Across Europe and Ireland, there have been several updates recently affecting UCITS. The Council of the EU adopted the UCITS V Directive, ESMA launched a consultation on counterparty risk calculation methods for UCITS subject to central clearing, while the Central Bank of Ireland issued a Consultation Paper on adoption of ESMA’s Guidelines on ETFs and other UCITS issues.
- UCITS V
- ESMA consults on counterparty risk calculation methods for UCITS subject to central clearing
- Central Bank of Ireland issues a Consultation Paper on adoption of ESMA’s Guidelines on ETFs and other UCITS issues
On 23 July 2014, the Council of the EU adopted the UCITS V Directive.
UCITS V is broadly aligned with AIFMD on remuneration and depositary requirements and additionally lays down a new framework on the application of sanctions for breaches of UCITS rules.
Rules on depositories have remained unchanged in substance since the original UCITS directive was adopted in 1985. Currently, the assets of a UCITS must be held by a depository who is liable for losses suffered as a result of a failure to perform its duties. However, each member state has the freedom to define what duties the depositary has.
UCITS V lists entities which are eligible to act as UCITS depositories, and clarifies the depository's liability in the event of the loss of a financial instrument held in custody. It also includes provisions on redress.
The text proposes a minimum catalogue of administrative sanctions and a minimum list of sanctioning criteria. Sanctions will generally be published, but can either be published anonymously or not at all depending on a case-by-case assessment that will take into account proportionality and the effect on financial stability.
The rules on remuneration also reflect those of the AIFMD, including the establishment of a remuneration policy to promote sound and effective risk management. It introduces rules on the payment of a 50% bonus out of units of the fund, bonus deferral over at least 3 years and provisions relating to clawback and malus.
Publication of the Directive in the Official Journal of the EU is expected in the third quarter of 2014. According to European Commission FAQs, member states will then have 18 months to transpose UCITS V into national law. Consequently, the new rules could apply in early 2016, while depositories will be given an additional 24-month transition period after the transposition deadline.
ESMA consults on counterparty risk calculation methods for UCITS subject to central clearing
On 22 July 2014, the European Securities and Markets Authority (ESMA) launched a consultation on the calculation of counterparty risk by UCITS, which enter into OTC derivative transactions which need to be centrally cleared under the European Markets Infrastructure Regulation (EMIR).
The UCITS Directive allows UCITS to invest in both exchange-traded derivatives (ETDs) and OTC derivatives. However, only investments in OTC derivatives are subject to counterparty risk exposure limits.
ESMA is now seeking stakeholders’ views on how the limits on counterparty risk in OTC derivative transactions that are centrally cleared should be calculated by UCITS, and whether the same rules should be applied by UCITS for both centrally cleared OTC transactions and ETDs.
The paper is focused on the impact of a default of a clearing member or of other clients of that member on UCITS that enter into centrally cleared OTC derivative transactions. This takes into account the fact that European clearing houses (CCPs) and non-EU CCPs recognised by ESMA are already subject to stringent collateral requirements, and should generally be considered as entailing low counterparty risk.
This discussion paper distinguishes between different clearing arrangements:
- Direct clearing arrangements, i.e. the UCITS is a client of the clearing member with:
• Individual client segregation;
• Omnibus client segregation;
• Other types of segregation arrangement; or
• Segregation arrangements with a non-EU CCP outside the scope of EMIR.
- Indirect clearing arrangements between the CCP, the clearing member, the client of the clearing member and the UCITS.
The consultation is open for feedback until 22 October 2014. ESMA will use the feedback received from the public consultation to determine its final views on the appropriate way forward, including a possible recommendation to the European Commission on a modification of the UCITS Directive.
Central Bank of Ireland issues a Consultation Paper on adoption of ESMA’s Guidelines on ETFs and other UCITS issues
ESMA’s “Guidelines on ETFs and other UCITS issues” includes a 20% issuer diversification rule with respect to collateral received for the purposes of efficient portfolio management (EPM) techniques and OTC derivative transactions. Following industry requests and consultation, ESMA issued a final report on 24 March 2014 which exempts government backed securities from the 20% collateral diversification rule. The exemption is available to all UCITS rather than solely money market fund UCITS, as previously proposed.
On 28 July 2014, the Central Bank of Ireland published a consultation paper (CP84) in which it outlines its proposals to implement the exemption from the 20% collateral diversification for all UCITS as provided for under the revised ESMA guidelines.
CP84 proposes that the derogation is available for collateral is “high quality”, which is to be determined according to criteria specified in CP84. It also aims to address the Central Bank’s concerns regarding risk mitigation without diverging from the ESMA guidelines.