Current investor protection transparency objectives are being implemented transversally through multiple regulations and now encompass most financial products, the product creation process, product distribution mechanisms and the market infrastructure.
These regulatory initiatives are specifically targeting, or have direct and indirect ramifications for, the European fund and asset management industry. The implementation of these different requirements is, needless to say, a very complex proposition and continues to require significant investment.
Following on from the legislative and regulatory implementation process around AIFMD and the European Securities and Markets Authority’s (ESMA) recent consultation on asset segregation, there is still plenty of room for debate on key issues around safekeeping. ESMA points to a risk of the assets being commingled rather than segregated, and subsequently at risk of misuse. The consequence could be that the ownership rights to the asset are questioned. There is a risk of loss of assets through the operational processes of safekeeping. These losses could be incurred due to fraud, theft, information technology failures, inadequate recordkeeping, conflicts of interest, legal and compliance failures.
There may also be country specific risk, for example due to the ineffectiveness of a market’s regulatory regime that may make it difficult to recover assets; and there is a risk of insolvency of the delegate to whom safe-keeping has been entrusted.
Picking up the baton from AIFMD, UCITS V continues to fine-tune investor protection by further mitigation of such risks. Importantly, it corrects the current ‘unintended anomaly’ whereby professional investors in alternative investment funds enjoy higher investor protection and asset safety standards than retail investors in UCITS funds.
Restitution liability provisions have been sharpened: liability for such loss cannot be limited, delegated or passed on in any way. To underline this, the UCITS V directive states that any agreement that attempts to limit the depositary’s liability is void. UCITS V also increases the scope of assets subject to restitution liability. The Directive now states that central securities depositaries (CSDs) may, in some instances, provide custody services. When a CSD provides custody services to the depositary, this is considered delegation of safekeeping under the terms of the Directive, and the delegated assets are deemed in scope for restitution liability.
UCITS V also tightens up the safekeeping delegation rules to a degree. A sub-custodian must take “all necessary steps” to ensure that the UCITS assets are not
available to creditors should it become insolvent. The Commission asked ESMA to advise on what these “necessary steps” entail. The resulting technical advice states that the delegate needs to provide, to the depositary, independent legal confirmation that any UCITS assets are segregated and unavailable to creditors in the event of an insolvency.
ESMA’s consultation on this topic closed in January and was conducted in the context of AIFMD. If the resulting technical advice is used as input into the UCITS V Level 2 text it should ensure equivalency between AIFMD and UCITS V on this point. With regards to investor protection and asset safety, the cost-benefit of further adjustments to protect investors in European funds is arguably declining.
Rolf Bachner is Managing Director, EMEA Funds Product Manager at BNY Mellon
The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute investment advice, or any other business, tax or legal advice, and should not be relied upon as such.
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