Verband der Auslandsbanken in Deutschland e.V., Interessenvertretung ausländischer Banken, Kapitalanlagegesellschaften, Finanzdienstleistungsinstitute und Repräsentanzen, eingetragen im Register der Interessenvertreter der Europäischen Kommission, Registrierungsnummer 9584080438 | Association of Foreign Banks in Germany, Representation of interests of foreign banks, investment management companies, financial services institutions and representative offices, registered in the European Commission’s Register for Interest Representatives, registration number 9584080438 via email : [email protected]UCITS Product Rules, Liquidity Management, Depositary, Money Market Funds, Longterm Investments 18 October 2012\MS Dear Madam or Sir, We appreciate the opportunity to provide input to the referenced consultation paper. Among our 220 members we represent various investment management companies as well as custodian banks from the EU/EEA and Third Countries operating under the UCITS Directive in Germany. With regard to custody services the market share of our members is around 70 per cent. With respect to our custodian bank members we are particularly concerned by the issue of the de positary passport. Generally speaking, we consider the initiative as a coherent step that comple ments the management company passport. However, special attention must be paid to the fact that an efficient and reasonable introduction of the depositary passport depends on a harmonised legal environment in the EU, which has not been established yet. In particular, the Securities Law Directive which deals with the custody law and common or comparable insolvency laws should be implement ed first. Moreover, since the AIFMD introduces the depositary principle also for nonUCITS, special care must be taken before introducing a passport. The harmonisation of depositary liability and con trol obligations under the AIFMD and the sophisticated accompanying Level 2 measures as well as the UCITS V Directive are a major step toward a depositary level playing field. However, before the effects of the UCITS V and the AIFMD implementation could not have been assessed carefully, the introduction of a depositary passport seems too early. Contact Dr. Martin Schulte Savignystr. 55 60325 Frankfurt T +49 69 9758500 [email protected]www.vab.de The EUROPEAN COMMISSION Directorate General Internal Market and Services FINANCIAL MARKETS Asset Management
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Verband der Auslandsbanken in Deutschland e.V.,·∙ Interessenvertretung ausländischer Banken, Kapitalanlagegesellschaften, Finanzdienstleistungsinstitute und Repräsentanzen, eingetragen im Register der Interessenvertreter der Europäischen Kommission, Registrierungsnummer 95840804-‐38 | Association of Foreign Banks in Germany, Representation of interests of foreign banks, investment management companies, financial services institutions and representative offices, registered in the European Commission’s Register for Interest Representatives, registration number 95840804-‐38
We appreciate the opportunity to provide input to the referenced consultation paper. Among our 220 members we represent various investment management companies as well as custodian banks from the EU/EEA and Third Countries operating under the UCITS Directive in Germany. With regard to custody services the market share of our members is around 70 per cent.
With respect to our custodian bank members we are particularly concerned by the issue of the de-‐positary passport. Generally speaking, we consider the initiative as a coherent step that comple-‐ments the management company passport. However, special attention must be paid to the fact that an efficient and reasonable introduction of the depositary passport depends on a harmonised legal environment in the EU, which has not been established yet. In particular, the Securities Law Directive which deals with the custody law and common or comparable insolvency laws should be implement-‐ed first. Moreover, since the AIFMD introduces the depositary principle also for non-‐UCITS, special care must be taken before introducing a passport. The harmonisation of depositary liability and con-‐trol obligations under the AIFMD and the sophisticated accompanying Level 2 measures as well as the UCITS V Directive are a major step toward a depositary level playing field. However, before the effects of the UCITS V and the AIFMD implementation could not have been assessed carefully, the introduction of a depositary passport seems too early.
Contact Dr. Martin Schulte Savignystr. 55 60325 Frankfurt T +49 69 9758500 [email protected] www.vab.de
The EUROPEAN COMMISSION Directorate General Internal Market and Services FINANCIAL MARKETS Asset Management
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Besides, we suggest reconsidering the scope of assets eligible for UCITS and include direct commodi-‐ty investments. One reason is that in the light of heavily volatile stock markets we do not consider these investments riskier than equities in particular. Another reason is that we believe that future regulation should be open to Islamic funds, which rely on commodity investments as we will explain below.
As a general remark we would like to emphasise that all new rules that are aimed at enhancing inves-‐tor protection must also be assessed under the premise that
― UCITS managers (just like other fund managers) are under high pressure to create attractive yields for their investors. This will get more and more difficult if the eligible asset universe was further limited or complicated, especially since UCITS are the most sophisticatedly regu-‐lated type of fund already;
― costs incurred by new regulatory requirements will also be borne by the investors. This might drive them to rather buying other products.
We hope that our attached position paper is helpful to the Commission at further developing the UCITS Directive.
We would be grateful to discuss these issues with you in a personal meeting.
Kind regards
Dr. Oliver Wagner Dr. Martin Schulte
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Position Paper on UCITS VI
Eligible Assets (Box 1) (1) Do you consider there is a need to review the scope of assets and exposures that are deemed eligible for a UCITS fund?
We do not see a need to reduce the scope of assets deemed eligible. On the contrary, the Commis-‐sion should rather consider extending it to help portfolio managers increasing the performance of UCITS funds. Today the product has a strong reputation for providing safety due to sophisticated regulatory standards but not necessarily for attractive or stable performances.
Especially with regard to the prohibition to directly invest in commodities the current regulation does not seem to reflect the actual risk exposure of this asset class in all aspects. Physical investments are not increasing the risk per se in comparison to investments that reflect the performance of such as-‐sets synthetically. For example, a direct investment saves structuring fees that occur when using cer-‐tificates. Moreover, from a general perspective, the volatility of securities markets is not lower than the volatility of commodities markets and the reason why many UCITS underperformed in the past was that the portfolio management was too focused on equity investments.
There seems to be no obvious reason why direct commodity investments are considered inappropri-‐ate for UCITS investors. Similarly, the prohibition of investing in single commodity indices (as pro-‐posed by ESMA for diversification purposes) does not lower the risk of a UCITS, which may invest in (usually volatile) securities. A rule stipulating that only a certain percentage of the fund’s exposure may be invested in a single commodity or single-‐commodity index would thus be beneficial and ap-‐propriate.
For example, in the growing industry of Islamic funds and in Islamic Finance in general, commodity investments are considered an important tool to reduce investment risks and to protect the investors from losses. This is why any transaction must be asset based. Islamic scholars also emphasise that commodity investments have a direct connection to the “real economy” and thus promote trade and production of goods. Islamic Finance has a long tradition and is not only in Islamic countries consid-‐ered as a particularly ethical approach.
Future regulation should thus reassess the presumptions regarding the usual risk exposure of certain asset classes and allow, for example, for the possibility to invest directly in certain commodities and single-‐commodity indices.
In order to protect investors and to allow for a qualified and informed investment decision, rather than applying a restrictive investment horizon, transparency of the portfolio strategy should be en-‐hanced by increasing the level of disclosure of the investment policy of the UCITS for investors.
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(2) Do you consider that all investment strategies current observed in the marketplace are in line with what investors expect of a product regulated by UCITS?
We have no indication that the current strategies counteract the expectations of investors in terms of a potential need for limitations. From our perspective, investors would rather prefer more invest-‐ment options in order to enhance the fund performance.
(3) Do you consider there is a need to further develop rules on the liquidity of eligible assets? What kind of rules could be envisaged? Please evaluate possible consequences for all stakeholders in-‐volved.
The liquidity rules for UCITS do not need to be extended since they already are quite elaborate. Li-‐quidity requirements are necessary to provide for the option for investors to return their fund units on a daily basis but they reduce the investment options of the fund manager and thus potentially lower the performance of the fund. In any case, future regulation should seek to avoid situations where the fund manager has to sell assets under pressure to comply with liquidity requirements.
(5) Do you consider there is a need to further refine rules on exposure to non-‐eligible assets? What would be the consequences of the following measures for all stakeholders involved:
― Preventing exposure to certain non-‐eligible assets (e.g. by adopting a "look through" approach for transferable securities, investments in financial indices, or closed ended funds).
― Defining specific exposure limits and risk spreading rules (e.g. diversification) at the level of the underlying assets.
As stated above, we strongly recommend reassessing the risks typically attached to certain types of assets based on empirical data. Accordingly, a “look-‐through” approach doesn’t seem appropriate from our perspective. Generally speaking, if such rules were refined and further exposure limits were introduced, the chances for UCITS managers to provide a competitive yield to investors would dimin-‐ish.
(6) Do you see merit in distinguishing or limiting the scope of eligible derivatives based on the pay-‐off of the derivative (e.g. plain vanilla vs. exotic derivatives)? If yes, what would be the conse-‐quences of introducing such a distinction? Do you see a need for other distinctions?
In our view such merit is not visible. In any case, it is essential that the UCITS manager (and the de-‐positary) do understand the derivative contracts entered into for the fund. To our knowledge, there is no general assumption or empiric evidence that plain vanilla derivatives contain higher risks than exotic derivatives. On the contrary, we see a merit in the possibility for UCITS managers to choose the derivatives that fit best into the investment strategy of the fund. And furthermore, simplicity does not always mean less risk.
(8) Do you consider that the use of derivatives should be limited to instruments that are traded or would be required to be traded on multilateral platforms in accordance with the legislative pro-‐posal on MiFIR? What would be the consequences for different stakeholders of introducing such an obligation?
We do not consider such limitation necessary. The forthcoming rules on derivatives will require cer-‐tain types of derivatives to be traded on multilateral platforms or intermediated by CCPs with sup-‐plementary margin obligations. But not every derivative will and can be traded on a multilateral plat-‐form which does not allow the conclusion that these derivatives are riskier than platform traded de-‐
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rivatives. Where a UCITS manager decides to use types of derivatives, which are not part of MiFIR or must not be cleared by a CCP, the limitations already in place still provide sufficient investor protec-‐tion. Most importantly, future regulation should not increase hedging costs or limit hedging possibili-‐ties for UCITS managers.
OTC Derivatives (Box 3) (1) When assessing counterparty risk, do you see merit in clarifying the treatment of OTC deriva-‐tives cleared through central counterparties? If so, what would be the appropriate approach?
In terms of risk assessment OTC derivatives that will be cleared through a CCP we consider it essen-‐tial that exposure to CCPs should not be taken into account at calculating counterparty limits under Article 52(1) of the UCITS IV Directive. EMIR’s primary objective is to eliminate counterparty risk at OTC transaction. Further protection seems unnecessary.
(2) For OTC derivatives not cleared through central counterparties, do you think that collateral requirements should be consistent between the requirements for OTC and EPM transactions?
The risk measures applied at CCP cleared transactions under EMIR are quite elaborate. Applying measures that exceed such requirements seems thus unnecessary.
(3) Do you agree that there are specific operational or other risks resulting from UCITS contracting with a single counterparty? What measures could be envisaged to mitigate those risks?
From our perspective there are no specific or enhanced operational or other risks resulting from UCITS contracting with a single counterparty. Since the counterparty risk must be reduced to a max-‐imum of 10% by the provision of appropriate collateral, proper collateral management is essential in this regard. Although counterparty diversification might reduce default risks, operational complexity increases from dealing with several counterparties. Since in the case of OTC derivatives the risk of a counterparty default is already mitigated by EMIR, an important step has been made already. We do not see a need for further risk mitigation. However, to further enhance investor protection, a UCITS prospectus should clearly state all risks attached to contracting with a single counterparty including the principles of the collateral management including its realisation.
(4) What is the current market practice in terms of frequency of calculation of counterparty risk and issuer concentration and valuation of UCITS assets? If you are an asset manager, please also provide information specific to your business.
(5) What would be the benefits and costs for all stakeholders involved of requiring calculation of counterparty risk and issuer concentration of the UCITS on an at least daily basis?
We support regulation that stipulates the valuation of assets provided as collateral on a daily basis and a regular reconciliation between both counterparties. Such procedures ensure that the amount of collateral is appropriately adjusted with the risk of counterparty default. Moreover this would avoid initial over-‐collateralization that causes unnecessary and costly immobilization of assets, which could be used for other purposes.
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(6) How could such a calculation be implemented for assets with less frequent valuations?
We support the approach in the ESMA guidelines regarding collateral, i.e. that the same rules apply for collateral in EPM techniques and in OTC derivatives.
Depositary Passport (Box 5) (1) What advantages and drawbacks would a depositary passport create, in your view, from the perspective of: the depositary (turnover, jobs, organisation, operational complexities, economies of scale …), the fund (costs, cross border activity, enforcement of its rights …), the competent au-‐thorities (supervisory effectiveness and complexity …), and the investor (level of investor protec-‐tion)?
First of all, an advantage would be that the market for depositary services would become more com-‐petitive and depositary services could be offered in Member States that currently do not have estab-‐lished depositary structures without creating significant supplementary costs for companies provid-‐ing depositary services in the EU financial centres. Gaps in the quality of depositary services or differ-‐ent standards would rather vanish.
On the other hand, a significant drawback would arise because the entities operating under the passport would still have to cope with different civil law regimes in the Member States. This might level some or a large amount of the cost benefits mentioned in the previous paragraph. Especially in the event of a depositary’s default the situation would be much more complicated than today.
It cannot be taken for granted that cost savings would be triggered by a depositary passport consid-‐ering that often the current operating models are already based on a delegation of functions associ-‐ated with the safekeeping of securities to entities located outside the fund’s domicile, which means that fund investors are already benefiting from cross-‐border operation models. Accordingly, a pass-‐port will not significantly modify existing practices, also because a complete standardisation of oper-‐ating models is impossible as long as national legal and regulatory particularities exist. UCITS are sub-‐ject to national corporate, securities and commercial laws and the implementing laws of the Di-‐rective. This means that the details of oversight and custody duties remain subject to local rules and their interpretation.
A successful implementation of a passport depends on common supervisory practices and a uniform civil law framework across all Member States that is apt to ensuring the same level of protection for all investors in the EU and avoiding regulatory arbitrage.
(2) If you are a fund manager or a depositary, do you encounter problems stemming from the regu-‐latory requirement that the depositary and the fund need to be located in the same Member State? If you are a competent authority, would you encounter problems linked to the dispersion of supervisory functions and responsibilities? If yes, please give details and describe the costs (finan-‐cial and non-‐financial) associated with these burdens as well as possible issues that a separation of fund and depositary might create in terms of regulatory oversight and supervisory cooperation.
From the perspective of fund managers and retail investors’, we believe that a local depositary pro-‐vides the best possible level of investor protection because of expertise in local laws regulatory prac-‐tises and specifics of business models of managing companies including personal relations. Finally, according to our perception, depositaries have not encountered problems regarding the current re-‐quirement of being in the same jurisdiction as the fund.
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(3) In case a depositary passport were to be introduced, what areas do you think might require further harmonisation (e.g. calculation of NAV, definition of a depositary's tasks and permitted activities, conduct of business rules, supervision, harmonisation or approximation of capital re-‐quirements for depositaries…)?
We believe that further harmonisation is needed regarding the NAV calculation and potentially also regarding the details of the depositary's specific tasks and permitted activities, conduct of business rules and supervision. As mentioned above, securities law including the notion of ownership as well as capital requirements for depositaries would require further harmonisation. The management company passport might serve as a role model since it covers subjects that would be equally relevant to depositaries. These are procedures and organisation, resources (legal and regulatory expertise with respect to the host country of the UCITS), control by the senior management and the superviso-‐ry function, compliance and audit functions, conduct of business rules and conflicts of interest.
(4) Should the depositary be subject to a fully-‐fledged authorisation regime specific to depositaries or is reliance on other EU regulatory frameworks (e.g., credit institutions or investment firms) suf-‐ficient in case a passport for depositary functions was to be introduced?
The successful operation of a depositary especially requires IT resources and appropriate capitalisa-‐tion combined with qualified staff having the expertise to effectively avoid losses and consequential liability. Relying on the respective rules in the Banking Directive and the CAD seems appropriate in this respect.
It is however important for the introduction of the depositary passport to establish full harmonisa-‐tion of the specific types of entities that could operate as depositary. Due to the important function of depositaries and their liability, only sophisticatedly regulated and highly capitalized entities should thus be authorised.
(5) Are there specific issues to address for the supervision of a UCITS where the depositary is not located in the same jurisdiction?
The AIFM and UCITS V Directives clarify and harmonise the depositary functions within the EU signifi-‐cantly, esp. with regard to the safekeeping functions and cash monitoring. The goal of the partly not yet finalised regulation should however be to eliminate all gaps in the liability regime and the eligibil-‐ity criteria defining which entities can carry out depositary functions for UCITS and AIFs. Only if har-‐monisation in these last two aspects plus in the relevant corporate and other civil laws was achieved, the passport could work in practice. Also with a view to the still on-‐going discussions of UCITS V, we believe that extending the eligibility criteria for entities to carry out depositary functions should be considered with due care. Stability could best be achieved if all depositaries would be subject to the Banking Directive, the CAD or MIFID.
Apparently, a UCITS fund is not only subject to financial regulation but also to nationally diverging corporate, securities and commercial laws. This is particularly relevant to the oversight duties, some aspects of the custody function and the NAV calculation. While the passport may create advantages in terms of rationalisation and competitiveness, drawbacks from a lack of harmonisation in these fields should be avoided with regard to investor protection, supervision and dialogue with local au-‐thorities including information reporting, eligibility criteria and capital requirements. As we have previously expressed, the fundamental principle for the success of the passport is the achievement of common supervisory practices and a common regulatory framework throughout the EU to ensure a harmonised approach to investor protection. This would also help to ensure that regulatory arbitrage is eliminated.
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We are in favour of a clear hierarchy of controls and supervision that clarifies which authority carries out supervisory functions especially in the event of a default or other crisis situation. Without effi-‐cient cross-‐border coordination of custody and harmonised insolvency and securities laws which ensure that investors can rely on foreseeable procedures especially in a crisis situation, a depositary passport should not be introduced.
