* LEGAL ALERT LUXEMBOURG LAW DATED 10 MAY 2016 TRANSPOSING DIRECTIVE 2014/91/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL OF 23 JULY 2014 AMENDING DIRECTIVE 2009/65/EC ON THE COORDINATION OF LAWS, REGULATIONS AND ADMINISTRATIVE PROVISIONS RELATIVE TO UNDERTAKINGS FOR COLLECTIVE INVESTMENT IN TRANSFERABLE SECURITIES (UCITS) AS REGARDS DEPOSITARY FUNCTIONS, REMUNERATION POLICIES AND SANCTIONS (THE LAW ) JUNE - 2016 2016
TABLE OF CONTENT I.INTRODUCTION AND SCOPE OF UCITS V AND THE LAW... 3 II. MAIN FEATURES OF THE LAW... 3 1. The Role of the UCITS Depositary... 3 2. Remuneration of UCITS Managers... 8 3. Administrative sanctions... 8 4. Changes to AIFM Law... 10 III. CONCLUSION... 11 2
I. INTRODUCTION AND SCOPE OF UCITS V AND THE LAW The Luxembourg law transposing the Directive 2014/91/EU ( UCITS V ) has finally been voted on 21 April 2016 and published in the Mémorial on 12 May 2016. The Law applies from 1 June 2016. Directive 2014/91/EU was adopted by the European Parliament and the Council of the European Union on July 23, 2014 and was published in the Official Gazette on August 28, 2014. Its objective is to modify Directive 2009/65/EC ( UCITS IV Directive ) in line with current market practices and, in particular, to remedy the discrepancies between national rules regarding the functions and liabilities of UCITS depositaries, remuneration policies of management bodies and risk takers of UCITS management companies and administrative sanctions. Moreover, UCITS V is designed to align the UCITS world with measures introduced under Directive 2011/61/EU for managers of alternative investment funds ( AIFMs ) to ensure greater transparency, increased investor protection and enhanced depositary best practice. The Law has transposed UCITS V and amends the Luxembourg law of December 17, 2010 on undertakings for collective investment, as amended (the 2010 Law ). More particularly, the Law amends Parts I (Chapter 2, 3 and 4), IV (Chapter 15) and V (Chapter 20) of the 2010 Law. In transposing UCITS V into Luxembourg law, the legislator took the opportunity to introduce modifications pertaining to UCIs authorised under Part II of the 2010 Law (Chapters 11, 12 and 13) ( Part II UCIs ) regarding depositaries and also to amend the Luxembourg law of July 12, 2013 on AIFMs (the AIFM Law ) concerning an AIFM s auditor and its cross-border investment services. II. MAIN FEATURES OF THE LAW The Law covers the three main elements that are the focus of the UCITS V Directive, being the role of the depositary bank, manager remuneration and administrative sanctions. In addition, the Law introduces certain changes to the existing AIFM Law. Each of these elements is described in more detail in the following paragraphs. 1. The Role of the UCITS Depositary UCITS V aims to ensure a uniform application of requirements to UCITS depositaries, irrespective of the legal form of the UCITS in order to enhance legal certainty, increase investor protection and contribute to the creation of uniform market conditions. The Law increases the existing obligations of the depositaries as well as introducing certain new obligations, including those applicable to depositaries of Part II UCIs. Either the management company or the board of a self-managed UCITS must ensure that a depositary is appointed for each UCITS via a written agreement that shall, inter alia, regulate the flow of information deemed to be necessary to allow the depositary to perform its functions. a) Intensification of existing obligations for UCITS depositaries i. Type of assets and functions The Law draws a distinction between (i) financial instruments that can be held in custody and (ii) other assets The depositary shall hold in custody all financial instruments that may be registered in a financial instruments account opened in the depositary s books and all financial instruments that can be physically delivered to the depositary and ensure that such financial instruments are registered in the depositary s books in segregated accounts, opened in the name of the UCITS or the management 3
company acting on behalf of the UCITS, so that they can be clearly identified as belonging to the UCITS at all times. For other assets, the depositary shall verify the ownership by the UCITS, or by the management company acting on behalf of the UCITS, of such assets by assessing whether the UCITS or the management company acting on behalf of the UCITS holds the ownership based on information or documents provided by the UCITS or by the management company and, where available, on external evidence and maintain a record of those assets for which it is satisfied that the UCITS or the management company acting on behalf of the UCITS holds the ownership and keep that record up to date. The depositary must, on a regular basis, provide the management company/ucits with a comprehensive inventory of all of the assets belonging to the UCITS in question. ii. Delegation UCITS V provides that the safekeeping functions (but not the general oversight functions or the cash oversight function) can be delegated by the depositary to third parties, subject to certain conditions. Similar to an AIF s depositary and, as already introduced by CSSF Circular 14/587, the Law contains provisions that will allow the UCITS depositary to delegate its safekeeping functions to competent third parties, provided such delegation is in accordance with the conditions specified therein, including, inter alia: the tasks shall not be delegated with the intention of avoiding the requirements applicable to depositaries under the Law; the depositary must be able to demonstrate an objective reason for the delegation; the depositary must exercise due skill, care and diligence in the selection and the appointment of any third party delegate and must continue to exercise such skill, care and diligence in the periodic review and ongoing monitoring of any third party delegate including a review of the arrangements that the third party has put in place in respect of the matters delegated. These functions may be delegated by the depositary to a third party only where that third party at all times during the performance of the tasks delegated to it: has structures and expertise that are adequate and proportionate to the nature and complexity of the assets of the UCITS which have been entrusted to it; for custody tasks, is subject to effective prudential regulation, including minimum capital requirements, and supervision in the jurisdiction concerned as well as an external periodic audit to ensure that the financial instruments are in its possession; segregates the assets of the clients of the depositary from its own assets and from the assets of the depositary in such a way that they can, at any time, be clearly identified as belonging to clients of a particular depositary; takes all necessary steps to ensure that in the event of insolvency, the assets of a UCITS held by the third party in custody are unavailable for distribution among, or realisation for the benefit of, creditors of the third party; and complies with the general obligations and prohibitions applicable to the depositary. Moreover, any delegation by the depositary to a third party cannot limit the depositary s liability in any way and the delegation must be mentioned and / or notified to the investors. UCITS V also requires that the prospectus for a UCITS must contain a description of any safekeeping functions delegated by the depositary, the list of delegates and sub-delegates and any conflicts of interest that may arise from such a delegation. This provision corresponds with an investor disclosure requirement contained in AIFMD; however, it is more onerous in that the AIFMD only stipulates that this information must be provided to investors and not that it must specifically be contained in the prospectus. 4
iii. Oversight functions The Law harmonises the depositary s supervisory/ oversight obligations towards all UCITS. The depositary must now: ensure that the sale, issue, repurchase, redemption and cancellation of units or shares are carried out in accordance with applicable law and the constitutional documents of the UCITS; ensure that the net asset value is calculated in accordance with the applicable law and constitutional documents of the UCITS; carry out the instructions of the UCITS or its management company unless they conflict with the applicable law or the constitutional documents of the UCITS; ensure the usual time limits for the assets transactions of the UCITS; ensure the application of the income in compliance with the applicable law and constitutional documents of the UCITS. b) New Obligations for UCITS depositaries i. Cash Flow UCITS V introduces a new depositary oversight function relating to cash, in line with the AIFMD requirements. The UCITS depositary is now obliged to ensure the adequate monitoring of the cash flow of each UCITS and that all the subscription payments made by investors are received and that all the cash belonging to the UCITS is booked on cash accounts opened correctly either in the name of the UCITS or in the name of the depositary with an entity specified by article 18, paragraph 1, points a), b) and c) of Directive 2006/73/EC (the Third Party Bank ). When the cash accounts are opened in the name of the depositary acting for the UCITS with the Third Party Bank, the cash of such Third Party Bank and of the depositary shall not be booked on such accounts. ii. Prohibitions The assets held in custody by the depositary shall not be re-used by the depositary, or by any third party to which the custody function has been delegated, for their own account (except in some cases provided for by the Law (e.g. re-use for the benefit of the UCITS, execution of the UCITS instructions). Re-use comprises any transaction involving the assets held in custody including, but not limited to, transferring, pledging, selling and lending. In the event of the depositary s insolvency and/or the insolvency of any third party delegate located in the EU, the assets belonging to the UCITS will not be available for the purpose of distributing among, or realising for the benefit of, creditors of the insolvent depositary and/or third party delegate. c) Liability of the UCITS depositary UCITS V aligns the liability of a depositary with the higher standard of liability of a depositary under the AIFMD rules. The new liability standard means that the UCITS depositary shall be liable for any losses by the depositary or a third party to whom the custody of financial assets, which can be held in custody, has been delegated. 5
In case of losses of financial instruments held in custody, directly by the depositary or through a delegate, depositaries will be obliged to return identical financial instruments or a corresponding amount of assets to the UCITS or the management company without undue delay unless the depositary can prove that the loss has arisen as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary. It is worth noting that UCITS V, like the AIFMD, acknowledges that certain financial assets cannot be held in custody and so this obligation only applies for certain types of assets. As a result of distinguishing the different safekeeping duties regarding (i) financial assets that can be held in custody; and (ii) other assets, UCITS V effectively recasts two different levels of liability for safekeeping functions. Indeed, the UCITS depositary is also liable for all other losses suffered by the UCITS (or its investors) as a result of the depositary s negligence or intentional failure to properly fulfill its obligations. The liability of the UCITS depositary may not be limited or excluded by agreement; such contractual clause will be declared void. d) Conflicts of interest No company shall act as both management company and depositary. No company shall act as both investment company and depositary. In carrying out their respective functions, the management company/ucits and the depositary shall act honestly, fairly, professionally, independently and solely in the interest of the UCITS and the investors of the UCITS. e) Changes for Part II UCI depositaries The Law also aligns the depositary regime applicable to Part II UCIs with that of UCITS. As such, the UCITS depositary regime applies to Part II UCIs whether or not the Part II UCI is required under the AIFM Law to appoint / be authorised as a fully authorised AIFM. This is not a deviation from UCITS V since it is justified by the possibility open to a Part II UCI to market its units or shares to the public, similar to UCITS. 6
2. Remuneration of UCITS Managers The Law also replicates the AIFM Law with respect to the detailed provisions on the remuneration of UCITS management companies. Specifically, UCITS management companies must put in place remuneration policies and practices for senior management and persons whose professional activities have a material impact on the risk profile of the management company or the UCITS. The management company needs thus to establish, maintain and approve a remuneration policy that is consistent with and promotes, sound and effective risk management. Moreover the remuneration policy should neither encourage risk taking which is inconsistent with the risk profile or constitutional documents of the UCITS under management nor impair compliance with the management company s duty to act in the best interest of the UCITS and its investors. Disclosure is also required in the UCITS annual report in relation to fixed and variable remuneration paid by the management company / self-managed UCITS to its staff. Management companies that are considered significant in terms of their size, or the size of the UCITS they manage, are required to establish a remuneration committee to exercise independent and competent judgment on remuneration policies and practices. Members of the remuneration committee shall not perform any executive functions in the management company. Remuneration of the senior officers in control functions shall be overseen by the remuneration committee. Also, the implementation of the remuneration policy will have to be reviewed, at least annually, by the control functions. 3. Administrative sanctions The third area of focus under UCITS V is the harmonisation of the minimum administrative sanctions available to competent regulatory authorities, such as the CSSF, in circumstances of key violations of the rules applicable to UCITS under the 2010 Law. For a more thorough understanding of the amendments made to the 2010 Law by the Law in this regard, it is helpful to understand the background concerning such amendments in EU legislation. a) Background of EU legislation It has been the aim of the EU legislators for some time now to introduce EU-wide minimum harmonised standards on certain key issues, in order to promote convergence and reinforcement of national sanctioning regimes. The European Commission included such uniform rules in its recent proposals for the review of the sectorial EU legislation concerned, including the Capital Requirements Directive IV (2013/36/EU), MiFID (2004/39/EC and 2014/65/EU), the Market Abuse Directive (2014/57/EU) and the Transparency Directive (2004/109/EC). The extension of this work to the UCITS framework is an additional step in this process. The new regime introduced by UCITS V is geared towards achieving the minimum harmonisation of the sanctioning regimes by requiring: (i) a catalogue of minimum administrative sanctions and measures (including harmonisation of the minimum and maximum amounts of administrative fines); (ii) a list of minimum sanctioning criteria; and (iii) competent authorities and management companies to establish whistle-blowing mechanisms. This sanctioning regime will apply to a catalogue of infringements of main investor protection safeguards outlined in UCITS V. b) New administrative sanctions The Luxembourg legislator, for the most part, transposed UCITS V in its current form, without any changes. 7
The Law integrates the new rules on administrative sanctions under Part V, chapter 20 of the 2010 Law. In order to ensure coherence, the new rules apply to both UCITS and Part II UCIs, save for those sanctions that cover aspects only applicable to UCITS. There will be further legislative measures taken in the future in order to consolidate and reform the administrative sanctions available to the CSSF. The new articles 148, 149,149bis and 149ter of the 2010 Law reflect current policies in the financial service sector concerning sanctions and measures and provide for sanctions applicable to infringements of the main provisions of the 2010 Law. In particular, article 148, para. 2, outlines the general cases that are considered as infringements and the new article 148, para. 3, lists those main infringements. The specific list of the main infringements contained in the new article 148 para. 3 includes, inter alia, cases in which the activities of a UCITS, the business of a management company or of an investment company are pursued or carried on without the necessary authorisation, or cases in which such authorisation was obtained through false statements or any other irregular means and a number of other cases in which the relevant party fails to comply with the 2010 Law. The new article 148 para. 5 lays down the administrative sanctions and measures that the CSSF is empowered to apply where such infringements occur. Sanctions can be applied against UCIs, as defined in the 2010 Law, and other parties responsible for the functioning of the UCIs, such as their managers, employees and the liquidator of a UCI in case of voluntary liquidation. Article 149 provides that sanctions of the CSSF may, under certain circumstances, be published on the CSSF s website, in order to inform the general public in the best interests of consumers. The new article 149ter requires the CSSF to establish effective mechanisms to encourage the reporting of infringements to the CSSF, such as protection for employees of UCIs and appropriate and confidential communication channels and procedures for whistleblowers. Given that the AIFM Law also contains provisions for administrative sanctions in the case of infringements, where the CSSF intends to take measures against a management company that is authorised under both the AIFM Law and the 2010 Law, it must choose the law (i.e. the 2010 Law or the AIFM Law) under which the administrative sanction shall be imposed. 4. Changes to the AIFM Law The Luxembourg legislator took the opportunity to introduce some amendments to the AIFM Law which are not in connection with the transposition of UCITS V. There are two main modifications that can be summarized as follows. a) Auditor The first amendment to the AIFM Law concerns the obligation for an authorised AIFM to have its annual accounts audited by an approved independent auditor (réviseur d entreprises agréé). The legislator hereby aligns the regime with the provisions applicable to management companies authorised under Chapters 15 and 16 of the 2010 Law. The wording of the new article 7bis of the AIFM Law is thus largely inspired by article 104 of the 2010 Law. A management company that is authorised pursuant to Chapters 15 or 16 of the 2010 Law, as well as under the AIFM Law, may be audited by the same approved independent auditor, which will perform the audit in accordance with the rules applicable under both the 2010 Law and the AIFM Law. A new paragraph 6 is added to Article 45 of the AIFM Law which contains transitional provisions. b) Cross-border investment services Another modification of the AIFM Law was required by Directive 2014/65/EU of the European Parliament and of the Council of May 15, 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU ( MiFID II ). 8
The AIFM Law allows AIFMs to provide certain investment services in addition to the collective management of alternative investment funds, including the discretionary management of investment portfolios, investment advice, safe-keeping and administration in relation to shares or units of collective investment undertakings, as well as reception and transmission of orders in relation to financial instruments (the AIFM Services ). In order to eliminate obstacles in the cross-border provision of harmonised AIFM Services and to ensure a level playing field between entities providing the same AIFM Services under the same legal requirements, the amended articles 32 and 33 of the AIFM Law now provide that AIFMs authorised by their home competent authorities to provide the AIFMs Services are not subject to any additional authorisation in Luxembourg nor to any other measure having an equivalent effect. Therefore, an AIFM that is authorised in a EU member state other than Luxembourg to provide AIFM Services will be permitted to provide such services on a cross-border basis in Luxembourg, subject to completion of the appropriate notification requirements vis-à-vis the competent authorities of its home member state. III. CONCLUSION On 24 March 2016, the delegated Regulation (UE) 2016/438 supplementing the UCITS V Directive was published in the Official Journal of the European Union (OJEU). The delegated Regulation will apply from 13 October 2016. On 31 March 2016 ESMA issued the ESMA/2016/411 Guidelines on sound remuneration policies under the UCITS Directive and AIFM which will apply from 1 January 2017. At this point in time, the key elements being introduced under UCITS V are already familiar in an AIFMD context. The transposition of UCITS V into Luxembourg law applies however, the corresponding measures in a UCITS context and in this regard it will serve to effectively level the playing field between UCITS and AIFs in terms of the increased regulatory rules that will now apply to both. For further information feel free to contact the following persons: CORINNE PHILIPPE cphilippe@bonnschmitt.net AMÉLIE THEVENART athevenart@bonnschmitt.net LAURENT HENNERESSE lhenneresse@bonnschmitt.net CLAUDIA PFISTER cpfister@bonnschmitt.net YI WANG ywang@bonnschmitt.net ALEX SCHMITT aschmitt@bonnschmitt.net *** BONN & SCHMITT JUNE - 2016 9
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