money market funds long term investments , UCITS IV improvement

REPLY to the European Commission Consultation Document on UCITS product rules, liquidity management, depositary, money market funds and long term investments Executive Summary: ALFI is the representative body of the 2.1 trillion Euro Luxembourg fund industry. It counts among its members not only investment funds but also a large variety of service providers of the financial sector. There are 3,872 undertakings for collective investment in Luxembourg, of which 2,458 are multiple compartment structures containing 11,505 compartments. With the 1,372 singlecompartment UCIs, there are a total of 12,025 active compartments or sub-funds based in Luxembourg. ALFI welcomes the European Commission Consultation Document on UCITS product rules, liquidity management, depositary, money market funds and long term investments. In the present response to this consultation we wish to develop the following views: In our opinion there is no need to review the scope of assets and exposures that are deemed eligible for a UCITS fund or the extent of the existing framework for EPM techniques. Regarding securities lending, we believe that there is no need to further extend the existing framework as it already features adequate requirements. With regard to OTC derivatives, a harmonized regime dealing with the counterparty risk in connection with instruments and EPM transactions would mean better investor protection. Concerning operational risks resulting from UCITS contracting with a single counterparty, we believe that the current risk management requirements are appropriate. As to extraordinary liquidity management tools, ALFI believes there is no single framework which could be effective across all types of UCITS. Exceptional cases to suspend should be proposed by the fund managers and decided by the Board based on recommendations by risk managers. A fixed set of criteria for such decision would not be useful. Furthermore, time limits to trigger fund liquidation would also not be effective in our view. We would like to underline that side-pockets should not be generally permitted and should only be used as a last resort. Finally, regarding liquidity safeguards in ETF secondary markets the topic is already adequately addressed in the current framework. On the issue of the Depositary passport, it must be underlined that whilst it is fair to say that the UCITS V regulation can be considered as a major step forward to the implementation of a Depositary Bank passport, ALFI is of the strong opinion that before moving forward, the Commission should thoroughly assess and re-examine whether: 1

the existing UCITS EU Regulatory framework as well as the way the Fund industry stakeholders interact and interpret the regulation are effectively compatible with an EU passport for Depositary and the implementation of a model where all the stakeholders (apart from the fund Regulator) could be located outside the domicile of the fund, potentially in three different jurisdictions, would have adverse consequences on investor protection. We therefore recommend a prudent approach vis a vis the Depositary passport and do not see it as a major priority for the future development of the UCITS brand. Concerning money market funds, ALFI broadly supports the EFAMA position. The reform of MMFs should mainly focus on the fund's internal liquidity risk. We agree that certain incremental steps could be considered to further enhance these products ability to resist pressure in times of crisis. However, we only see a further harmonization within the UCITS regime. In the context of the discussion on additional regulation of CNAV, we would like to underline that eliminating the ability to retain a constant NAV would eliminate the ability to manage the fund so as to provide for yield stability and would put increased pressure on the demand for bank deposits. On the topic of long term investments, ALFI welcomes the Commission s proposal to investigate the role that the investment fund industry could play in channeling retail investor s money towards the financing of long-term investments in Europe supporting infrastructure and social development through the setup of a common framework for longterm investments for retail investors. ALFI however believes that such framework should be dealt with in a parallel and distinct regime from the UCITS regime. ALFI also strongly believes that UCITS should be allowed to invest in Responsible Investing in general and in EuSEFs in particular, subject to some restriction, and would welcome a common framework to support long-term investing for retail investors in a parallel regime to the UCITS regime. Finally, with regard to UCITS IV improvement, and self-managed investment companies in particular, ALFI is of the opinion that some level of consistency in the application of prudential rules for self-managed investment companies could be appropriate and that certain prudential rules contained in UCITS IV Management Company Directive applicable to management companies could be applied to self-managed investment companies. However, ALFI deems it of outmost importance that due consideration to the principle of proportionally is given in order to avoid significant organizational requirements and related costs and ensure that the SICAV model remains viable. As regards master feeder structures, ALFI agrees that the scenario of the conversion of a feeder UCITS into an ordinary UCITS is comparable with the conversion of a UCITS into a feeder and cases where a master UCITS changes. Therefore, similar information standards ensuring consistency of the treatment of master-feeder structures should apply. ALFI would also like to suggest further improvements related to UCITS investments in feeder funds, the calculation of the percentage of investments not held in the master fund, 2

the calculation of the global exposure at the level of the feeder fund, the applicable law to the agreements and the contribution in kind. ALFI agrees with the suggestion to clarify the provisions on the timelines for mergers, and also with the proposal for an electronic notification of updates to the UCITS host Member State, the clarification that information on a share class is limited to share classes marketed in a host Member State, and the introduction of a regulator-to-regulator notification for any changes to the notification file. In addition we would recommend that the procedure to deregister a UCITS or a share class is foreseen. Finally, we do not consider that a systematic alignment between the AIFMD and UCITS regime is needed in order to improve consistency of rules on the European asset management sector. An appropriate level of consistency should rather be encouraged if and when it is justified. In our view the AIFMD framework should be first digested and implemented before assessing whether to further harmonize the UCITS regime. Box 1: Eligible assets (1) Do you consider there is a need to review the scope of assets and exposures that are deemed eligible for a UCITS fund? Based on the answer to the below detailed questions, we do not believe they should be reviewed. (2) Do you consider that all investment strategies currently observed in the market place are in line with what investors expect of a product regulated by UCITS? ALFI considers that UCITS provide a safe and transparent framework which gives the investor a lot of opportunities to invest in various assets. Further and similarly to ALFI s position on the questions of "complex UCITS" and their distribution to retail investors (the Answers ) in the context of ESMA s consultation paper on draft guidelines for ETFs and other UCITS issues, ALFI strongly believes that the focus should not be on the complexity of the investment strategy as such, but rather on the management thereof through the setting-up of an appropriate RMP, as well as on the disclosure of potential additional risks implied thereby. (3) Do you consider there is a need to further develop rules on the liquidity of eligible assets? What kind of rules could be envisaged? Please evaluate possible consequences for all stakeholders involved. Liquidity is variable and depends on various contextual factors that might affect it: assets deemed to be liquid today might not be liquid anymore tomorrow (or vice versa) depending upon market conditions: ALFI s view for the UCITS Directive is to remain principles based as it best allows regulators to adapt to changing circumstances. It hence belongs to the supervisory authorities to determine and implement monitoring measures aiming at ensuring that liquidity requirement is met consistently in the relevant market conditions. ALFI deems it worthwhile, in this respect, to recall that the liquidity requirement is to be applied to the whole portfolio of investments and not on an asset by asset basis, subject to 3

market conditions, to enable UCITS to meet their redemption requests any time. Developing further liquidity rules would restrain possible investments. A consequence could be a shrinking attractiveness of UCITS which could shift investors into less regulated products. ALFI does not consider that there is a need to further align with AIFMD which gives more detailed requirements - in the context of less liquid funds that could be subject to gating, suspension, etc. - than UCITS IV regarding the appropriate liquidity management which must be implemented. Indeed, the UCITS regulatory framework already gives answers to several liquidity questions which minimize the risk of illiquidity of UCITS. Indeed, being principle based (i.e. imposing a liquidity result), UCITS is more protective of the investors than is specific detailed provisions were applied in order to achieve liquidity. (4) What is the current market practice regarding the exposure to non-eligible assets? What is the estimated percentage of UCITS exposed to non-eligible assets and what is the average proportion of these assets in such a UCITS portfolio? Please describe the strategies used to gain exposure to non-eligible assets and the non-eligible assets involved. If you are an asset manager, please provide specific information to your business. No comment - currently no figures available. (5) Do you consider there is a need to further refine rules on exposure to non-eligible assets? What would be the consequences of the following measures for all stakeholders involved? - Preventing exposure to certain non-eligible assets (e.g. by adopting a "look through" approach for transferable securities, investments in financial indices, or closed ended funds). - Defining specific exposure limits and risk spreading rules (e.g. diversification) at the level of the underlying assets. Initial backgrounds for the UCITS scope of eligible assets were based on three pillars, risk diversification, liquidity requirement and appropriate risk management. The ineligibility of certain assets (commodities, real estate) was not implied by the need to protect retail investors from specific inherent risks but rather to avoid liquidity management issues linked to those types of assets. In this respect, to the extent investment is done through a wrapping of the underlying ineligible assets, through which the UCITS gets exposure to such assets (by opposition to direct investment), the liquidity requirement is to be met at the level of the wrapping product itself. ALFI s view is to remain principles based at the level of the UCITS Directive and it considers that, on a case by case basis, it may nonetheless appear to be appropriate that supervisory ineligible assets are adequately captured by the risk management function. We believe that retail investors shall be allowed to be exposed to such asset categories through the UCITS product that offers high level of investor protection in terms of risk diversification, liquidity and operational risk management. Should UCITS not be allowed to invest in such asset class, retail investors will inevitably be encouraged to switch to nonregulated products offering the same exposure without the investor protection framework (structured products for instance). 4

(6) Do you see merit in distinguishing or limiting the scope of eligible derivatives based on the payoff of the derivative (e.g. plain vanilla vs. exotic derivatives)? If yes, what would be the consequences of introducing such a distinction? Do you see a need for other distinctions? There is no necessity that derivative financial instruments be categorized and, if doing so, it might be difficult to determine where and how to draw the line to categorize them. Same reasoning may apply to a limitation of scope of eligible derivatives. Having said that, exotic derivative financial instruments usually require complex valuation systems and risk management processes. It is therefore important that such systems are calibrated to the nature and complexity of the instruments used (as required by existing guidelines). (7) Do you consider that market risk is a consistent indicator of global exposure relating to derivative instruments? Which type of strategy employs VaR as a measure for global exposure? What is the proportion of funds using VaR to measure global exposure? What would be the consequence for different stakeholders of using only leverage (commitment method) as a measure of global exposure? If you are an asset manager, please provide also information specific to your business. ALFI considers that it is important to keep VaR as a measure for global exposure as it ensures a consistent approach throughout various types of UCITS. ALFI recommends, on such basis, keeping VaR as a reference method for global exposure. It is indeed not advisable to impose different/more subjective calculation methods to adapt the multiple investment strategies of UCITS since this would imply discrepancies in the global exposure figures. ALFI supports the view that VaR combined with the other already existing UCITS measures in place as imposed by applicable EU regulation (such as the leverage disclosure based on the sum of notionals, imposed by ESMA Q&A regarding risk measurement and calculation of global exposure and counterparty risk of July 9, 2012 and the cover rule for transactions in financial derivative instruments and stress testing as imposed by ESMA in CESR Guidelines 10-788 of July 28, 2010) constitutes an adequate approach to ensure that fund managers do not leverage UCITS too much. The industry has also massively invested in VaR systems in order to meet the UCITS monitoring requirements. It would not seem appropriate to discard a significant investment imposed by the regulator to move to tailor made calculation methods which will never be a one fits all solution. (8) Do you consider that the use of derivatives should be limited to instruments that are traded or would be required to be traded on multilateral platforms in accordance with the legislative proposal on MiFIR? What would be the consequences for different stakeholders of introducing such an obligation? We do not have, to date, a clear picture of the derivative financial instruments that will be covered by MiFIR. In this context, ALFI s view is that it is not possible, from an industry stand point, to limit non standardized derivative financial instruments to instruments that are traded or would be required to be traded on multilateral platforms in accordance with the legislative proposal on MiFIR. Indeed, that would exclude derivative financial instruments that are essential to certain strategies aiming at retail investors (notably to 5

guaranteed or protected UCITS) such as asset swaps, TRS, etc., or largely used to hedge exposure such as foreign exchange contracts and swaps for instance. Box 2, EPM techniques (1) Please describe the types of transactions and instruments that are currently considered as EPM techniques. Please describe the types of transactions that, in your view, should be considered as EPM techniques. In accordance with existing regulatory framework, securities lending, repurchase agreements and reverse repurchase agreements are considered as EPM techniques. We believe that such a list is appropriate. (2) Do you consider there is a specific need to further address issues or risks related to the use of EPM techniques? We believe that there is no need to further extend the existing framework as it already requires that: - such techniques do not change the risk profile of the fund (Article 11 of the Commission directive 2007/16/CE of March 19, 2007); - they are adequately covered in the risk management system (Article 11 of the Commission directive 2007/16/CE of March 19, 2007); - they are adequately covered by collateral; - the fund be able to meet at any time its redemption requests (Article 84 (1) of the UCITS Directive). - they are economically appropriate and realized in a cost-effective way (Article 11 of the Commission directive 2007/16/CE of March 19, 2007) The new ESMA guidelines specifically address the collateral risks and we do not believe that there is a need to further develop new rules. If we were to suggest one point in order to improve investors protection, we would mention that very often there is, in the UCITS reporting, a lack of clarity on the contribution of EPM to the fund objectives and how they are being used. More transparency would be welcome, provided that such clarity is provided in a way understandable to the investors and taking into consideration the concept of proportionality: transparency should mean that the investor understands the aim and use of EPM s, how they are combined, why are they used and what is the outcome generated by such techniques, rather than a long list of risks, or a list of transactions or counterparties as it is the case today. We believe that the current approach for achieving transparency, i.e. requiring detailed lists of data to be disclosed, does not add value but is rather confusing most investors. Therefore, we suggest replacing enumerative detailed lists as required today with appropriate qualitative explanation of the strategy, that would be more meaningful for the investors. (3) What is the current market practice regarding the use of EPM techniques: counterparties involved, volumes, liquidity constraints, revenues and revenue sharing arrangements? No comment. 6

(4) Please describe the type of policies generally in place for the use of EPM techniques. Are any limits applied to the amount of portfolio assets that may, at any given point in time, be the object of EPM techniques? Do you see any merit in prescribing limits to the amount of fund assets that may be subject to EPM? If yes, what would be the appropriate limit and what consequences would such limits have on all the stakeholders affected by such limits? If you are an asset manager, please provide also information specific to your business. We do not see merits as the use of such techniques depends on the strategies pursued. As mentioned in our response in question 2, the existing framework adequately ensures that the EPM techniques do not alter the risk profile of the fund. Moreover, we anticipate that there will be further need to use such techniques in order to generate cash that will be required in order to post collateral in accordance with the new OTC derivatives systems requirements under EMIR. (5) What is the current market practice regarding the collateral received in EPM? In general, the market practice is that such transactions are fully or over-collateralized and mark-to-market on a daily basis. Collateral may include assets that would not be included in the fund s investment policy: for instance, an equity fund may receive government bond as collateral, which is deemed appropriate as the UCITS does not intend to get market exposure through the collateral received but to realize promptly such collateral to re-acquire assets in case of counterparty default. (6) Do you think that there is a need to define criteria on eligibility, liquidity, diversification and re-use of collateral? Eligibility, liquidity, diversification and re-use of collateral are addressed in the new ESMA guidelines and we believe that there is no need to either go beyond nor to include such rules in a directive as it is critical to keep the possibility to adjust promptly such rules to market circumstances. We would like nevertheless to mention that we are concerned by some of rules imposed in the ESMA guidelines. These guidelines impose stricter rules than those applicable to UCITS assets in term of diversification. We believe that such rules should be aligned to those applicable to UCITS. Moreover, too strict rules on the re-use of collateral might be preventing funds to use cash generated by EPM transactions in order to post collateral required under the new OTC derivatives framework (EMIR) and may prevent UCITS funds to access derivatives transactions that are necessary to achieve their strategy. (7) Do you see merits in prescribing mandatory haircuts on received collateral? We believe that the requirement to impose a haircut policy, as mentioned in the ESMA guidelines is the right approach and we do not suggest any change to the framework in this regard. (8) Do you see a need to apply liquidity considerations when deciding the term or duration of EPM transactions? The current requirement to appreciate liquidity at the portfolio level and vis à vis of ability to meet redemption requests is the most appropriate from an investor protection stand point as 7

currently foreseen in the Article 84 (1) of the UCITS Directive. We do not favor a rule based approach singling out each asset class or each type of transactions. Indeed, we believe that investors are better protected by a provision which is principle based and focus on the outcome for the investors than detailed provisions that may become quickly inappropriate given market circumstances or in the context of the UCITS strategy as a whole and may fail ensuring its intended objective. (9) Do you think that EPM should be treated according to their economic substance for the purpose of assessment of risks arising from such transactions? We believe that EPM techniques should be treated according to their economic substance for the purpose of assessing risks and compliance. Indeed, when funds assets are lent or subject to repo s, the funds remain economically exposed to market movements on these assets and the risk management system should reflect this. (10) Is the EPM counterparty allowed to re-use the assets provided by a UCITS as collateral? If so, to what extent? ALFI believes that the rules are worth clarifying. (11) Do you think that there is a need to define collateral provided by a UCITS? The purpose of this question is unclear to ALFI. (12) Do you think that there should be greater transparency on EPM techniques? See question 2 of Box 2. Box 3, OTC derivatives (1) When assessing counterparty risk, do you see merit in clarifying the treatment of OTC derivatives cleared through central counterparties? ALFI does not have, to date, a clear picture with sufficient granularity of (i) the financial derivative instruments that will be covered by MIFIR/EMIR and (ii) their treatment under MIFIR/EMIR. (2) For OTC derivatives not cleared through central counterparties, do you think that collateral requirements should be consistent between the requirements for OTC and EPM transactions? Collateral requirements should indeed be consistent between OTC financial derivative instruments and EPM transactions. ESMA (10-788 and 2012/474) already goes into that direction. A harmonized regime dealing with the counterparty risk in connection with financial derivative instruments and EPM transactions would mean better investor prospection and would have the merit of simplicity (i.e., single set of rules instead of two separate sets of rules). 8

(3) Do you agree that there are specific or other operational risks resulting from UCITS contracting with a single counterparty? What measures could be envisaged? No one model fits all situations. On the one hand, using several counterparties may facilitate switches from one counterparty to another if necessary. On the other hand, managing simultaneously several counterparties means additional work and increased risks of operational errors. Moreover, the best execution duty will come into play in the selection by the UCITS of a single or several counterparties. Such best execution duty may lead to the selection of one or several counterparties depending on the prevailing market circumstances. The volume, number and nature of OTC derivatives are also to be taken into consideration. It would not be appropriate to impose several counterparties to a UCITS entering to OTC derivative contracts for a very small percentage of its assets or a very limited number of transactions (for instance, one or very few foreign exchange contracts for hedging purposes). As one model cannot fit all situations, we believe that the current requirement imposing that operational risks are adequately captured by the risk management of the UCITS is the appropriate one. (4) What is the current market practice in terms of frequency of calculation of counterparty risks and issuer concentration and valuation of UCITS assets? The current market practice is to rely largely on daily valuations of the issuer risks, market risk, OTC financial derivative instruments, OTC counterparty risk and collateral posted under OTC financial derivative instruments and EPM transactions (even in circumstances where the NAV is not calculated on a daily basis for dealing purposes, meaning for processing subscription, conversion and redemption orders). Proper risk management requires indeed daily valuations of all assets, commitments and collaterals. Current applicable rules require a daily valuation of (i) the market risk/global exposure (intraday valuation is even required in some cases), (ii) OTC financial derivative instruments (art. 41(1)g) of the UCITS Directive) and (iii) the collateral posted in respect of OTC financial derivative instruments and EPM transactions (in accordance with the applicable Luxembourg rules). (5) What would be the benefits and costs for all stakeholders involved of requiring calculation of counterparty risk and issuer concentration of the UCITS on at least daily basis? See answer as for question No. 4 of Box 3. (6) How could such a calculation be implemented for assets with less frequent valuation? See answer as for question No. 4 of Box 3. Box 4: Extraordinary liquidity management tools (1) What type of internal policies does a UCITS use in order to face liquidity constraints? If you are an asset manager, please provide also information specific to your business. In most cases the internal policy is integrated into the general risk management policy. Liquidity risk related topics are associated with pre-investment due diligence and eligibility evaluations, the ongoing monitoring of the positions as well as rules in case significant redemption requests are made. 9

(2) Do you see a need to further develop a common framework, as part of the UCITS Directive, for dealing with liquidity bottlenecks in exceptional cases? We believe that the current market practice is evolving in this respect. A common framework would prevent the market to further develop alternative approaches at this stage. Some ways to manage liquidity risk in exceptional cases are described in ALFI s guidelines on liquidity risk management paper. We believe that there is no single framework which could be effective and efficient across all types of UCITS. (3) What would be the criteria needed to define the "exceptional case" referred to in Article 84(2)? Should the decision be based on quantitative and/or qualitative criteria? Should the occurrence of "exceptional cases" be left to the manager's self-assessment and/or should this be assessed by the competent authorities? Please give an indicative list of criteria. According to Art. 84 (2), temporary suspension shall be provided only in exceptional cases where required and where suspension is justified with regards to the interest of the unitholders. We believe that exceptional cases to suspend should be proposed by the fund managers (or the management company as the case may be) and decided by the board based on the recommendations submitted by the risk managers. The fund manager (or the management company as the case may be) could use either quantitative or qualitative criteria whereas industry experience shows that often both are used. We also believe that a fix set of criteria is not useful as some criteria are more useful than others depending on the risk profile and the way the UCITS is managed. However, the suspension policy in exceptional cases should be disclosed by the fund in order to allow the investors to understand that there may be or may be no cases where such a temporary suspension could happen. Due to the complex issue, we believe that transparency is superior to specific rule settings. (4) Regarding the temporary suspension of redemptions, should time limits be introduced that would require the fund to be liquidated once they are breached? If yes, what would such limits be? Please evaluate benefits and costs for all stakeholders involved. We do not believe that time limits to trigger fund liquidation would be useful and effective. First, this would indicate that possible scenarios in the future are known as there might be specific events unknown today which cause necessary suspension beyond these hard limits. But if those limits are established, there might be no way out of liquidation. This means that there could be events in the future that will systematically trigger liquidation of a wide range of funds without a stopping mechanism. Second, if hard limits were required by regulation, they should be established by each fund depending on the respective risk appetite. Different fund types have different risk profiles leading to different liquidity risk profiles. Setting hard limits would mean that for some funds those limits are too narrow and for some other funds they are too wide. Hence, such pre-defined limits would result in inefficient portfolio management to the disadvantage of the investors. However, limits established by a fund should be subject to appropriate information to investors. Third, the costs of such limits will likely be significant. For example, a particular market could face temporary liquidity constraints, but the limits are set in a point of time when the market is recovering. In such cases, regulatory limits would damage investor value. Again, limits subject to a fund s discretion and based on its risk profile combined with appropriate disclosures could reduce such a risk. 10

(5) Regarding deferred redemption, would quantitative thresholds and time limits better ensure fairness between different investors? How would such a mechanism work and what would be the appropriate limits? Please evaluate benefits and costs for all the stakeholders involved. Quantitative thresholds and hard time limits of and pre-defined limits for deferred redemptions have the same drawbacks as those described for time limits triggering forced liquidation (refer to (4)). (6) What is the current market practice when using side pockets? What options might be considered for side pockets in the UCITS Directive? What measures should be developed to ensure that all investors' interests are protected? Please evaluate benefits and costs for all the stakeholders involved. Side-pockets are generally not a tool which is widely used; they are also not allowed in Luxembourg. Moreover, side-pockets are also not deemed as an appropriate management tool under the UCITS regime for the reasons stated. If side-pockets are systematically allowed, it would create a hidden sub-regime within the UCITS regime which does generally not comply with the UCITS rules. We believe, side-pockets should not be generally permitted and may only be used as a last resort. (7) Do you see a need for liquidity safeguards in ETF secondary markets? Should the ETF provider be directly involved in providing liquidity to secondary market investors? What would be the consequences for all the stakeholders involved? Do you see any other alternative? ALFI believes that this topic is adequately covered by the combination of article 1.2 of the current UCITS Directive and "IX. Treatment of secondary market investors of UCITS ETFs" of the ESMA/2012/474 ("Guidelines on ETFs and other UCITS issues"). Indeed authorized participants ("APs") provide liquidity in secondary markets, under UCITS ETF supervision to ensure that the Stock Exchange Value of its units does not significantly vary from their net asset value. In addition to secondary trading, UCITS ETF or its Management Company offer direct redemptions, constantly or only in times of market upheaval after a market warning publication, as disclosed in the prospectus of the fund. ALFI believes that similar requirements should apply to other listed retail products such as non-ucits ETFs or certificates sold to retail investors on a European Stock Exchange in order to ensure a level playing field between UCITS ETFs and these other products. (8) Do you see a need for common rules (including time limits) for execution of redemption orders in normal circumstances, i.e. in other than exceptional cases? If so, what would such rules be? We currently do not see a need for those rules for various reasons: The current rules already require immediate redemption. Any delay may indicate and trigger an exceptional case for a fund as each UCITS should be able to redeem at any time without delay in normal circumstance. We believe this principle is sufficiently enough established in the current rules. Furthermore, normal circumstances are complementary to exceptional 11

circumstances which should be defined on a fund by fund basis in line with its risk profile. In other words, for a clear cut, normal cases should be defined in a complementary sense to exceptional cases. Hence, the equivalent reasoning is valid for normal cases as described above. Overall, we believe the current rules are sufficient. Box 5: Depositary passport Preamble ALFI welcomes the Commission s consultation paper on the UCITS Depositary function and considers this consultative approach as a very important step since Depositories play a crucial role in the value chain of the Fund industry, not limited to the processing and operational aspects, but also through their supervisory function and ultimately, in the overall investors protection. The question of the European Passport for the Depositary function was broached during the previous EU Commission consultations dated 2009 and 2010 respectively and the overall consensus was that the harmonization of the status, role, liability regime and market practice was an unconditional pre-requisite before implementing such a European passport for UCITS. Since then, the EU Commission has issued the UCITS V text proposal aiming at addressing this harmonization issue using the principles applicable to the Depositary function as set by the Directive on Alternative Investment Fund Managers. Whilst it is fair to say to that the UCITS V regulation can be considered as a major step forward to the implementation of a Depositary Bank passport, ALFI is of the strong opinion that before moving forward, the Commission should thoroughly assess and re-examine whether: the existing (e.g. UCITS IV) and future EU Regulatory framework (e.g. UCITS V) as well as the way the Fund industry stakeholders (e.g. Management Companies, Depositaries, Regulators ) interact and interpret the regulation are effectively compatible with an EU passport for Depositary the implementation of a model where all the stakeholders (apart from the fund Regulator) could be located outside the domicile of the fund, potentially in three different jurisdictions, would have adverse consequences on investor protection The fact that the UCITS and its Depositary must be located in the same Member State has todate not been perceived to be an impediment for the development of the UCITS brand. Assuming the costs element is the main driver for implementing the Depositary Bank passport, it is important to note that over the last decade, Depositary Bank fees have remained stable or even decreased due to investments in technology, outsourcing to lower cost centers, leverage expertise accumulated over the years whereas the complexity of the product has significantly increased. In addition, one should note as well that the Depositary Bank fee s contribution to the funds Total Expense Ratios ( TER ) is marginal and in the range of a couple of basis points. Therefore, ALFI strongly encourages, in the first place, all the stakeholders to debate and challenge their expectations on the potential of the passport to further reduce the costs whilst maintaining an adequate investor protection. ALFI believes that the final impact may fall short such expectations and that spreading key functions over several geographies might act against investors interests. That explains why ALFI has always adopted a prudent approach vis a vis the 12

Depositary passport and does not see it as a major priority for the future development of the UCITS brand. Reply to questions in Box 5: (1) What advantages and drawbacks would a Depositary passport create, in your view, from the perspective of: the Depositary (turnover, jobs, organization, operational complexities, economies of scale ), the fund (costs, cross-border activity, enforcement of its rights ), the competent authorities (supervisory effectiveness and complexity ), and the investor (level of investor protection)? The main potential argument in favour of a European passport for Depositary lies essentially in the opportunity for the Management Company and/or the fund to leverage established relationships and existing infrastructures located in a given EU country for domestic products in order to develop a more centralized operating model. The resulting costs savings associated with the potential economies of scale from the Depositary passport service are still to be proven considering that the Depositary Bank s operating models can / are already largely, for the safekeeping function, based on delegation of the associated tasks outside the domicile of the Fund. The underlying investors are already benefiting from the savings today. Whilst the rationale for a more global safekeeping model was not entirely costs driven (Fund promoter, especially for UCITS, are increasingly looking for global service model and players to service their products), the financial parameter remains a key driver. Besides the pure financial aspects, we would like to draw the Commission s attention on the following anticipated issues, potential drawbacks and areas of concerns: Specific EU regulations aiming at harmonising the regulatory framework (e.g. UCITS V, AIFMD...) including the Depositary function, are not yet implemented and have therefore not been satisfactorily tested or harmonized among the member states, The potential for having a fund in jurisdiction A, Depositary in jurisdiction B and Manager in jurisdiction C raises significant concerns over coordination of regulatory oversight. A clear hierarchy of controls and supervision would need to be established so that it is clear to regulators, managers, depositaries and investors which regulatory authority takes overall control especially in a crisis situation, We acknowledge that UCITS IV introduced a management company passport and that they may have some merit in having the Depositary in the same jurisdiction as the management company rather than in the fund domicile. However, to date, we believe there are relatively few examples of an effective use of the management company passport. Before introducing a Depositary passport, we recommend an analysis of the success and feedback from regulators and market players in this regard, We believe that a prerequisite for an effective provision of Depositary services is the cross border coordination of custody, insolvency and securities laws. Until those initiatives have been successfully implemented, it appears premature to push forward a Depositary passport as investors in different UCITS in the same jurisdiction could run with the risk of being subject to different regulatory outcomes and treatment dependent on the location of the Depositary, 13

Tax considerations also need to be taken into account especially for non-corporate funds as locating the Depositary outside the jurisdictions of the fund could potentially change national tax authorities treatment of a Fund, ESMA s role in coordinating the supervision of any cross border provision of services is essential. Given ESMA s current and projected future workload any extension of oversight will need to be matched by appropriate resources at ESMA, Considering that non EU countries, especially Asia (such as Hong Kong, Taiwan and Korea), are key contributors to the growth of the UCITS products, we recommend to analyse the compatibility of a Depositary Bank passport with their local regulatory framework; already today the passport for management companies has revealed reluctance and sensitivity of most Asian regulators, The historical UCITS centres have built over the last 25 years a very specific expertise and experience in Depositary activities which will not necessarily exist in all the EU countries since the latter did not have the same exposure to UCITS products, The multiplication of domiciles and operating centres will inevitably create practical challenges and additional costs such as additional reporting and oversight among the different jurisdiction including audit, regulators, translation, coordination between the different sites...), The Depositary passport could even harm on-going efforts to reduce systemic risk since Depositaries might decide to consolidate all of their activities into a single domicile / under a single legal entity to benefit from economies of scale which will inevitably lead to a higher concentration of risks (credit, operational...), Last but not least, in the current UCITS IV environment, the Depositary is potentially the last man standing in the domicile of the Fund and the more recent UCITS V and AIFM regulation emphasize the image of the Depositary acting as an extended arm of the local Regulator. The implementation of the Depositary passport could in that context be a very sensitive topic for the investors themselves in the context of their own protection. (2) If you are a fund manager or a Depositary, do you encounter problems stemming from the regulatory requirement that the Depositary and the fund need to be located in the same Member State? If you are a competent authority, would you encounter problems linked to the dispersion of supervisory functions and responsibilities? If yes, please give details and describe the costs (financial and non-financial) associated with these burdens as well as possible issues that a separation of fund and Depositary might create in terms of regulatory oversight and supervisory cooperation. Based on our experience, the requirement for the fund and Depositary to be located in the same Member State does not raise concerns and actually is proven to be quite efficient as it contributes to an effective control and supervision of the UCITS. We strongly believe that the dispersion of the supervisory functions will definitely complicate the supervision of the fund for the reasons highlighted in question 1 and could be detrimental to the investors, especially in case of crisis situation. Efforts required in terms of coordination, sharing of information, harmonization of both regulatory and market practice, acquisition of the expertise will inevitably lead to costs increase, slow down the time to market of the product and ultimately increase risks to investors. 14

(3) In case a Depositary passport were to be introduced, what areas do you think might require further harmonization (e.g. calculation of NAV, definition of a Depositary s tasks and permitted activities, conduct of business rules, supervision, harmonization or approximation of capital requirements for depositaries )? As emphasized in our general remarks above, ALFI holds the view that the harmonization of the UCITS Depositary regime across all EU Member States is an essential pre-requisite for a UCITS Depositary passport. The purpose of such harmonization is to ensure that all UCITS investors enjoy the same level of protection and to avoid possibilities of regulatory arbitrage. The UCITS V legislative proposal presented by the Commission and currently examined by the Council and the European Parliament constitutes a step in the right direction as it covers key topics such as eligibility requirements, appropriate conduct of business rules, scope of the safekeeping function, delegation This said, it is at this stage very difficult to assess the effectiveness of such regulation in the absence of Level 2 provisions and practical and concrete experience. To the contrary, we do not see the need in this context for a harmonisation of the NAV calculation as it is usually not part of the Depositary functions. (4) Should the Depositary be subject to a fully-fledged authorization regime specific to depositaries or is reliance on other EU regulatory frameworks (e.g. credit institutions or investment firms) sufficient in case a passport for Depositary functions was to be introduced? Considering the Depositary is playing a key role in the supervision of the fund s activities and investors protection, a fully-fledged authorization regime appears to be appropriate until the Policy Makers and EU Regulators are satisfied that the Depositary Bank function across the EU is fully harmonized. (5) Are there specific issues to address for the supervision of a UCITS where the Depositary is not located in the same jurisdiction? ALFI believes this question is best answered by the competent authorities. Generally speaking and as already highlighted in our preamble and in our answers to questions 1 and 2, having a UCITS and its Depositary located in two different countries is likely to complicate the supervision of these entities. Robust supervision by competent authorities, including thorough monitoring reviews, is key to maintaining worldwide confidence in UCITS products. Box 6-9: Money Market Funds Preamble ALFI believes that Money Market Funds ( MMFs ) have been through some reforms that have strengthened their resilience, such as the CESR/ESMA guidelines on a common definition of European MMFs. Hence, at this stage, the reform of MMFs should focus on the fund's internal liquidity risk, including by requiring MMFs to adhere to certain liquidity requirements (such as by 15

stipulating that a minimum amount of a fund's portfolio should mature within one day and within five business days) and to know their clients by taking into account client concentration and client segments, industry sectors and instruments, and market liquidity positions. ALFI has worked closely with EFAMA and for the avoidance of repetition we broadly endorse the EFAMA positions and comments to the consultation and have only included below aspects we wish to ensure are considered. Reply to questions in Box 6: (1) What role do MMFs play in the management of liquidity for investors and in the financial markets generally? What are close alternatives for MMFs? Please give indicative figures and/or estimates of cross-elasticity of demand between MMFs and alternatives. ALFI supports the comments from EFAMA. (2) What type of investors are MMFs mostly targeting? Please give indicative figures. ALFI supports the comments from EFAMA. (3) What types of assets are MMFs mostly invested in? From what type of issuers? Please give indicative figures. ALFI supports the comments from EFAMA. (4) To what extent do MMFs engage in transactions such as repo and securities lending? What proportion of these transactions is open-ended and can be recalled at any time, and what proportion is fixed-term? What assets do MMFs accept as collateral in these transactions? Is the collateral marked-to-market daily and how often are margin calls made? Do MMFs engage in collateral swap (collateral upgrade/downgrade) trades on a fixed-term basis? ALFI supports the comments from EFAMA. (5) Do you agree that MMFs, individually or collectively, may represent a source of systemic risk ('runs' by investors, contagion, etc ) due to their central role in the short term funding market? Please explain. ALFI supports the comments from EFAMA and would also like to note the following: ALFI welcomes the initiatives taken by ESMA in this area and would also specifically draw the Commission s attention to recent steps taken in the US by the SEC around such funds. Addressing a risk of runs on money funds should be done by addressing the quality and liquidity of the underlying assets held by such funds. As an example, at the height of the crisis in 2008, USD-denominated constant NAV money market funds in Europe lost an aggregate of 32.5% in assets between 1 September and 30 September. Under the revised rule 2a-7, the liquidity requirements would mean that fully 30% of the underlying portfolio matures within 7 days and thus, even in such extreme circumstances, redemptions could have been met through portfolio maturity, thus minimizing both the risk of significant asset disposal by the funds impacting the financial system and the risk of capital loss to investors. 16

We would further advocate that disclosure to investors is enhanced to stress the absence of any guarantee of capital preservation in both constant NAV and variable NAV money market funds. ALFI believes that the money market fund industry in Europe proved its current resilience through the height of the financial crisis when taken as a whole. We do, however, agree that in the context of systemic risk and financial stability, certain incremental steps could be considered to further enhance their ability to resist pressure in times of future crisis and to ensure a consistency of application across the industry. In addition, we have noted the recent IOSCO publication related to money market funds and in this regard, we would have the following comments to make on the content of the Green Paper: The 5 key risks highlighted by IOSCO are aligned to a large extent with the concerns highlighted in the Green Paper: 1. Susceptibility to runs we believe this is most appropriately addressed through ensuring the liquidity requirements of money funds are such that significant redemptions can be met as and when needed and again commend the work done by ESMA on setting, for example, weighted average maturity (WAM) and weighted average life (WAL) restrictions for money market funds. We point to the steps taken by the SEC in their efforts to enhance the rule 2a- 7 as guidance for further enhancements in this area. 2. Contagion risk to the extent that the above-suggested liquidity requirements are such that instruments held have a short-term maturity, there should be no need for a significant disposal of paper in the money markets and thus the risk of contagion is similarly reduced to an acceptable level. 3. Implicit guarantee of sponsors for return of capital. We accept that outside the fund industry, there may be a perception that such funds come with an implicit guarantee, but we believe this should be addressed through appropriate disclosure and risk warnings making it clear that no such guarantee exists and a risk of loss of capital is inherent in any investment. Any decision by a sponsor to thus support their money fund in times of crisis is solely a commercial decision taken in light of current circumstance. Investor feedback indicates that the lack of a guarantee is well understood amongst many investor types, but we accept that there may be segments where this is less well understood and should be addressed through disclosure. 4. Constant NAV funds causing an increased risk the use of amortized cost accounting should be more seen as a technique to manage the fund to achieve a constant NAV rather than any specialized valuation methodology unique to money market funds. All such funds structured as UCITS strictly follow the valuation requirements of that regime. Maintaining the ability to manage the fund to a constant NAV remains an important element for money funds to be able to provide the valuable alternative funding mechanism referred to by M Barnier. Clients value the accounting and tax simplicity of the constant NAV product, together with the risk diversification and management aspects associated with the funds. Eliminating the ability to retain a constant NAV would eliminate the ability to manage the fund in such a manner as to provide for the yield stability sought by the end customer and would put significant increased pressure on the demand for bank deposits. In order to ensure proper and transparent management of the valuation process, similar regulation to that introduced by the SEC recently requiring monthly publication of the deviation to market value could be something worthy of consideration. 17