COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) as regards depositary functions, remuneration policies and sanctions
Date: 2012-07-03
Institutions: European Commission
Subjects: administrative sanction, approximation of laws, bank deposit, financial legislation, investment company, market access, market supervision, remuneration of work, right of establishment, securities, venture capital

EUROPEAN COMMISSION 

Strasbourg, 3.7.2012  
SWD(2012) 186 final 

COMMISSION STAFF WORKING DOCUMENT 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the document 

Proposal for a  
DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

amending  
Directive 2009/65/EC on the coordination of laws, regulations and administrative 
provisions relating to undertakings for collective investment in transferable securities 
(UCITS) as regards depositary functions, remuneration policies and sanctions 

{COM(2012) 350 final} 
{SWD(2012) 185 final} 

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COMMISSION STAFF WORKING DOCUMENT 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the document 

Proposal for a  
DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 

amending  
Directive 2009/65/EC on the coordination of laws, regulations and administrative 
provisions relating to undertakings for collective investment in transferable securities 
(UCITS) as regards depositary functions, remuneration policies and sanctions 

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1. 

PROBLEM DEFINITION  

The problem 

European rules on depositaries that act on behalf of collective investment schemes, contained 
in  the  Directive  on  undertaking  for  the  collective  investment  in  transferable  securities 
("UCITS"),  have  remained  unchanged  since  their  introduction  in  1985.  The  financial  crisis, 
notably the Madoff affair that came to light on 11 December 2008, has exposed weaknesses in 
the UCITS rules on the duties and liability of depositaries.  

The Madoff case raised in particular the issue of the liability of a depositary where custody of 
a UCITS fund's assets is delegated to a sub-custodian. In the Madoff case, national courts in 
different  Member  States  took  different  approaches  when  deciding  whether  the  principal 
custodian of a UCITS fund was liable for the return of fund assets that were lost while held in 
sub-custody.  

In addition, the harmonised UCITS framework lacks general principles on remuneration and 
on sanctions consistent with other areas of the financial services. 

Who is most affected?  

The investment fund industry is a vital part of the EU financial sector. The success of UCITS 
as a cross-border vehicle for investments is borne out by the rapid growth of assets managed 
in  UCITS  funds.  Total  assets  under  management  (AuM)  grew  from  €3,403bn  at  the  end  of 
2001 to €5,889bn by 2010. In September 2011 AuM stood at €5,515bn. This development is 
in part due to the UCITS Directive's harmonized rules on collective investment schemes that 
establish a European capital market for the free circulation of investment fund products that 
comply with the UCITS standard. The evolution of the UCITS rules is therefore important for 
the development of an integrated market that allows the cross-border sales of UCITS. 

The target group most affected when assets held in custody are lost are retail investors. If the 
principal  custodian  is  not  liable  for  the  return  of  assets  lost  in  custody,  the  loss  is  borne  by 
investors. On average, 10% of European households invest directly in funds: Germany (16%), 
Italy (11%), Austria (11%), France (10%), Spain (7%), United Kingdom (6%).  

Another  group  affected  by  the  loss  of  assets  is  the  manager  of  a  UCITS  fund.  The  fund 
manager needs clarity as to the scope of a depositary's liability for the loss of custodial assets, 
especially when this loss occurs while the assets are held in custody at a sub-custodian. Sub-
custody  is  an  increasingly  wide-spread  phenomenon  as  UCITS  managers  invest  in  a  wide 
range  of  financial  instruments  (stock,  bonds,  debt  instruments,  money  market  instruments, 
shares or units in other invest funds, etc.) that are often issued in other Member States or third 
countries.  For  practical  reasons  and  sometimes  on  account  of  legal  requirements,  these 
instruments have to be kept in custody in the country where they are issued. Sub-custody has 
therefore important implications for a fund manager's investment decisions. 

Finally,  depositaries  and  their  delegation  practices  will  be  affected.  Even  large  global 
custodians do not have custody operations of their own across all of the jurisdictions in which 
a UCITS manager might seek to invest. No single custody bank is believed to have operations 
in  more  than  40  jurisdictions.  Custody  is  often  "outsourced"  therefore  to  sub-custodians 

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operating  in  jurisdictions  not  covered  by  a  global  custodian's  network.  The  conditions  that 
govern such delegation are core issues affecting depositaries.  

2. 

ANALYSIS OF SUBSIDIARITY  

Necessity  

National approaches on the issue of the duties and liability of depositaries, especially where 
safekeeping  is  delegated,  have  created  an  uneven  level  of  consumer  protection,  as  made 
particularly evident following the Madoff case.  

In  particular,  national  rules  diverge  on  the  conditions  applying  where  safekeeping  is 
delegated.  In  addition,  differences  exist  over  the  on-going  duties  of  a  depositary  to  monitor 
sub-custodians and, most importantly, the liability of the depositary for loss of assets held in 
sub-custody.  While  some  national  courts  oblige  the  depositary  to  return  instruments  lost  in 
sub-custody, others make this obligation contingent on a failure to perform due diligence and 
oversight duties. 

Added value 

Differences  in  the  implementation  of  high-level  principles  within  the  UCITS  Directive  on 
delegation,  and  in  particular  on  the  liability  of  depositaries,  undermine  investor  confidence, 
especially where UCITS are sold cross-border. Only action at European level can address this 
issue effectively and introduce harmonised standards, both in relation to a depositary's duty of 
care in selecting and overseeing a sub-custodian and in relation to its liability for assets lost in 
custody.  

3. 

OBJECTIVES OF EU INITIATIVE 

Existing  'high  level'  UCITS  rules  allow  for  considerable  inconsistencies  amongst  national 
authorities  in  interpreting  duties  of  care  and  liability  in  case  of  their  breach.  More  detailed 
rules on delegation and liability are necessary to reduce such inconsistencies. This concerns in 
particular: (1) the permitted scope of delegations; (2) the conditions covering delegations; and 
(3)  the  system  of  liability  that  applies  when  instruments  in  custody  are  lost,  either  at 
depositary level or at the level of the sub-custodian.  

General objective 

Increase protection and transparency for all UCITS investors. 

Specific objectives 

Standards  of  investor  protection  should  be  uniform:  depositaries,  subject  to  consistent 
prudential  and  capital  requirements,  should  ensure  the  same  level  of  protection  of  assets  in 
custody, independent of their domicile.  

Redress  against  depositaries  for  loss  of  a  financial  instrument  should  be  consistent  and 
effective:  uniform  standards  of  care  and  uniform  rules  on  liability  should  avoid  lengthy 
litigation and inconsistencies in outcomes depending on the domicile of the depositary.  

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Legal  certainty  in  relation  to  depositaries'  duties  in  respect  of  safekeeping  and  delegation: 
allow  the  industry  to  adapt  to  a  uniform  standard  and  make  the  necessary  arrangements  in 
their organisational structures/business models.  

Operational objectives 

These are to: 

(1) harmonise criteria on eligibility to act as depositary;  

(2) introduce a uniform rules on delegation of safekeeping;  

(3) introduce a uniform level of depositaries' liability for the return of an instrument lost in the 
course of custody; and  

(4) introduce a uniform level of liability for cases when the loss occurs at the level of the sub-
custodian.  

In  line  with  the  objective  of  enhancing  investor  confidence  and  transparency,  the  other 
operational objectives related to remuneration and sanctions are: introducing rules to ensure 
remuneration does not contribute to risks, by ensuring remuneration practices are transparent 
and sound; and introducing a uniform UCITS sanctioning regime.  

4. 

POLICY OPTIONS  

The baseline scenario relating to the tasks and liability of depositaries is the existing UCITS 
framework.  The  general  principles  of  the  UCITS  rules  would  remain  in  place,  leaving 
significant discretion on the level of duties and liability to national authorities, who would be 
responsible  for  ensuring  investor  protection  and  confidence,  especially  when  making  cross-
border investments with funds domiciled in other Member States.  

Against this baseline, the impact assessment assesses different options in relation to three core 
issues:  (1)  eligibility  to  become  a  UCITS  depositary;  (2)  the  conditions  that  apply  in  case 
safekeeping  is  delegated;  and  (3)  the  scope  of  a  depositary's  liability,  in  particular  the 
obligation to return financial instruments that are lost in custody.  

On eligibility to act as a depositary, three options emerged, identifying different institutions 
that are deemed to provide sufficient guarantees in terms of prudential regulation and capital 
requirements  to  fulfil  the  task  of  safekeeping  assets  and  ensuring  their  return  in  case  of  a 
custodial loss.  

On  the  issue  of  delegation  of  custody,  three  options  were  assessed:  (1)  the  baseline;  (2) 
introducing diligence and prudential requirements to cover delegations, including special rules 
on  delegations  to  non-compliant  third  country  custodians  and  (3)  introducing  the  same 
diligence and prudential requirements for all delegations.  

On the issue of liability, the impact assessment examined four options: (1) limiting liability to 
'unjustifiable  failures  to  act'  (the  baseline);  (2)  introducing  strict  liability  with  an  option  to 
discharge  liability  in  case  of  delegations;  (3)  introducing  strict  liability  with  the  discharge 
option limited to mandatory delegation to third country custodians; and (4) introducing strict 
liability with no option of discharge in case of delegations.  

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In  relation  to  remuneration,  the  baseline  was  compared  with  an  option  requiring  UCITS 
management  companies  to  have  general  principles  on  remuneration  in  place  and  an  option 
required detailed remuneration policies coupled with disclosure of actual remunerations paid 
in the annual report.  

In relation to administrative sanctions, the baseline was compared to an approach harmonising 
sanctions in a general manner, as set out in Commission policies in this area, and an option of 
further harmonisation of administrative sanctions.  

5. 

ASSESSMENT OF IMPACTS 

On  eligibility  to  act  as  a  depositary,  the  impact  assessment  concludes  that  both  credit 
institutions  and  regulated  investment  firms  provide  sufficient  guarantees  in  terms  of 
prudential  regulation,  capital  requirements  and  effective  supervision  to  act  as  UCITS 
depositaries.  As  most  UCITS  depositaries  in  almost  all  Member  States  are  already  credit 
institutions  or  regulated  investment  firms,  the  burden  of  adapting  is  estimated  to  be  rather 
low. The impact of the chosen option would thus only concern a small minority of unlicensed 
service providers. In these cases, the cost of seeking a license as an investment firm appears 
justifiable given the benefits in case of depositary liabilities.  

On  delegations,  the  impact  assessment  concludes  that  delegations  should  be  subject  to  high 
quality standards in terms of selection and on-going monitoring of the sub-custodian. These 
duties should be incumbent on the principal custodian. In terms of third countries, delegations 
should be allowed to non-compliant custodians, so long as local custody is mandated by law 
and  so  long  as  investors  are  duly  informed  that  investments  in  certain  jurisdictions  may 
require  local  custody.  The  option  of  not  allowing  third  party  delegations  to  non-compliant 
custodians  was  discarded  as  this  would  reduce  the  investment  opportunities  available  to 
UCITS funds. Furthermore, the risk of delegation to non-compliant third party custodians was 
considered  negligible  given  the  current  preponderance  of  conservative  investment  strategies 
pursued by UCITS funds. As and if investment strategies evolve, this choice may need to be 
reviewed.  

With  respect  to  liability,  the  impact  assessment  concludes  that  a  'strict  liability'  standard 
obliging depositaries to return instruments lost in custody irrespective of fault or negligence is 
both  conducive  to  ensuring  a  high  level  of  investor  protection  and  to  achieving  a  uniform 
standard  across  the  EU.  While  there  are  strong  arguments  to  'carve  out'  losses  that  arise  in 
case of a mandatory delegation to a third country custodian, the impact assessment concludes 
that, in light of the retail orientation of UCITS funds, that there should be no such 'carve out'.  

6. 

SUMMARY OF RETAINED OPTIONS 

The  preferred  option  is  to  limit  eligibility  to  become  a  UCITS  depositary  to  either  a  credit 
institution  or  a  regulated  investment  firm.  Delegations  should  be  governed  by  rules  on  due 
diligence in selecting, appointing and monitoring the activities of the sub-custodian. For the 
rare  case  in  which  a  UCITS'  investment  strategy  would  involve  investing  in  financial 
instruments issued in countries that require mandatory local custody and where no custodian 
operates  that  could  comply  with  the  above  delegation  requirements,  delegation  should  be 
allowed under strict circumstances.  

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In  line  with  the  retail  investor  profile,  liability  in  case  of  the  loss  of  an  instrument  held  in 
custody should be based on a uniform EU standard entailing an obligation to return the lost 
instrument at the cost of the principal custodian. There should be no option for the principal 
custodian  to  discharge  liability,  even  in  cases  where  local  custody  is  mandatory  in  a  third 
country.  

In  relation  to  remuneration,  the  approach  follows  that  taken  with  respect  to  AIF  managers. 
This  avoids  regulatory  arbitrage  between  the  UCITS  and  the  AIFMD  frameworks.  On 
sanctions general Commission policy in this area is followed.  

7. 

MONITORING AND EVALUATION 

Monitoring  and  evaluation  will  take  place  on  two  levels.  First,  the  Commission  will  ensure 
that  the  reformed  rules  are  implemented  correctly.  In  a  second  phase,  three  years  after  the 
deadline of full implementation for the Directive, the Commission will proceed to conduct an 
economic  evaluation  of  whether  the  new  rules  have  increased  investor protection, enhanced 
transparency  on  remuneration  and  have  fostered  investor  confidence  necessary  for  the 
continued relevance of the UCITS retail brand.  

The  economic  evaluation  shall  be  performed  on  the  basis  of  the  objectives  identified  in 
section 3.  

The evaluation shall be carried out by the Commission's services, in cooperation with ESMA 
and/or with the aid of external studies as may be necessary to assess the impact of changes to 
delegation and liability schemes for depositaries.  

For  the  purpose  of  evaluating  the  effects  of  the  amendments  and,  more  importantly,  of 
gathering  essential  data  on  the  impact  of  some  of  the  proposed  measures  on  the  depositary 
industry, further fact-finding with all relevant stakeholders is likely.  

The review shall concentrate its attention, in particular, on the extent to which expected cost 
savings deriving from a clearer and harmonised liability regime for depositaries are realised; 
possible  impacts  of  new  delegation  and  liability  rules  may  have  on  depositary’s  operating 
costs;  an  assessment  of  the  extent  to  which  delegations  to  non-compliant  third  country 
depositaries  have  occurred  and  the  impact  of  these;  and  an  estimate  of  the  impact  of  any 
incremental operating costs on UCITS fund costs and returns for investors.  

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