the depositary would be considered as sufficient. At this point, we are of the opinion that the depositary should in any case not become obliged to perform a complete secondary calculation in parallel to the investment company. In principle, it seems sufficient in such cases if the depositary safeguards by means of plausibility checks and supervision of the calculation methods that the unit value calculation by the investment company complies with the statutory and contractual regulations. The depositary is liable for proper fulfilment of such supervisory duty. A duty

5 page 5 of 14, letter of 15 September 2009 of complete re-calculation or, as the case may be, calculation in parallel by the depositary would merely lead to an increase in costs. 7. If so, what clarification do you suggest? In our opinion, clarification makes sense insofar as it serves to remove, in particular, legal uncertainties contravening investor protection and to contribute to the enhancement of a level playing field. 8. To what extent does the list of supervisory duties need to be extended? In our point of view, the supervisory duties of a depositary are regulated in the UCITS Directive in sufficient detail. 9. Do you agree that the only one depositary requirement should be clarified? We understand the above referenced only one depositary requirement in the sense that the proper function of a UCITS depositary, being a cornerstone of the investment fund concept, should be exercisable by one single depositary only. Such principle complies with the current German investment law practice and, according to our knowledge hitherto, is also applied in the other Member States. Hence, clarification would only be required insofar as Member States deviate from such principle. However, it must be safeguarded that the depositary is allowed to entrust third parties with the custody of fund assets in all markets (for this see answer on question 15).

6 page 6 of 14, letter of 15 September 2009 II. Responsibility Regime A. Liability Regime in case of improper performance 1. Identification of the associated risks 10. Do you think that the risks related to improper performance have been correctly identified? 11. Do you foresee other situations where a risk associated with improper performance of the depositary duties might materialise? In our opinion, the risks that can materialise through improper performance of the depositary s duties were correctly identified. As far as the Commission considers mis-valuation of a fund's assets as a substantial risk, it must be pointed out that under German law the responsibility for the calculation of the NAV not necessarily rests with the depositary. While the fund's value can be calculated by the depositary in cooperation with the investment company, this can also be done by the investment company itself. Hence, mis-valuation of a fund should not as such be considered as a risk which arises in connection with the improper performance of a depositary's duties. 12. Do you agree that safeguards against the risk associated with 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? ln our understanding, the question of the EU Commission is related to the general requirement of segregation by the depositary or the sub-custodian, as the case may be, between proprietary holdings on the one hand and client holdings on the other hand. In Germany, the above is current legal practice anyhow since it is required by the Safe Custody Act (Depotgesetz). We cannot make statements concerning regulations of other Member States but in any case there are comparable duties also under the scope of application of the MiFID. However, insofar as a segregation of assets should not be statutorily safeguarded within the context of third-country subcustody, we are of the opinion that a corresponding duty of examination and supervision of the depositary on the EU level makes sense for reasons of investor protection.

7 page 7 of 14, letter of 15 September 2009 A further-going segregation or, as the case may be, sub-categorisation of client holdings would not produce any additional protection for UCITS assets. 2. Liability regime: Unconditional performance v obligation of means 13. Do you agree there should be a general clarification of the liability regime applicable to the UCITS depositary in case of improper performance of custody duties? 14. What adjustments to the liability regime associated to the custody duties of the UCITS depositary would be appropriate and under what conditions? We consider it as necessary to clarify the liability regime with regard to the UCITS depositaries. In the UCITS investor's interest, uniform liability standards on the European level should be tried to achieve. The most recent events around the financial markets crisis and the Madoff fraud scandal have revealed the existence of obvious legal uncertainties as regards the assessment of liability standards applicable to the design of depositary liability permitted by the UCITS Directive on the Member State level. Deviating liability standards applicable to the safe-keeping of UCITS assets on the Member State level contradict to the standard of a widely acknowledged financial product harmonised on the European level. Furthermore, they would neither be comprehensible to nor acceptable for the UCITS investor. The discussion around a harmonised regime of depositary liability can ultimately only be conducted in an adequate manner once the actual differences in the implementation of the UCITS Directive in the individual Member States have been disclosed. However, the results of the announced evaluation by the EU Commission are still missing and impede the development of adequate solutions. In our opinion, such discussion should primarily be guided by the principle of investor protection. The Commission rightly points out that the depositary has played a crucial role in the investment fund industry since the UCITS regime came into being. By its self conception, it should be an institution which justifies the investor's confidence with regard to the safe-keeping of

8 page 8 of 14, letter of 15 September 2009 fund assets. Such aspect should in our opinion likewise be the key criterion for the evaluation of liability standards. Obviously, the EU Commission contemplates in the context of the above discussions to make regulations contained in the proposed AIFM Directive also a standard for UCITS. The Commission in this context declares that the liability regime proposed as regards AIFM depositaries should be strengthened compared to the liability regime applicable to UCITS in the sense that the depositary would be subject to a reversal of the burden of proof to the investor's advantage. This allows for the conclusion that no further-going changes are intended. Insofar, we take the liberty to comment as follows: - The proposed regulation of Art. 17 subs. 5 sentence 1 of the AIFM Directive is drafted in deviation from the regulation contained in Art. 9 or 16, as the case may be, of the UCITS Directive. According to the UCITS Directive, the depositary is liable for losses occurring as result of its unjustifiable failure to perform its obligation or its improper performance. The AIFM Directive, however, provides for a liability as result of its failure to perform its obligation. The background of this difference, in particular the omission of the term unjustifiable, remains in the vague. In our opinion, this creates the impression that fundamental changes in the liability regime were intended. - The consequences of the proposed regulation of Art. 17 subs. 5 sentence 2 of the AIFM are not sufficiently clear. According to the statements, a reversal of the burden of proof to the depositary s detriment is provided for as far as assets safe-kept go astray. However, it seems also conceivable to interprete the above regulation, in conjunction with Art. 17 subs. 5 sentence 1 of the AIFM Directive, as a liability standard. Such interpretation would almost be equivalent to a warranty liability on the part of the depositary. That is to say because an exoneration from liability shall only be possible where the losses have been unavoidable. In practice, this would most likely apply to force majeure cases only. We consider it as important that no (residual) risk of a loss of assets arises for the investor which could jeopardise the confidence in the safety of the assets. Only in really restricted cases (e.g. in case of political upheaval in the country where the assets are kept in custody), an exclusion of liability may at all seem conceivable. One should be able to use the argument safe custody thanks to an independent depositary also in the future without any

9 page 9 of 14, letter of 15 September 2009 restricting addenda. On the other hand, we acknowledge that an unacceptable liability standard for depositaries should be avoided. B. Liability regime of depositaries in cases of delegation 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? 16. Under which conditions should the depositary be allowed to delegate the performance of its duties to a third party? 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? The conditions upon which the UCITS depositary shall be able to delegate the custody of assets to a third party should, in our opinion, be clarified. The depositary should undoubtedly be allowed to delegate the custody of assets to third parties as far as it is unable to perform this service on its own. However, this possibility of exercise of the depositary s function which is statutorily provided for and required by practical needs should in our opinion, as a matter of principal, not involve any restrictions in investor protection. Any (residual) risk of a loss of assets on the part of the investor which might be able to shatter the latter's confidence in the safety of UCITS should be excluded in this regard. In this context, the delegation of the custody of assets to third parties should no longer have the ultimate consequence that both asset management and asset custody are carried out by one and the same entity in an illegal manner what can be assumed to have occurred in the Madoff fraud case. In this context, it seems likewise unacceptable that the issue of depositary responsibility can be resolved obviously only after protracted court proceedings. Independent from liability issues, additional requirements with regard to the involvement of sub-custodians seem to make sense to exclude risks of loss of whatsoever UCITS assets. The criteria referred to by the Commission in this context offer adequate preconditions which should be put in concrete terms. Furthermore, all possibilities available on the EU level should be exhausted in order to achieve a safer design of the safety of UCITS assets within the chains of custody. The restriction contained in the proposed AIFM

10 page 10 of 14, letter of 15 September 2009 Directive (Art.17 subs. 3) is unacceptable since it must remain possible for depositaries to delegate the custody of assets to third parties on all markets. Further to the investor's interest in a secure safe-keeping of his assets, also the interests of the depositary should be taken into account in the scope of an overall view where the depositary s duties are put into concrete terms. The conditions under which a depositary may delegate third parties with the custody of assets should in total not cause disproportionate increases in depositary costs or increases of such costs which are not justified by investor interests. The investor's interest in a UCITS' access to emerging markets may not end up in the depositary being burdened with unmanageable risks. Therefore, it is necessary that the depositaries on their part provide solutions for a limitation of liability without abandoning the objective of avoiding a loss of assets by the investor. In this context, a duty for custodians to segregate assets could be examined. Moreover, the avoidance of a concentration of the depositary market on some few global custodians should also be contemplated. In the institutional business, it should possible to regulate the scope of liability on a case-by-case basis. In this context, an additional duty on the part of the depositary to continuous monitoring of the delegated sub-custodians seems in principle adequate. The depositary should be concerned already in its own interest to safeguard the permanent suitability of the persons carrying out its custody duties. As far as it is the express objective of the EU Commission to make the regulations contained in the proposed AIFM Directive a standard for UCITS, we take the liberty to comment as follows: - The AIFM Directive provides for an option on the part of depositaries to sub-delegate their duties to other depositaries only. Such regulation is unclear. It is questionable whether the involvement of a sub-custodian can be interpreted as delegation in the meaning of Art.17 subs. 4 of the AIFM Directive. If this should be the case, third-country sub-custody would no longer come into question due to the restriction of Art.17 subs. 3 of the AIFM Directive. This is impracticable both for AIFM and UCITS and, hence, is to be rejected. In case of portfolios diversified on a worldwide scale, the involvement of sub-custodians in third countries must be urgently possible since this is required by the investors' interest.

11 page 11 of 14, letter of 15 September The proposed regulation of Art.17 subs. 5 sentence 2 of the AIFM Directive on the reversal of the burden of proof is vague since it does not make clear in sufficient detail if and in what manner such regulations should also be applicable to the delegation to sub-custodians by the depositary. C. Default (bankruptcy) 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? This issue has already been the object of a call for evidence by the Commission with regard to the amendment of the Directive 1997/9/EC on schemes for the compensation of investors Investors Compensation Scheme Directive of February 9, In general, we have a critical view on such inclusion of UCITS into the scope of application of the Investor Compensation Scheme Directive in case that the depositary should default. As a matter of principal, the UCITS and the UCITS investors are adequately protected under German law in case of insolvency of the UCITS' depositary with regard to the assets under custody by applicable provisions in the Safe Custody Act and the Insolvency Code. As far as the improper performance of depositary duties is concerned, a sufficient protection in case of loss should be safeguarded by corresponding requirements to depositaries and liability regulations in the UCITS Directive. Details can be taken from the attached comments of BVI (pp. 3 et seq.) dated April 8, 2009 (Annex). 19. Do you agree that UCITS holders should also benefit from compensation if their custodian defaults and these assets are lost? Within the scope of application of the Investor Compensation Scheme Directive, UCITS unit holders are already protected to a certain extent with regard to the custody of their investment fund units by a credit institution or the investment company. We do not consider a further-going regulation as necessary.

12 page 12 of 14, letter of 15 September 2009 III. Organisational requirements 20. Do you agree that the general organisation requirements that are applicable to a UCITS depositary should be clarified? 21. If so, to what extent? 22. Do you agree that requirements on conflicts of interest applicable to UCITS depositaries should be clarified? 23. If so, to what extent? The Commission sets out that the UCITS Directive presently would not contain detailed regulation on the organisational requirements as to depositaries. In this regard, differences in the individual Member States would also result from the fact which institutions are eligible as depositary according to the law of the respective Member State. In particular, the provisions governing the treatment of conflicts of interest were merely superficial. Depositaries could get into situations where they could no longer safeguard an action in the exclusive interest of the unit holder. From our point of view, a clarification of the general organisational requirements on depositaries only makes sense if the requirements existing in the realm of the respective Member State would have provably shown up as inefficient. However, the Commission does not give any concrete indication as to the above but rather expresses a general concern. The same applies from our point of view to the duty of the depositary to safeguard the investors' interest. Furthermore, the necessity of an increase and clarification of the above fields as regards depositaries seems doubtful, taking into account the introduction of the requirement for depositaries, subject to the provision of Art. 17 subs. 3 of the AIFM Directive, to be credit institutions (for this see answer on questions 24 et seq.) IV. Eligible Depositary Institutions 24. Do you agree that there is a need for clarifying the type of institutions that should be eligible to act as UCITS depositaries? 25. Do you agree that only institutions subject to the CDR should be eligible to act as UCITS depositaries? 26. If so, which types of institutions should be eligible to act as UCITS depositaries, and why? Under German law, only credit institutions are eligible for the depositary function. From our point of view, there are no principal objections against such clarifications or, as the case may be, the transfer of the approach of

13 page 13 of 14, letter of 15 September 2009 Art. 17 subs. 3 of the AIFM Directive to UCITS in order to restrict the depositary function to credit institutions. V. Supervision Issues A. Supervision by auditors 27. Do you agree that additional auditing requirements should be imposed, such as an annual certification of the depositary s account by independent auditors? Under German law, credit institutions are subject to periodic auditing by external auditors with regard to the correct fulfilment of the statutory and contractual duties in their role as depositaries. We do not see any necessity for regulation going beyond the above on the European level. B. Supervision by national regulators 28. Do you agree that UCITS depositaries should be subject to a specific depositary approval by national regulators? 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? Under German law, depositaries at first require a general license to carry on deposit and custody business. Furthermore, the selection of and any change in a depositary additionally require the approval of the Federal Financial Supervisory Authority (BaFin) for each individual UCITS. We do not see any necessity for regulation going beyond the above on the European level. From our point of view, a promotion of the co-operation among European regulators also with regard to the activities of UCITS depositaries should in principle be welcomed. Taking into account the introduction of the management company passport under UCITS IV and the related requirements on depositaries, we do not consider a discussion on the introduction of an EU passport for depositaries as adequate at this point.

14 page 14 of 14, letter of 15 September 2009 VI. Other Investors protection issues A. Calculation of the net asset value of the UCITS shares and units by an independent valuator? 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? 31. If so, what should be the applicable conditions for an entity to be eligible to act as an UCITS Valuator? From our point of view, there is no necessity with regard to the present regulations in the UCITS Directive to subject UCITS assets or units/shares in UCITS to a valuation by an independent valuator. There is no visible additional value added for the sake of investor protection. At best, the option should be maintained that the depositary can likewise act as such valuator. This applies both to UCITS and to the corresponding regulatory proposal of the AIFM Directive, which is this regard requires clarification. The introduction of independent valuators also involves the risk that the latter could manage to place themselves in a de facto monopoly position and that the formation of prices might be impaired. Furthermore, CESR in the current discussion on UCITS IV plans the involvement of external valuators for OTC derivatives only, to the extent that the investment company cannot perform this duty on its own in a separate department. Finally, the quality of valuation by an investment company or the latter s depositary, as the case may be, can always constitute a competition criterion, which should not be leveled without any visible reason whatsoever. Yours sincerely BVI Bundesverband Investment und Asset Management e.v. Alexander Kestler Timm Sachse Encl.

15 BVI Eschenheimer Anlage 28 D Frankfurt am Main European Commission Directorate General Internal Market and Services Unit G3 - Securities Markets SPA 2 03/079 B-1049 Brussels Belgium By Markt-g3@ec.europa.eu Bundesverband Investment und Asset Management e.v. Contact: Peggy Steffen Phone: Fax: peggy.steffen@bvi.de Frankfurt, 8 April 2009 BVI response to the Commission s Call for Evidence on Directive 1997/9/EC on Investor Compensation Schemes Dear Sir or Madam, BVI 1 is grateful for the opportunity to participate in the call for evidence in relation to the review of Directive 1997/9/EC on investor compensation schemes ( ICSD ). We support the notion to gather information about the practical application ten years after the entry into force of the ICSD. Given the current financial markets conditions, we are in favour of an immediate revision of the ICSD. First of all, the ICSD and the Deposit Guarantee Schemes Directive 94/19/EC ( DGSD ) have different objectives. The DGSD protects depositors in the event of closure of an insolvent credit institution. In contrast, the ICSD provides protection against fraudulent misapprehension of clients assets. For this reason, we strongly disagree with the idea that the rules of ICSD concerning e.g. the amount covered by the compensation claim should be adapted following the updating of the DGSD. In accordance with the objective of the ICSD to provide for a harmonised minimum level of protection for small investors, we support the exemption of investment services to non-retail clients from the ICSD provisions. Furthermore, investment firms authorised to provide investment services but not to hold clients assets should be kept outside the scope of the ICSD. Last but not least, BVI members are clearly against the idea that money market funds shareholders should be subject to special treatment within the ICSD. 1 BVI Bundesverband Investment und Asset Management e. V. represent the interest of the German investment fund and asset management industry. Its 92 members manage currently assets in excess of EUR 1.6 trillion both in mutual funds and mandates. For more information, please visit BVI is filed in the EU register of interest representatives ( ). Director General: Stefan Seip Managing Director: Rüdiger H. Päsler Rudolf Siebel Eschenheimer Anlage 28 D Frankfurt am Main Postfach D Frankfurt am Main Phone: Fax: info@bvi.de

16 page 2 of 7, letter of 8 April 2008 I. Preliminary remarks: German scheme Germany does not have only one investor compensation scheme covering all investment firms that hold the single authorisation provided for in Directive 93/22/EEC ( ISD ). In fact, there are three legal schemes which do not cover losses of non-retail clients and which are principally in good working order: Deposit guarantee and investor compensation scheme for private credit institutions (Entschädigungseinrichtung deutscher Banken GmbH, EdB ) Deposit guarantee and investor compensation scheme for public credit institutions (Entschädigungseinrichtung des Bundesverbandes Öffentlicher Banken Deutschlands GmbH, EdÖ ) Investor compensation scheme for remaining investment firms (Entschädigungseinrichtung der Wertpapierhandelsunternehmen, EdW ) Furthermore, in accordance with Article 2 (1) of ICSD, Germany has exempted some credit institutions to which the ICSD applies from the obligation of membership to an investor compensation scheme (cf. Paragraph 12 of the German Act on deposit guarantee and investor compensation schemes). Over one third of BVI members are investment firms required by Article 2 (1) of ICSD to belong to a investor compensation scheme. They render investment services covered by the ISD and the Directive 2004/39/EC ( MiFID ) like portfolio management and investment advice mainly to non-retail clients. They are not authorised to hold clients assets. In this context, we would like to submit the following remarks: II. Issues at stake 1) Should the operation of multilateral trading facilities be excluded from the scope of the ICSD? In our view, the ICSD should not be adapted to all types of new services covered by MiFID and notably to the management of multilateral trading facilities (MTFs). MTFs are operated for a professional clientele, so that their membership in an investor compensation scheme is not required. We also reject the suggested extension of the ICSD to the new MiFID activity of investment advice. Compensation for losses in client s assets resulting from fraudulent misappropriation on the part of the advisor are subject to national civil law and must be claimed before civil courts. The existing German investor compensation schemes do not provide protection in such cases.

17 page 3 of 7, letter of 8 April 2008 In addition, investment advisors are generally not authorised to hold clients assets. Compensation under the ICSD would only make sense in cases in which the advisor is authorised to hold client s assets and misapplies the assets, thus causing losses to the client. Even though such cases should be rare in practice, any extension of the scope of the ICSD to investment advice should apply only to these. 2) Would it be appropriate to include in the scope of the ICSD all investment firms seeking authorisation to the provision of investment services, although their authorisation would not allow holding clients assets? BVI members are against extending the scope of application of the ICSD to all investment firms. For investment firms lacking authorisation to hold clients assets, there is no need for additional protection under ICSD. If the assets are not held in the firm s name, they are held in the client s name or in a collective investment scheme. In either case they are segregated from the investment firm s assets and would not be affected by the firm s bankruptcy or default. 3) Would it be appropriate to include in the scope of the ICSD all investment firms seeking authorisation to the provision of investment services, although they provide their services only to non-retail clients? Having regard to the objective of the ICSD to provide for a harmonised minimum level of protection for small investors, we reject this suggestion. All German schemes do not cover losses incurred by non-retail clients. In fact, incidents by firms providing services solely to non-retail clients do not give rise to a claim against the scheme. A basic principle of MiFID is the assumption that a professional client has the necessary level of experience and knowledge in order to understand the risks involved in the transaction or in the management of his portfolio. Thus, it appears unjustified to extend the liability to contribution under the ICSD to investment firms the business of which is generally excluded from the corresponding compensation entitlement. 4a) Should investors be able to claim compensation in the case of default of the third party where their assets had been deposited? 4b) Should investors (such as UCITS or a UCITS unit holder) be able to claim compensation for loss of assets under the ISCD in those cases where the UCITS depositary or the institution which has been mandated to safe keep the assets, fail to perform its duty?

18 page 4 of 7, letter of 8 April 2008 Initially, the ICSD covered the provision of the MiFiD non-core service of safekeeping and administration of securities. Therefore, in Germany investors are principally able to claim compensation in the case of default of a (German) investment firm which has been entrusted with safe-keeping of their assets. In line with the general concept of the ICSD, however, investors should also in this case be able to claim compensation only for loss of assets caused by fraudulent misappropriation (cf. Paragraph 4 (2) of the German Act on deposit-guarantee and investor-compensation schemes). Otherwise, in the event of closure of an investment firm pursuant to bankruptcy proceedings, the deposited assets are selected from the insolvency estate and investors are entitled to claim the restitution of assets against the liquidator of the insolvent firm. However, the question is whether an investor should be able to claim compensation for losses of assets provoked by the third party entrusted with the safe-keeping function, even if he may not have a directive contractual relationship with that party. All German schemes do not cover losses of clients assets arising from the default of third parties. In our view, investors should not be able to claim compensation in such cases. Rather, the entitlement to compensation should be limited to losses of assets caused by fraudulent misappropriation in cases where the investor has a directive contractual relationship with the depositor. There is a sufficient investor protection in the event of closure of an insolvent investment firm. In cases where an investment firm transfers investors funds to a third party which subsequently defaults on its duties, it is the task of regulatory authority to supervise and control these circumstances. For these reasons, investors (such as UCITS or UCITS unit holders) should not be able to claim compensation for losses of assets under the ICSD in cases where the UCITS depositary or the institution which has been mandated to safe-keep the assets fail to perform its duty. At present all collective investment undertakings whether or not coordinated at Community level and the depositaries or manager of such undertakings are explicitly excluded from the scope of regulation under the ICSD and MiFID, since they are subject to specific rules directly adapted to their activities. The UCITS Directive clearly establishes the basic responsibilities and liabilities of the depositary. It clearly assigns responsibilities for safe-keeping of the fund assets to the depositary and imposes liability on the depositary in the event of wrongdoing or negligent performance of its duties. Determination of liability and its extent must be established in accordance with the relevant national civil law. Otherwise, should the scope of the ICSD be extended to cover failures of third parties, we would suggest that the entitlement be granted to the management company of the damaged UCITS or, in the case of corporate funds, the UCITS itself who should be obliged to claim compensation on behalf of investors. Regarding the compensation amount, the claim should be assessed taking into account the number of investors in a fund. We are aware,

19 page 5 of 7, letter of 8 April 2008 however, that in these cases it is quite difficult to identify the number and structure of shareholders after the relevant event. 5) Should loss events include also any losses suffered by (retail) investors as a consequence of the violation of conduct of business rules? We are clearly against such extension as it implies a conceptual discontinuity in the ICSD which currently provides for compensation only in case of violation of principal contractual obligations such as restitution of assets under custody. In contrast, breaches of conduct of business rules relate to ancillary obligations. Moreover, any claim for damages would need to be established on the basis of individual circumstances, mostly through legal proceedings before civil courts, which means obviously that the decision would depend upon the rules of national civil law. Also, the primary objective of ICSD is to cover unpredictable losses caused by punishable activities such as fraud, whereas compliance by an investment firm with conduct of business rules is subject to supervision and sanctions by the authorities as well as to regular controls by independent auditors. 6) Do you agree with the idea that the amount covered by the ICSD should be adapted following the updating of the DGSD? BVI members strongly disagree with the idea that the amount covered by the ICSD should be adapted following the updating of the DGSD. This appears unjustified, especially as the ICSD provides for compensation only in case of fraud and thus, is in its scope limited in comparison to the DGSD which also covers general business failures of a company. 7) The ICSD does not harmonize the funding systems of the schemes. Should the ICSD provide for some general principles concerning the funding of the schemes? BVI members support the idea that the ICSD should provide for some general principles concerning the funding of the schemes. This could be a feasible way to avoid unfair competition between European investment firms which render the same investment services. In our view, the following issues should be harmonized: The moment contributions are due (We prefer the ex post-approach to scheme funding). Prudential criteria for the management of contributions collected ex ante (in the event that the ex post collected contributions are not enough to claim compensation)

20 page 6 of 7, letter of 8 April 2008 The way contributions are calculated (We think that due consideration should be given to the risk of an investment firm to prompt a case of compensation). The minimum level and the maximum limit on the amount that may be collected from firms in a given period and in case of collecting contributions ex ante. Liability of investment firms which are reassigned to the investorcompensation scheme after determination of a compensation case. 8a) Does the legislation of the Member State you know the best provide mechanisms aimed at limiting compensation schemes obligations over time? If yes, how many clients saw their compensation unpaid as a result of such mechanisms? 8b) Should this kind of mechanisms be prohibited? Germany does limit the cover to an investor s claim to 90 % with a cap of Euro for each investor. In our view, this kind of mechanism should not be prohibited. In order to encourage investors to take due care in their choice of investment firms, it appears reasonable to allow Member States to require investors to bear a small proportion of any loss. In accordance with the objective of the ICSD to provide protection against acts of fraud, it appears justified to proceed as previously done. 9a) Should the process of recognizing the eligibility of the claim be regulated for the purposes of the ICSD? 9b) Should, at least, a mechanism be introduced providing for provisional partial compensation based on a summary assessment of clients positions? 9c) Irrespective of the harmonisation of their funding systems, should compensation schemes ensure that they have minimum reserve funds in order to comply rapidly with any immediate needs? In our view, the process of recognizing the eligibility of the claim should not be regulated for the purposes of the ICSD. Currently, the recognition of eligibility takes place in accordance with national civil and insolvency law. Therefore, BVI members have doubts as to the feasibility of harmonising the relevant parts of insolvency law in order to establish common criteria for eligibility and the amount of the claim at EU level. Irrespective of the harmonisation of funding systems under the ICSD, BVI members endorse the proposal to have minimum reserve funds in the compensation schemes.

21 page 7 of 7, letter of 8 April 2008 III. Other issues to be discussed: Money market funds 10) Do you think special attention should be given to money market funds? BVI members are clearly against the idea that money market funds shareholders should be given a special attention within the ICSD, since they are subject to specific rules directly adapted to their activities. For that reason all collective investment undertakings, including money market funds, whether or not coordinated at Community level, are explicitly excluded from the scope of the ICSD. The legal documentation of money market funds and the funds distributors should clearly explain the objectives of the fund in terms of capital preservation, liquidity and yield in order to enhance investor protection by proper disclosure of investment risks. These steps should be sufficient to achieve adequate perception of risks on the part of investors. There is no other reason to extend the scope of the ICSD to money market funds. Furthermore, we do not think that stabilisation of money market funds can be achieved within the ICSD. First of all, compensations for losses in market value would mean a shift in paradigm of the current directive which grants compensation only for losses due to the institutional failure of an investment firm. Moreover, in case of extending the scope of the ICSD to money market funds or the respective management companies, all other members to the compensation scheme must be expected to entail high membership fees to reflect the actual risk of value losses. This should pose a significant burden to the industry already suffering from high financial strains. 11) Based on the concrete application of the ICSD do you see further issues other than the ones mentioned in the present document that might be of relevance to this analysis? At the moment we do not see further issues that might be of relevance to the analysis. We hope that our suggestions will help to devise a viable concept for the revision of ICSD. We would like to assure the Commission of our willingness to provide continuing assistance and to engage in further discussions on the subject at hand. Yours sincerely BVI Bundesverband Investment und Asset Management e.v. gez. Alexander Kestler gez. Peggy Steffen