The ESMA Q&A on the application of the UCITS Directive was updated on July 23rd 2018 with four new questions and answers, one of them being a new section X on Depositary.
The question was raised whether netting and hedging arrangements can be taken into account for the purposes of calculating issuer concentration limits pursuant to Article 52 of the UCITS Directive? ESMA states that only netting arrangements in accordance with the definition and conditions set out in the guidelines on Risk Measurement and the Calculation of Global Exposure and Counterparty Risk for UCITS (Ref. CESR /10-788) may be taken into account when calculating issuer concentration limits.
UCITS investing in other UCITS with different investment policies
ESMA has clarified that the prospectus of a UCITS should clearly disclose whether in case of fund of fund investments, the target fund(s) have different investment strategies or restrictions. Where the fund rules or articles of incorporation and prospectus (“Fund Documents”) of a UCITS expressly rule out certain types of assets or derivative use without any reservations, UCITS management companies/self-managed investment companies should carry out proportionate due diligence to ensure that fund of fund investments does not result in a circumvention of the investment strategies or restrictions set out in the Fund Documents of the investing UCITS.
Supervision of branches
ESMA has clarified that, under both the UCITS and the AIFM Directive, the supervisory powers of competent authorities in relation to branches of UCITS management companies or alternative investment funds managers (“AIFMs”) established in a Member State that is not the home Member State are shared. The competent authority of the Member State in which the branch is located (the host Member State) is responsible for supervising the branch’s compliance with conduct rules referred to in Article 17(5) of the UCITS Directive and Article 45(2) of the AIFM Directive, while the competent authority of the Member State in which the UCITS management company or the AIFM is established (i.e., the home Member State) is responsible for supervising the other requirements provided under the relevant applicable framework.
Neither the UCITS Directive nor the AIFM Directive provides for an explicit framework for the allocation of supervisory responsibilities and powers for those cases where UCITS management companies or AIFMs are authorised to carry out investment services set out in Article 6(3) of the UCITS Directive and Article 6(4) of the AIFM Directive and have branches providing those services in other Member States. ESMA takes the view that responsibilities of home and host Member States should be identified similarly to, and consistently with, the general framework established for the provision of activities pursued by UCITS management companies and AIFMs through branches as well as with the MiFID II framework regulating the supervision on the provision of investment services across the EU. Under Article 35(8) of MiFID II, the competent authority of the host Member State is responsible for ensuring that the services provided by the branch of an investment firm or a credit institution in its territory comply with the MiFID II requirements under Articles 24 (General principles and information to clients) and 25 (Assessment of suitability and appropriateness and reporting to clients) of MiFID II, which also apply to UCITS management companies and AIFMs providing investment services.
Section X Depositary
Depositaries as counterparties in a transaction of assets that they hold in custody
According to Article 22(7) of the UCITS Directive the depositary (or any third party to which the custody function has been delegated) shall not reuse the assets they hold in custody for their own account. Does this provision imply that a depositary (or delegated third party) should never act as a counterparty in a transaction of assets that they hold in custody (including, but not limited to, transfer, pledge, sale and lending of those assets)?
The answer is no. A depositary (or a delegated third party) should be able to act as a counterparty in a transaction of assets that they hold in custody, provided that (i) the four conditions under Article 22(7)(a) to (d) of the UCITS Directive are complied with, and (ii) conflicts of interest are properly managed and (ii) the transaction is conducted on an arm-length basis.