Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry

Proposals for Better Management of Non-Financial Risks within the European Fund Management Industry - December 2012

1. Regulation and Non-Financial Risks

across the European Union; a study by the European Commission shows capital ranging from circa EUR113,000 to EUR100 million (COM(2004) 207). The mapping of duties and liabilities of UCITS depositaries done by the Committee of European Securities Regulators (CESR/09-175) shows that France is at one end of the spectrum in terms of investor protections as it imposes a strict liability of prompt restitution of assets lost under custody or sub-custody and its supervisor has strong administrative powers; Greece, Hungary, Lithuania, Portugal, Romania and Sweden are amongst Member States defining the depositary’s safekeeping obligation as an obligation of results. As for Luxembourg, in the last instance, it is up to the civil court to decide whether and how the Civil Code rules on deposit agreements apply to the depositary and to what extent it would have to restitute the assets e.g. in case of sub-custody arrangements; while the supervisor is not devoid of administrative powers, it falls exclusively to the courts to decide whether a supervised entity committed a civil tort which would require it to indemnify investors (CESR/09-175). The case illustrates that the protection offered by UCITS depositaries is subject to legal interpretations and varies widely within Europe. In reality then, UCITS is not a European brand; it is country specific. This uneven protection raised immediate concerns, and politicians agreed on an agenda focused on a better definition and a strengthening of depositaries’ responsibilities. As things stand, uncertainties regarding responsibilities and liabilities with respect to restitution of lost assets can force

controlled by Bernard Madoff. UBS stated that the vehicle had been set up at the request of wealthy clients to invest their funds with Bernard Madoff and that the CSSF has been informed thereof (UBS, 2009); the CSSF has denied this allegation (CSSF, 2009c) and there is no mention of Bernard Madoff entities in the fund documentation and no mention of the delegation of management and custody functions to the same third party. The bank also explained that fund documentation had made it clear, via an explicit waiver, that it would not be responsible for safe-keeping. The UBS/LuxAlpha case caused a row between France and Luxembourg, the two main domiciles for UCITS. The French Finance Minister wrote to the European Union Internal Market Commissioner to complain that different transpositions and interpretations of the role and liability of fund depositaries had led to insufficient levels of investor protection in some jurisdictions. Luxembourg authorities rejected any suggestion that they had loosely implemented the Directive. 8 These issues arise because the depositary’s safe-keeping duties and its liability in case of loss of assets under custody have not been defined by the Directive. Since liability is defined in accordance with each Member State law, it differs across the European Union: some jurisdictions impose a strict liability of restitution (obligation of results) while others require the depositary to diligently choose and monitor the sub-custodian (obligation of means). Differences in legal obligations, in particular regarding restitution, are indirectly evidenced by the widely dispersed capital requirements of depositaries

8 - The CSSF contended that the law applicable to Luxembourg based

depositary banks reflected faithfully the provisions of the UCITS Directive, that the responsibility of the depositary was not affected by delegation of custody (CSSF, 2009a) and that, under Luxembourg civil law, a depositary had an obligation to return the assets in its safe-keeping, subject to valid and opposable contractual clauses to the contrary (CSSF, 2009b). Weber and Gruenewald (2009), however, dispute this interpretation and explain that while Luxembourg law prohibits circumvention of the depositary’s surveillance diligence in the selection and monitoring of sub-custodians to discharge its liability. Reviewing the case at the end of 2009, the CSSF stated that it had discharged its duties and that the competence for deciding on the civil liability of an entity towards individual lied exclusively within the power of the competent civil and commercial courts (CSSF, 2009c). obligation by restriction of liability, a depositary only needs to exert due

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An EDHEC-Risk Institute Publication