UCITS V – An overview from the Swedish perspective

Introduction
An overview of UCITS V

The UCITS Directive, which dates back to 1985, has been amended several times and was recast in 2009 (the UCITS IV Directive). The latter directive was later amended through a new directive in 2014.
The UCITS V Directive (UCITS V) entered into force on 17 September 2014 and must be implemented into Swedish law on 18 Mars 2016.

The main purpose of UCITS V is to increase investor protection and to harmonise the rules for management companies with the rules that apply in other parts of the financial markets in certain aspects. The rules aim to clarify the responsibilities of depositaries and to impose rules regarding remuneration and sanctions similar to those that other types of financial actors already face. Implementation of these rules into Swedish law will be described below.

The Swedish procedure for implementing the UCITS V Directive

In October 2014 a public commission (“the Inquiry”) was tasked with investigating the need for necessary changes in the existing Swedish UCITS Act (2004:46) (Swe. lagen om värdepappersfonder) as a consequence of UCITS V. The work and the conclusions of the Inquiry have thereafter been submitted to a number of respondents for consideration. The suggestions by the Inquiry and the submitted opinions from organisations and authorities serve as the basis for a government bill, which in turn will serve as the proposal for a decision by the parliament.

The Inquiry presented the results of its work on implementation of UCITS V this summer. No bill has yet been published. Consequently for the purposes of this article we can only rely on the proposals from the Inquiry. UCITS V includes rules for which the Inquiry has no suggestions for implementation into Swedish law. The reasons vary; in some cases, the rules have already been implemented (see section 6), while in others the Inquiry found that the rules should be implemented through other types of legal acts. The rules in UCITS V that require the relevant authority to have effective procedures to receive and follow up on notifications of breaches by management companies or by depositaries are an example of the latter. The Inquiry concluded that such rules should not be implemented through law, but instead through a regulation issued by the government.

Remuneration and information regarding remuneration

UCITS V contains rules about remuneration that the Inquiry has proposed for incorporation into the Swedish UCITS Act.

According to the proposal, management companies must have a remuneration system that encourages sound and effective risk management. The term ‘remuneration system’ includes an actual written policy, as well as its application in practice. According to the Inquiry, the remuneration system may not conflict with the risk profile of the managed funds, or any other document that regulates the operations of the management company.

However, having such a system is not sufficient. The management company must also inform its stakeholders about this system through the prospectus, through a reference in the KIID-documentation, and through detailed information in the financial statements.

Duties and liabilities of depositories
Generally

One of the main objectives of UCITS V is to provide more detailed regulation of depositaries in response to their increased significance to the financial industry. The Inquiry suggests that these new rules should be implemented into Swedish law.

UCITS V stipulates that a management company is obliged to appoint one, and only one, depositary for each fund that the management company manages. The depositary must act honestly, fairly, professionally, independently and solely in the interest of the unit holders and the fund. Beside these general rules, the Inquiry suggests specific rules regarding  the duties of the depositary as stipulated in the rules in UCITS V.

Duties of the depositary

The depositary must hold deposit operations separate from any other operations or activities that might conflict with the interests of the management company, the fund or the unit holders. According to the Inquiry, the management company must first assess whether the depositary fulfils these obligations prior to hiring a depositary. The unit holders must be informed about any conflicts of interests.

The depositary is also responsible for monitoring the cash flow of the fund and is obliged to adhere to some specific rules about actual custody holding and to register the fund assets in a separate account. A list of all fund assets must be provided to the management company on a regular basis. The depositary must specifically ensure that payments made by investors for investments in the fund are booked in a settlement account used solely for that fund.

According to the proposal, the depositary is also obliged to hold in custody all financial instruments of the fund and to ensure the management company´s, on behalf of the fund, proprietorship of other assets of the fund and to keep an updated register of those assets.

Outsourcing

The right of the depositary to outsource functions that the management company has engaged it to perform is strictly limited to certain specific duties, and may only be permitted under certain conditions.

Outsourcing to an agent may take place only if the depositary can show that there is an objective reason for doing so, and that there is no intention to supersede the Swedish UCITS Act. The depositary must also, on a regular basis, supervise the agent and the agent´s procedures with respect to outsourced activities. The depositary shall also make sure that the agent i.a. has the structure and relevant knowledge that is needed for the assignment, and that the agent follows general rules, such as those related to handling conflicts of interests.

Some duties carried out by others, however, are not to be regarded as duties for which the depositary is required to apply the rules on outsourcing. Utilisation of clearing and liquidation are examples of such duties.

Furthermore, the agent may sub-outsource functions if all conditions related to outsourcing by the depository are met.

Loss of financial instruments

The Inquiry has proposed that, if the depositary loses financial instruments that have been under its custody, the depositary must, without unnecessary delay, retransfer a financial instrument of the same kind, or an amount corresponding to the value of that instrument, to the fund. The depositary will not be held liable if it can show that the loss occurred due to external factors beyond the reasonable control of the depositary. The consequences of the occurrence that led to the loss must also have been unavoidable despite all reasonable efforts to prevent it.

Whistleblowing

The supervisory powers of the SFSA have been extended as a result of UCITS V.

According to a proposal by the Inquiry, a management company must ensure that it has appropriate reporting systems that employees can use to report suspected violations of rules governing the activities of the management company. This rule is new for management companies, but has already been implemented in banking and investment firm regulations.

One rule that is new for the entire industry, however, is that the person who made the report may not be held responsible for disregarding rules regarding mandatory secrecy. The Inquiry has therefore suggested such a rule for several other types of companies as well.

Sanctions
General about the extended circle of persons

The Inquiry proposes rules that broaden the circle of individuals upon whom sanctions may be imposed. This extended group includes management company owners, the managing director and members of the board of directors of the management company and the depositary.

The Inquiry also proposes a rule that empowers the SFSA to impose a pecuniary sanction on a company that acts as a management company without due authorisation.

Sanctions on physical persons
Management companies

A new rule is proposed regarding intervention against the executive manager or the board of directors in the event that the management company is in breach of certain rules in the Swedish UCITS Act. The grounds for intervening against these individuals in the management company are defined under 11 different points, such as wilfully giving false information when applying for authorisation, not fulfilling fundamental requirements regarding organisation and conducting business, not fulfilling requirements on diversification and risk management, and others.

Of course some criteria must be met for the SFSA to intervene against a person. First of all, the intrusion by the company must be severe, and secondly the SFSA must prove that the breach is intentional or the result of gross negligence by the relevant person. The intervention may entail a decision to ban the person from serving on the board or acting as the executive director of a management company for a period of 3-10 years, or a decision to impose a pecuniary sanction. There is a list of what information must be included in the sanction order.

If a person upon whom such a sanction order has been  imposed does not approve the order, the SFSA has a  possibility to make an application to the Administrative Court for a decision on a sanction.

Depositaries

The Inquiry has also proposed an option to intervene against physical persons (the board of directors and the executive manager) of the depositary. The grounds for intervening against these persons are, of course, that the depository is in breach of rules that the depositary is required to fulfil.

Current position of the SFSA

The proposed legislation regarding sanctions imposed on the senior management of a management company and depositaries puts these individuals in a more exposed situation than is currently the case. This type of legislation is relatively new in Sweden and is highly controversial. As can be seen in another article in this Report, similar rules have been introduced with respect to board members and managing directors in banks and investment firms. The SFSA has currently adopted a restrictive policy in actually applying these rules, stating that their main mission is to supervise companies rather than individuals.

Previously implemented rules

A few rules in UCITS V have not resulted in any proposals for chan- ges in Swedish legislation because corresponding rules were previously implemented into laws other than the Swedish UCITS Act, most commonly the implementation of CRD IV. The duty of the SFSA to protect individuals who exercise their rights as whistleblowers has already been introduced into Swedish law in connection with the implementation of CRD IV and CRR in Sweden. These rules can be found in the Freedom of Information and Secrecy Act (SFS 2009:400). The right of the SFSA to demand information regarding data traffic records, based on article 98 of the UCITS V, is considered to be previously implemented into Swedish law.

Concluding remarks

As can be seen above, many new rules must be implemented and a considerable amount of work lies ahead for the Ministry of Finance. It now remains to be seen whether the timetable will hold. In addition to UCITS V, we are also awaiting implementation of MiFID II, MAD and other EU Directives next year, which will also demand considerable resources from the Ministry of Finance.