Luxembourg: New CSSF Circular 16/644 On UCITS Depositary Bank Duties

On 11 October 2016, the Commission de Surveillance du Secteur Financier ('CSSF') published the CSSF Circular 16/644 (the 'New Circular') which is a revised set of rules of the former CSSF Circular 14/587 ('Circular 14/587'). The New Circular repeals and replaces Circular 14/587.

The New Circular is addressed to Luxembourg credit institutions acting as depositary banks for UCITS and to all Luxembourg UCITS and managements companies acting for these UCITS. It includes clarifications of the regulatory requirements contained in the Law of 17 December 2010, as amended (the 'Law of 2010') and by the Commission Delegated Regulation (EU) 2016/438 (the 'Regulation'). The New Circular also clarifies the regulatory framework applicable to depositary banks for UCITS by adding new definitions and requirements and confirming the vast majority of the rules previously detailed in Circular 14/587.

The safekeeping of assets

The New Circular clarifies and confirms that the cash has to be considered as part of the other assets and not the financial instruments to be held in custody. Hence depositary duties relating to cash are to be in line with those relating to other assets.

Designation of a credit institution as depositary for UCITS

The provisions of the New Circular relating to the procedure and criteria to be fulfilled by a credit institution to act as a depositary remain substantially the same as under Circular 14/587.

The New Circular however details the information that shall be submitted to the CSSF to enable their assessment of the substance of the entity, and stresses that the CSSF analysis will mainly be based on the delegation and operational model adopted by the credit institution.

The New Circular also states that an additional approval from the CSSF is only required in case of fundamental change in the elements of the initial approval, such as changes in the delegation or operational model.

Clarification of strategic definitions

The New Circular provides a clear distinction between 'delegation' and 'outsourcing' of activities. 'Delegation' refers to the safekeeping activities entrusted to a third party whereas 'outsourcing' refers to the complete or partial transfer of operational tasks from the depositary to a third party, which may be part of the same group. Only the delegation of safekeeping duties may be named 'delegation' under the regime of the New Circular.

Further to the split between 'delegation' and 'outsourcing', the New Circular introduces another layer of distinction between the outsourcing of a 'material activity' and of a 'non-material activity'. According to the New Circular, a 'material activity' is considered as such when the incorrect or non-performance of the activity reduces the compliance of the depositary with regulatory requirements or prevents the depositary to continue performing its duties, as well as any activity being necessary to the proper risk management of the depositary. Prior authorization of the CSSF is required for the outsourcing of a material activity.

Additional guidance relating to the depositary agreement

In compliance with the Regulation, the New Circular provides additional guidance in relation to the information to be included in the depositary agreement signed between the parties.

It confirms that for a UCITS set up as an investment company (i.e. SICAV) and having appointed a management company, the depositary agreement may be a tripartite agreement between the UCITS, the depositary and the management company, notably to ease the mandatory exchange of information between the depositary and the management company.

The depositary agreement has now to be supplemented by a mapping table evidencing that all the requirements of the Article 2.2 of the Regulation are covered by the agreement, which will be sent to the CSSF on an annual basis.

In accordance with the Regulation, the New Circular specifies that the depositary agreement must include a clause relating to the applicable law which is, in any case, the Luxembourg law. It is recommended to also add a clause stating that any dispute in relation to the depositary agreement is subject to the exclusive jurisdiction of the Luxembourg courts.

The New Circular adopts a pragmatic and flexible approach and confirms the possibility to only disclose the main principles of the escalation procedure in the depositary agreement while the details of the procedure are disclosed in documents such as a service level agreement or an operating memorandum agreed between the parties of the depositary agreement.

The depositary's right of pledge on the assets of the UCITS is confirmed by the New Circular. Therefore, the depositary may, on condition of the inclusion of specific contractual provisions in the depositary contract and subject to certain exceptions, benefit from a general or specific pledge on the assets of the UCITS on deposit.

The specific provisions applicable in case of termination of a depositary agreement have been amended. Should a depositary agreement be terminated without the appointment of a new depositary before the end of the notice period applicable to the termination, particular custody arrangements relating to the assets of the UCITS must  be put in place with due consideration of the interest of the investors and the UCITS must inform the CSSF accordingly.

Delegation framework

The New Circular clarifies the delegation regime applicable to the depositary.

Firstly, the New Circular adds a new definition of 'delegate' and states that it refers to any third party appointed by the depositary to which the depositary delegates its safekeeping duties. There is no reference to 'sub-custodians' or 'third-party custodians' anymore and both of them are now referred to as 'delegate'.

After specifying the possibility for a UCITS to delegate the asset management function to an entity linked to the depositary by a common management or control under specific conditions, the New Circular was reworked to only present general delegation rules applicable to the depositary. Contrary to Circular 14/587, there is no further reference to particular rules applicable to the delegation of activities within the depositary group (points 163 and 164 of Circular 14/587) and to IT outsourcing (point 165 of Circular 14/587). Similarly, the New Circular does no longer focus on rules applicable to specific situations such as the particular case of the concentration of the deposit of assets of a UCITS with a limited number of third parties or with a single third party. Therefore, these particular situations will now be addressed under the general delegation rules stated in the New Circular.

Using the specificities of collateral management as an illustration, the New Circular adds a general right for the depositary to refuse any third party acting as delegate of safekeeping functions chosen and appointed by the UCITS.

Governance relating to the assets of a UCITS

The New Circular confirms the application of the set of rules relating to diligence and segregation, and corroborates the approach adopted by Circular 14/587 regarding the segregation duties of the depositary and its delegates as well as the use of 'omnibus account'.

An important change in the New Circular refers to the prime broker. The reference to the latter as well as any related rules have been removed from the New Circular. That implies that in case of appointment of a prime broker general rules mentioned in this circular, the Law of 2010 and/or the Regulation will be applicable.

Amendment of the Annex 1

The New Circular has also amended the Annex 1 – where information to be reported to the CSSF is listed – by removing the obligation to send both the annual auditor report on the adequacy of the depositary's organization and the annual description of the compliance section.

No further guidance on independence and UCI governed by Part II of the Law of 2010

Although it was awaited by stakeholders, the Luxembourg regulator does not take the opportunity of the revised set of rules of the New Circular to provide additional guidance on independence rules applicable to the management company and the depositary nor on the specific depositary regime applicable to UCI governed by Part II of the Law of 2010..

All parties to which the New Circular is addressed had to comply with the requirements by 13 October 2016.

The New Circular (only in French) is available under the following web link.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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