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

2. Key Topics on the European Regulatory Agenda

102-3-(b)).The depositary liability regime created by AIFMD served as benchmark for the preparation of the UCITS V proposal. However, given the wide retail access to UCITS, the Commission concluded that a strict liability regime obliging depositaries to return assets lost in custody (in the hands of the depositaries or a sub-custodian) was required to promote a high-level of investor protection across the European Union. In other words, contractual discharges are not allowed. Consistently, it has restricted the possibility of sub-custody to those jurisdictions where, in the event of insolvency of the sub-custodian party, the assets held in custody do not become assets of the insolvency estate. 41 While this is fine in theory, it may be difficult in practice to dispel legal uncertainties in some jurisdictions. 42 This could lead to a situation where depositaries collectively shun certain jurisdictions where sub-custody is authorised, thus restricting investment opportunities. This could also lead to a state of affairs where depositaries de facto compete on the restitution obligation and the level of non-financial risks they are willing to take on. The latter could result in concentration of non-financial risks in the hands of the most commercially aggressive providers, which would increase systematic risk. 43 It would also defeat the purpose of the regulator should UCITS holders eventually suffer losses brought about by the default of a depositary. AIFMD and the draft UCITS V also make the depositary liable for other losses suffered as a result of its “negligent or intentional failure to properly fulfil its obligations.”

The insistence of the Commission on a strict liability of UCITS depositaries is generally opposed by the industry: the European Banking Federation (EBF, 2012) or the Alternative Investment Management Association (AIMA, 2012) advocate alignment of the depositary provisions of UCITS V on those of AIFMD and even the European Fund and Asset Management Association advocates allowing discharge in exceptional circumstances, subject to appropriate disclosure to investors e.g. when third-country law requires local custody and delegation requirements cannot be met (EFAMA, 2012). Likewise, our survey found that while there was clear support for an unconditional responsibility of the depositary for assets under custody or control (69% agreed, 24% disagreed), there was a stronger consensus for a contractually-defined perimeter of responsibility to be defined between asset managers and depositaries (68% agreed, 17% disagreed) or those and the sub-custodians (65% agreed, 17% disagreed). Admittedly, identifying one link in the fund management value chain and making it liable for the bulk of non-financial risks and imposing a strict liability as far as assets lost in custody are concerned greatly simplifies matters for investors seeking redress as even a properly disclosed contract detailing the responsibilities of each link may be hard to decipher, especially for retail investors, and would be more costly and difficult to enforce. However, identifying a link that will be responsible for enforcing the restitution liability vis-à-vis (retail) investors does not require that this link be the only one assuming the risk.

41 - This restriction is not present in AIFMD and the latest draft of the AIFMD Level 2 measures considers that the depositary is discharged of its liability when local insolvency law does not recognise asset segregation (EBF, 2012). 42 - The proposed UCITS V would require Member States to ensure effective segregation is possible for UCITS (Article 22 (6)). 43 - And all the more so if the most competitive providers simply exhibited a higher tolerance for risk rather than a higher ability to manage it.

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An EDHEC-Risk Institute Publication