UCITS, Non-UCITS & Hedge Funds
(i) Draft of UCITS V Directive released
A draft of the UCITS V Directive was unofficially released in April 2012, ("UCITS V"). This is a further revision to the regime for Undertakings for Collective Investment in Transferable Securities ("UCITS") and is intended to enhance certain measures within the UCITS framework, particularly in relation to investor protection.
The European Commission (the "Commission") has stated that the purpose UCITS V is to bring the UCITS regime into line with the Alternative Investment Fund Managers Directive ("AIFMD").
UCITS V covers three key elements, namely the Depositary role (covering eligibility criteria, liability, delegation and oversight function relating to cash), Manager remuneration and Regulatory sanctions.
Depositary role
Eligibility
The proposed wording of UCITS V prescribes an exhaustive list of entities that are eligible to act as a depository to a UCITS; (i) authorised credit institutions, (ii) MiFID authorised investment firms which also provide the ancillary service of safe-keeping and administration of financial instruments and (iii) all existing UCITS depositary institutions (which at the point the new requirements come into effect, engage a noncompliant depositary) who chose to avail of a grandfathering mechanism.
UCITS V does not refer to the third broader category of eligible entity contained in AIFMD namely, entities subject to prudential supervision and ongoing supervision. The relevant provision in AIFMD cross refers to the UCITS IV Directive that is being amended, and this may mean that UCITS V will restrict the scope of eligible depositaries for both UCITS and for non-UCITS.
Liability
UCITS V proposes to extend the circumstances in which a depository may be liable if a UCITS fund suffers a loss as a result of the depository's negligence or intentional failure to perform its duties. A depository of a UCITS will be liable for (i) any losses suffered by the UCITS or its investors unless "it can prove that the loss has arisen as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary" and (ii) all losses suffered as a result of the depository's negligent or intentional failure to properly fulfil its obligations.
Depositories will be obliged to return the identical financial instruments or a corresponding amount of assets (where they are capable of substitution, e.g. cash) to the UCITS without delay.
UCITS V also proposes to give new rights to all UCITS investors so that they are able to directly or indirectly sue the UCITS depository.
In this way UCITS V proposes to align the standard of liability of a depository with the standard contained in AIFMD.
Delegation
UCITS V provides that a depository may delegate all or part of its safekeeping tasks to a sub-custodian. UCITS V also elaborates on the conditions applicable to the delegation of a depository's activities, inter alia, requiring the depository to demonstrate that there is an objective reason for the delegation. UCITS V clarifies that a depository when delegating must exercise "all due skill, care and diligence in the selection and the appointment of any third party to whom it wants to delegate parts of its tasks, and keeps exercising all due skill, care and diligence in the periodic review and ongoing monitoring of any third party to whom it has delegated parts of its tasks and of the arrangements of the third party in respect of the matters delegated to it."
The new conditions introduced by UCITS V in relation to the delegation by a depository are very similar to the requirements contained in AIFMD.
Oversight function relating to cash
UCITS V introduces a depositary oversight function relating to cash that is not present in the current UCITS regime. UCITS V imposes an obligation on a depository to monitor cash flows of the UCITS and in particular imposes an obligation on a depository to ensure that subscription monies are properly received by the UCITS.
Manager remuneration
UCITS V proposes to apply new rules relating to remuneration of UCITS management companies. The new requirements are consistent with those requirements which are already contained in the Capital Requirements Directive and with the proposals contained in AIFMD. Remuneration policies should be designed to promote sound and effective risk management and should discourage disproportionate risk-taking by the UCITS. In particular the remuneration policy should contain rules for guaranteed variable remuneration and contain criteria for calculating compensation for different categories of staff.
The new requirements would apply to persons whose professional activities have a material impact on the risk profile of the UCITS and in particular to senior management including the board of directors, those in supervisory functions, risk management functions and other employees in the same pay bracket as senior management.
The board of directors of the management company should adopt the general principles of the remuneration policy and be responsible for its implementation and periodic review. The compliance function would also be charged with an annual review of the remuneration policy and to ensure that it is being implemented in the organisation.
These measures are similar to measures contained in AIFMD.
Regulatory sanctions
UCITS V creates a requirement that all EU Member States give wide-ranging investigative powers and administrative sanctions capabilities to their competent authorities for a wide range of breaches of regulatory requirements. These measures expand on the broad principles in the UCITS IV Directive and are similar to measures contained in AIFMD.
It is expected that UCITS V will be formally published this summer, and national implementation could be required by mid- 2014.
(ii) The IFIA publish a response to the draft UCITS V text
In May 2012 the Irish Funds Industry Association ("IFIA"') UCITS V taskforce published their key comments in relation to the draft UCITS V text. The comments set out in the response represent the initial thoughts of the Taskforce and are intended to highlight issues which may be raised by the IFIA with the Central Bank and the Department Finance and in turn with the Commission.
(iii) New Irish Fund Structure to Facilitate U.S Investment
The Irish Minister for Finance has announced that he has approved the development of legislative proposals for a new corporate structure for the Irish funds industry (the "SICAV"). This new SICAV structure will sit alongside the existing public limited company ("PLC") structure.
One of the main advantages of the SICAV is that it will provide for a corporate entity that can elect its classification under the U.S. "check-the-box" taxation rules. If the SICAV elects to "check-the box" to be treated as a partnership for US tax purposes, it will avoid certain adverse tax consequences for U.S. taxable investors which would arise if the structure is deemed to be a 'passive foreign investment company' (PFIC) for US federal income tax purposes. In addition, the SICAV structure will remove the need for compliance with certain requirements under Irish company law resulting in reduced administrative burden and costs.
The new SICAV structure will complement the current fund structures available in Ireland. These structures (namely, the existing PLC structure, the unit trust, the common contractual fund and the investment limited partnership) will continue to be available to promoters who wish to use them. For existing PLC structures, there will be an option to convert to the new SICAV structure.
The new SICAV development reflects the Irish Government's commitment to ensure that Ireland remains a leading domicile for investment funds.
(iv) Industry Guidance on Global Exposure Disclosure in Annual Reports
The updated UCITS Notices issued by the Central Bank of Ireland (the "Central Bank") in December 2011 provide that a UCITS fund must disclose in its annual report the method used to calculated global exposure. The IFIA in its annual report has issued a technical paper on "Annual Financial Reporting requirements around the disclosure of Global Exposure under UCITS IV." The paper gives practical guidance relating to the preparation of these disclosures, and in particular contains guidance on whether information regarding global exposure should be disclosed as part of the FRS 29 note.
The paper is available in the members' area of the IFIA website – www.irishfunds.ie
(v) Central Bank Consultation Paper on proposed changes to the regulatory reporting requirements of Irish authorised collective investment schemes
The Central Bank published a consultation paper on proposed changes to the regulatory reporting requirements of Irish authorised collective investment schemes ("CIS") on the 28th May 2012, ("CP 59"). CP59 sets out the Central Bank's proposals for a number of changes to the existing regulatory reporting regime for CISs whereby reports will now be submitted through an online reporting system.
The Central Bank currently requires CIS to file annual and interim financial statements within 4 and 2 months, respectively, of the relevant reporting periods. These financial statements are currently filed in hardcopy via post or soft copy via e-mail. It is proposed that the submission of financial statements will now be made online in PDF format using an online reporting system. In addition, the CIS auditor will be required to separately file online the annual statutory duty confirmation return and any additional reports relating to the annual financial statements.
It is further proposed that the annual financial derivatives instrument report filed on completion of the annual financial statements will be submitted separately online.
In addition the Central Bank is introducing two new structured online returns, which will require CIS to submit data in a pre-specified format. These returns are entitled (i) Sub-Fund Profile Questionnaire and (ii) Regulatory Report (suspensions form part of this report and must also be filed online).
Finally, it is proposed by the Central Bank that the annual update to the Key Investor Information Document ("KIID") will now be filed online.
It is noted that it will be necessary to amend the provisions of the Central Bank's UCITS and Non-UCITS Notices to reflect any proposed changes. It is likely that any proposed amendments to these documents will be the subject of a separate industry consultation.
The consultation period for CP 59 closed on the 25th June 2012.
(vi) IFIA publish response to Central Bank Consultation Paper on proposed changes to the regulatory reporting requirements of the Irish authorised collective investment schemes
On the 26th June 2012 the IFIA published a response to CP 59. They highlighted the negative impact they believed the changes proposed in CP 59 would have on competitiveness in the Irish funds industry. The response also details the IFIA's opinion on operational concerns, specific reports and finally proposes responses to specific questions posed in CP 59.
(vii) KIID Deadline
All UCITS must have their KIID in place by the 30th June 2012.
Articles 78 to 82 of the UCITS IV Directive outline the provisions on the KIID and in particular Article 78(2) provides: "Key investor information should include appropriate information about the essential characteristics of the UCITS concerned, which is to be provided to investors so that they are reasonably able to understand the nature and the risks of the investment product that is being offered to them and, consequently, to take investment decisions on an informed basis."
This requirement is imposing significant challenges for the majority of UCITS funds which are in transition from the simplified prospectus regime.
(viii) Letter from the Central Bank of Ireland regarding KIID's
On the 8th June, 2012 the Central Bank issued a letter addressed to the IFIA regarding the KIID, in particular in relation to the provision of the KIID to investors making a subsequent subscription. The letter provides that existing investors have to be provided with an up-todate KIID when making a subsequent subscription. Accordingly, it seems that where an investor has previously been provided with a KIID and they are making a subsequent subscription, the KIID must only be provided to investors if the KIID has been updated since the version previously provided to investors. To meet this requirement a fund would need to have a system in place to track which version of the KIID was issued to the relevant investor(s).
It should be noted that the Central Bank letter does not refer to the requirements relating to the provision of a KIID on a website as set down by Article 38 of the Commission Regulation 583/2010 (which, as it is an EU Regulation, is directly effective and does not need to be transposed into local law). By way of reminder, Article 38 requires investors to specifically consent to accessing the KIID or the Prospectus on a website, however there are numerous practical difficulties associated with this.
Separately, we expect ESMA to issue a Q&A Document in relation to this matter, however, we are not currently aware of when this Q&A is expected to be published.
(ix) Foreign Account Tax Compliance Act
The Foreign Account Tax Compliance Act ("FATCA") was enacted in 2010 and is a new US reporting and withholding regime, the aim of which is to ensure tax compliance among US persons who hold offshore accounts.
Following the issue of the Joint Statement by the U.S. and a number of EU countries, a spokesperson for the Irish Revenue Commissioners has confirmed that they are in contact with the US Treasury in relation to exploring a common approach to FATCA. It was confirmed that any agreed approach would be based on domestic tax reporting legislation and automatic exchange of information under existing bilateral tax treaties.
It is understood that the approach being explored is to develop a model global agreement, which will be adopted under relevant bilateral tax treaties/exchange of information agreements. Ireland is one of a number of countries with which discussions in relation to a model agreement are ongoing. The model agreement will not alter or amend the obligation to identify or report certain information under FATCA, but will outline an alternative pathway for reporting FATCA information. The model agreement was expected by the 30th June 2012.
(x) Irish Funds Industry Association Taskforce publishes two papers on the area of Money Market Funds
The IFIA established a Taskforce to focus on the position the Irish funds industry should be taking to influence policy in the area of Money Market Funds ("MMF") and to lead the industry response on MMF regulation or market practice. On the 15th of June 2012 the IFIA published two papers.
The first paper was published in response to the Commission's Green Paper on Shadow Banking Consultation Report which issued on the 19th March 2012. The paper sets out some specific commentary on the elements of the Shadow Banking discussion which are pertinent to the Irish funds industry. In particular, the IFIA argues that MMFs and Exchange Traded Funds ("ETFs) should not be included as part of an umbrella category of entities referred to as "Shadow Banking" and further argues that MMFs should not be required to adopt a variable net asset value.
The second paper was published in response to IOSCO's Consultation Paper which was issued on the 27th April 2012 on "Money Market Fund Systemic Risk Analysis and Reform Options", (the "Consultation Paper"). The IFIA's response contains an overview of their opinion relating to individual elements of MMF reform such as the comparison of MMFs with banks and possible changes relating to fund pricing and certain recommendations to adopt variable net asset value. The paper sets out detailed responses to questions raised in the Consultation Paper.
AIFMD
(i) AIFMD Update
AIFMD came into force on the 21st July 2011, and must be transposed into the national law of EU Member States by 22nd July 2013. Its aim is to create a comprehensive and effective regulatory and supervisory framework for alternative investment fund managers within the EU. AIFMD also introduces a passport for the marketing of alternative investment funds within the EU.
AIFMD is subject to a legislative process involving (i) the adoption of the framework Directive by the European Council of Ministers and European Parliament ("Level 1"), which has already entered into force, (ii) technical implementing measures adopted by the Commission and approved by the European Securities Committee, in consultation with the European Parliament, on the basis of advice from ESMA ("Level 2") and (iii) recommendations from ESMA on interpretation to ensure consistent implementation and application ("Level 3").
The Commission released its draft Level 2 Regulation on AIFMD to a restricted circle in late March 2012. The Commission did not adopt ESMA's advice (which was provided to the Commission on the 16th November 2011 by ESMA) on a variety of areas and this has led to a considerable level of commentary which has been released into the public domain. It is likely that the official Level 2 Regulation will be published by the Commission in July 2012.
The Alternative Investment Management Association has published an analysis of the differences it has identified between the Commission's draft Level 2 Regulation implementing AIFMD and the technical advice provided to the Commission last November by ESMA. The note analyses important policy divergences from the ESMA guidance and highlights a number of "unintended consequences" of the changes proposed by the Commission. It is clear that the divergences do not arise as a result of the restatement of technical recommendations into legal language. The note also provides that the differences between the Commission's draft regulation and the ESMA advice seems to be "significant and wide-ranging" in effect. It is interesting to note that the Commission has chosen to implement its Level 2 measures as a Regulation which has direct effect, as opposed to a Directive which would require implementing legislation. The Commission has indicated that this is necessary to ensure a single set of rules applicable throughout the EU without delay.
(ii) ESMA has published a consultation paper on proposed Guidelines on remuneration of alternative investment fund managers (AIFMs)
On the 28th of June 2012, ESMA published a consultation paper on proposed guidelines on remuneration of alternative investment fund managers. The proposed guidelines will apply to managers managing alternative investment funds including hedge funds, private equity funds and real estate funds. These funds will be asked to introduce sound and prudent remuneration policies and structures with the aim of increasing investor protection and avoiding conflicts of interest that may lead to excessive risk taking. ESMA invites comments on the proposals put forward in the paper by the 27 September 2012. Comments should be submitted online at; www.esma.europa.eu under the heading 'Your input –'Consultations'.
MiFID II
In our Legislative Update for Quarter 2 of 2012, we referred to the publishing of legislative proposals by the Commission in October 2011 to amend the Markets in Financial Instruments Directive (2004/39/EC) and its implementing legislation ("MiFID"). The proposals (MIFID II) consist of a Directive and a Regulation. We also summarized the key proposals contained in MIFID II.
The text of MiFID II is now with the European Parliament and the Council of the European Union for discussion. A final agreement between the legislative bodies on the Level I proposals is expected by the end of 2012. Once the Level 1 text has been adopted the Commission will prepare more detailed Level 2 implementing measures, which will supplement the Level 1 framework legislation. It is expected that Level 2 measures will be agreed in early 2014.
The Level 3 Committees (which consist of representatives of national supervisory authorities) will prepare joint interpretation recommendations and guidelines. The Commission will conduct extensive consultations with ESMA, the European Banking Authority (the "EBA") and European Insurance and Occupational Pensions Authority ("EIOPA") and providers/users of financial services before the Commission will issue its advices. The Commission ensures compliance by Member States with legislation and where required, pursues enforcement action.
Implementation of the new measures is not expected until at least 2015.
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