KPMG Executive Briefing UCITS Management Companies

Transcription

1 Investment management KPMG Executive Briefing UCITS Management Companies March 2013 kpmg.lu

2 Introduction UCITS funds have proven to be an outstanding European success with more than funds representing nearly EUR 6 trillion being distributed to a significant number of countries throughout the world. The success is largely due to the robustness and adequacy of the legal framework that has allowed a dynamic industry to flourish. The European authorities were keen to further enhance the efficiency of the UCITS framework by adopting the UCITS IV measures that aim at facilitating cross-border activities of UCITS funds. For instance, the UCITS IV Directive introduces the concept of a European passport for a UCITS management company whilst ensuring a common framework for the organization and structure of such management companies throughout Europe. This new framework, largely inspired from the MiFID Directive, will apply to all UCITS management companies, regardless of whether the European passport is used or not, as well as to self-managed UCITS. We are happy to provide you with an overview of the key requirements that UCITS management companies will be subject to. Should you have queries on this topic, our UCITS professionals will be happy to discuss these with you. Nathalie Dogniez Head of Investment Management KPMG Luxembourg 2013 KPMG Luxembourg S.à r.l., a Luxembourg private limited company, is a subsidiary of KPMG Europe LLP and a member of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Luxembourg.

3 KPMG Executive Briefing UCITS Management Companies 1 Authorisation Reporting and taxation Delegation Relationship with depositary UCITS Management Companies Organisation Risk management Conflicts of interest and rules of conduct Contents 03 KPMG comment 04 Investment fund industry in Luxembourg 07 Evolving business models 12 Conditions for obtaining authorisation 16 Organisation 28 Conflicts of interest and rules of conduct 37 Delegation 39 Risk management 46 Relationship with the depositary 48 Reporting and taxation

4 2 KPMG Executive Briefing UCITS Management Companies About the publication KPMG Executive Briefing UCITS Management Companies is designed to provide an overview of best practice and regulatory requirements applicable to a management company under the UCITS IV passport. It covers the authorisation process, organisational requirements, conflicts of interest, rules of conduct, relationship with depositaries, reporting and taxation aspects. In the same series: KPMG Executive Briefing UCITS in Luxembourg European directives applicable to UCITS management companies Directive 2009/65/ EC of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company Transposition into Luxembourg law and regulations Law of 17 December 2010 CSSF Regulation No CSSF Circular 12/546

5 KPMG comment KPMG Executive Briefing UCITS Management Companies 3 Organisation and risk management The management company passport comes with a number of measures designed to protect UCITS investors in a harmonised way across the European Union: minimum substance, internal control mechanisms, and functions such as compliance, internal audit, and risk management, to ensure that potential risks to investors are properly identified, managed and supervised. Ravi Beegun, Partner Audit Taxation Fatca, the EU Financial Transaction Tax as well as the EU and OECD discussion around fair taxation will for sure have a growing impact on the operations of international investment platforms and will require more and more C-level attention.i strongly believe that AIFMD will become a UCITS-like brand and the opportunity to manage UCITS and Alternative Funds out of a SuperManCo is likely to become a next Luxembourg success story. Georges Bock, Managing Partner Tax Delegated functions After the adoption of UCITS IV, the market has started to address the compliance requirements such as Risk Management and KIIDs. In 2013, market players will now make use of the UCITS IV tool box and streamline their funds range and their operating model across locations with objective to reduce the TER and increase profitability. Vincent Heymans, Partner Advisory

6 4 KPMG Executive Briefing UCITS Management Companies Investment fund industry in Luxembourg The size of the investment fund industry in Luxembourg was EUR 2.4 trillion at 31 December 2012, made up of 13,420 fund compartments. These figures put Luxembourg in the leading position in Europe when it comes to investment funds and as the second largest investment fund centre in the world after the USA. Investment fund industry size in Europe at 30 September 2012 Country Assets under of which UCITS management ( trillion) ( trillion) Luxembourg France Germany Ireland Source : ALFI and EFAMA 2.4 trillion in total net assets at 31 December 2012 (Source : CSSF) Evolution in the number and net assets of investment funds in Luxembourg billion 3500 Overview: number and net assets of subfunds Net assets Number of subfunds Number of subfunds Source: Data from CSSF Annual Reports and cssf.lu

7 KPMG Executive Briefing UCITS Management Companies 5 Investment fund figures at 31 December 2012 Overview of investment funds by type of fund, and type of legal vehicle Net assets UCITS (Part I of the 2010 law) Part II of the 2010 Law Specialised Investment Funds SICAV 1,439 billion 116 billion 148 billion FCP 474 billion 77 billion 118 billion Source: CSSF Overview of investment funds by type of investment Fixed-income securities Variable-yield securities Mixed transferable securities Fund of funds Cash Real estate Futures, options, warrants Other securities Source: CSSF 13,420 fund compartments at 31 December 2012 (Source : CSSF)

8 6 KPMG Executive Briefing UCITS Management Companies Management company figures at 31 December 2011 Overview of origin of management companies of UCITS at 31 December 2011 Germany: 41 Switzerland: 31 France: 18 Italy: 21 UK: 12 USA: 7 Luxembourg: 8 Belgium: 8 Sweden: 6 Others: 27 Source: CSSF Annual Report trillion Assets under management by UCITS Management Companies at 31 December 2011 (Source: CSSF Annual Report 2011) 179 UCITS management companies at 31 December 2011 (Source: CSSF Annual Report 2011) 2,516 Staff of management companies at 31 December 2011 (Source: CSSF Annual Report 2011)

9 KPMG Executive Briefing UCITS Management Companies 7 Evolving business models Survey findings The 2013 Management Company - Operating Model and IT Survey conducted by KPMG in Luxembourg confirmed that the asset management industry is being subject to a range of challenges and opportunities which are placing increasing pressure on margins and shaping the boardroom agenda. The overall challenges are: Increasing regulation Changing competitive dynamics and shifting value chains Evolving client needs and product requirements Globalization and increasing cross-border activity Ongoing market volatility New and emerging wealth regions Key findings from the survey are summarized below: Outsourcing model Currently, most of the management companies in Luxembourg are outsourcing their non-core functions such as IT, audit, risk management and compliance. IT systems Management companies are globally satisfied with their current IT solutions and are not intending to replace them in the near future. Internal Audit The majority of respondents believe that the internal audit function is adding value to the internal processes and the company, rather than just being a mandatory control function. Implementation of new regulations The level of readiness regarding the implementation of new regulations is higher amongst larger management companies compared to smaller ones. Threats and challenges The top 3 IT and organizational challenges are new regulations, IT strategy/business process optimization, and to hire adequate resource profiles. The future outsourcing trend analysis shows that the proportion of management companies insourcing their non-core functions will increase. With respect to outsourcing partners, the proportion of management companies outsourcing their business activities within the group is more or less equivalent to the proportion outsourcing to a third party.

10 8 KPMG Executive Briefing UCITS Management Companies According to 77% of survey respondents, rising costs are the most relevant threat faced by the asset management industry in Luxembourg (only 9% indicated it as low relevance and 4% as no relevance). Luxembourg financial market threats Low relevance Moderate relevance High relevance No relevance No answer Rising costs 9% 34% 43% 4% 10% Securing adequate resources 23% 41% 19% 4% 13% Flexibility of regulatory framework 28% 26% 23% 10% 13% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% When looking at local business strategy, 72% of the survey respondents indicated that expanding their operations in Luxembourg is the most relevant business strategy. 75% indicated that closing their Luxembourg operations is not a relevant option. Luxembourg business strategy Low relevance Moderate relevance High relevance No relevance No answer Expand operations 11% 41% 31% 13% 4% Close operations 15% 2%2% 75% 6% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

11 KPMG Executive Briefing UCITS Management Companies 9 Cost efficiency will impact strategy In terms of trends and developments in the fund industry, management companies and fund promoters are focused on cost efficiency leading them to a streamlining of their product lines and - as the case may be - to a reorganization of their corporate structure. It could be noticed that larger management companies, which usually form part of an international financial group, establish centralized Centers of Excellence as hubs for fund management services. In doing so, they can take advantage of a scalable and flexible platform and offer competitive pricing by leveraging their costs across multiple locations. Furthermore, a common approach to the implementation of regulatory requirements at a group level increases the technical feasibility of investment governance. International financial groups will need to assess where to best locate their different Centers of Excellence, knowing that for groups with management companies in two or more jurisdictions, it will no longer be cost efficient to keep two or more full-sized fund platforms spread over different jurisdictions. 1- Resource optimization through the use of Management Company Passport (MCP) The MCP allows a management company domiciled in a Member State to manage funds established in other Member States. It can either do so by setting up a branch in another Member State or by providing services under the freedom to provide services regime. 2- From the ManCo to the Super ManCo UCITS management companies can build on their existing know-how, resources and infrastructure to expand into the management of AIFs. This would require an extra AIFM license. Incremental measures to adapt the management and oversight activities to include alternative assets will be less than setting up a new AIFM vehicle from zero. Such a Super ManCo, if designed well, can deliver much needed cost-efficiency. Source: KPMG Luxembourg, Management Company - Operating Model and IT Survey by, Simone Delcourt, Directeur, Commission de Surveillance du Secteur Financier.

12 10 KPMG Executive Briefing UCITS Management Companies Some challenges in the use of the passport Management companies wishing to use their passport still face a few challenges: Category Tax Key considerations As tax rules are not harmonised within the EU, there may be different tax impacts for investors depending on where the fund and the management company are located. In addition, the management company s corporate tax and VAT can also be impacted as a result of multiple or different tax rules applying to cross-border activities. The management company will have to decide on the most suitable operating model to adopt, including activities it intends to perform and those it intends to delegate. Delegation model Another key topic relates to the selection of service providers and related initial and on-going due diligence process: depending on the number of service providers selected and their location, monitoring of service providers may be resource consuming. Delegation agreements and service level agreements need to be adapted to take into account different legal jurisdictions, or specify the legal jurisdiction to be used for any litigation. Operational Skills and resources Legal responsibility of the management company s conducting officers Reporting and disclosure requirements Regulatory and Compliance Relationship with the depositary bank in each UCITS s home member state Additional information flows need to be set up from new service providers of foreign funds to the management company, for it to be able to exercise its oversight duties, and to ensure that reporting and disclosure requirements for these foreign funds are met. The management company may require additional knowledge, skills and resources for specific local and regulatory requirements which apply to foreign UCITS being managed. The Board and conducting officers will have different sets of responsibilities under different jurisdictions, which they need to consider in performing their duties. Local reporting and disclosure requirements for foreign funds financial statements may be different from the management company s current known framework. For foreign funds, there is likely to be specific legal and regulatory requirements which apply. The management company will need to perform oversight over compliance with these specific requirements. Content of the agreement between the management company and each of the depositaries will have to be tailored to the product and circumstances, in light of the applicable laws and regulations. Contractual discharges, where possible, will have to be considered on a case by case basis, as well as country specific requirements. Access to relevant information for the management company to review the performance of the depositary.

13 KPMG Executive Briefing UCITS Management Companies 11 Is the Super ManCo structure a solution to combat increasing costs? AIFM UCITS Man Co Super ManCo Foreign AIFMs and UCITS Man Cos Super ManCo with cross-border activities Luxembourg AIFs Depositary Banks Super ManCo Delegation Luxembourg UCITS UCITS domiciled outside Luxembourg Depositary Banks Depositary Banks AIFs domiciled outside Luxembourg Depositary Banks

14 12 KPMG Executive Briefing UCITS Management Companies Conditions for obtaining authorisation

15 KPMG Executive Briefing UCITS Management Companies 13 Conditions The conditions for obtaining authorisation as a UCITS management company are as follows: Conditions Capital Central Administration Shareholding Description Minimum capital of EUR , plus an additional 2 basis points on assets under management exceeding EUR 250 million. Total initial and additional capital capped at EUR 10 million. Own funds may not be constituted by contribution in kind and only surplus own funds may be invested in another company. The head office of the UCITS management company must be located in Luxembourg and must consist of a decision-making centre and an administrative centre. The shareholders holding at least 10% of the capital must be suitable to ensure a sound and prudent management of the management company. Relevant criteria which are considered are the professional repute of the shareholders, professional repute and experience of senior management in charge of the activities, financial strength of the shareholders, compliance with regulations and supervision at a group level, and risk of money laundering and terrorism financing. The shareholding structure should be organised in such a way the prudential supervision can be exercised without obstruction. The shareholders must dispose of own funds at least equivalent to the amount it intends to invest in the capital of the management company. The CSSF may request a sponsorship letter. Fit and proper persons External audit Participation to an investor compensation scheme The persons who effectively conduct the business of a management company are of sufficiently good repute and are sufficiently experienced also in relation to the type of UCITS managed by the management company. The 2 conducting officers must, in principle, permanently reside in Luxembourg, or may have their domicile in a place permitting them to come to Luxembourg every day. The management company must be audited by a registered auditor with adequate professional experience. Participation is required for management companies which are also offering individualised discretionary management services.

16 14 KPMG Executive Briefing UCITS Management Companies Application for authorisation An example of the structure of an application for authorisation as a UCITS management company is given below. Section Shareholding Capital Governance bodies Structure and organisation Risk management, Internal audit, Compliance Other Appendices Indicative information to be provided Detailed group structure, direct and indirect shareholders indicating number of shares, final beneficial owners Regulators supervising group entities Last three audited financial statements or latest relevant information in certain situations Articles of association of shareholders Declarations/certificates on honorability of shareholders Confirmation that the capital is not from a loan or equivalent taken by the shareholder, and the shares of the management company are not pledged Capital structure envisaged A draft of the guarantee provided by the credit institution or the insurance company which will enable the management company not to provide up to 50% of additional own funds (if applicable) Details of supervisory board, board of directors, and senior management of the management company Curriculum vitae Declarations/certificates on honorability of persons in governance bodies Draft employment contract of conducting officers Description of the specific areas of responsibility of each conducting officer and their respective experience The proof that the exercise of multiple functions (for other companies) by the conducting officers does not prevent them to fulfill their tasks and responsabilities. Legal form of company and denomination Reasons for establishing activities in Luxembourg Programme of activity for the next three years Three years budget forecasts Draft articles of association Description of administrative, accounting and IT infrastructure, with number of staff and names (if available) Name of the person responsible for providing information on the financial situation of the management company Description of outsourcing arrangements, copies of draft outsourcing contracts, and monitoring and oversight controls by the management company Information on distribution networks Additional information regarding central administration Policies on conflicts of interest and code of conduct Policy on investment of capital Name of external auditor Remuneration policy details Draft procedures on anti-money laundering Name of the person in charge of the handling, centralisation and follow-up of complaints Description of the risk management process, Internal audit function and Compliance function Name of the persons in charge of the risk management, the internal audit function and the compliance function Information on UCITS to be managed by the management company, and arrangements regarding foreign UCITS to be managed Detailed information to support main sections of the application file

17 KPMG Executive Briefing UCITS Management Companies 15 Permitted activities The activities which are allowed under the management company authorisation are given in Directive 2009/65/ EC* and the implementing Directive, as shown below. Annex II of UCITS Directive 2009/65/EC* Functions included in the activity of collective portfolio management: - Investment management. - Administration: (a) legal and fund management accounting services; (b) customer inquiries; (c) valuation and pricing (including tax returns); (d) regulatory compliance monitoring; (e) maintenance of unit-holder register; (f) distribution of income; (g) unit issues and redemptions; (h) contract settlements (including certificate dispatch); record keeping. - Marketing. Other activities (Chapter III of UCITS Directive 2009/65/EC*) Management of portfolio of investments, including those owned by pension funds, in accordance with mandates given by investors on a discretionary, client-by-client basis, where such portfolios include one or more of the instruments listed in Annex 1, section C of Directive 2004/39/EC As non-core services: (i) Investment advice concerning one or more of the instruments listed in Annex 1, section C of Directive 2004/39/EC (ii) Safekeeping and administration in relation to units of collective investment undertakings Regarding collective portfolio management, the authorisation permits: To distribute, through the establishment of a branch, the units of the harmonised unit trusts/common funds managed by that company in its home Member State; To distribute, through the establishment of a branch, the shares of the harmonised investment companies managed by that company; To distribute the units of the harmonised unit trusts/common funds or shares of the harmonised investment companies managed by other management companies; To perform all the other functions and tasks included in the activity of collective portfolio management; To manage the assets of investment companies incorporated in Member States other than its home Member State; To perform, on the basis of mandates, on behalf of management companies incorporated in Member States other than its home Member State, the functions included in the activity of collective portfolio management; Where a management company distributes the units of its own harmonised unit trusts/common funds or shares of its own harmonised investment companies in host Member States, without the establishment of a branch, it should be subject only to rules regarding cross-border marketing. (*) Transposed in Luxembourg in Annex II and chapter 15 of the Law of 17 December 2010 n undertakings for collective investment

18 16 KPMG Executive Briefing UCITS Management Companies Organisation Applicable to both Management Companies and Self-managed UCITS the rules of this Directive on administrative procedures and internal control mechanism should, as a matter of good practice, apply both to management companies and investment companies that have not designated a management company, taking account the principle of proportionality. Source: Implementing Directive 2010/43/EU Management Companies Self-Managed UCITS

19 KPMG Executive Briefing UCITS Management Companies 17 Application of the proportionality principle The proportionality principle is intended to achieve both of the following objectives: applying measures that are suitable and appropriate to meet the pursued regulatory objective of achieving a high level of investor protection; avoiding the creation of excessive administrative or procedural burdens either on UCITS/management companies or the relevant competent authorities. The application of the proportionality principle in practice is likely to be based on a certain degree of judgment, based on the individual circumstances, and on criteria such as the nature, scale and complexity of activities (e.g. type of investment strategies, operational infrastructure etc) and corresponding inherent risks. The management company may apply the principle of proportionality in the organisation of its compliance, internal audit and risk management function. The nature, scale and complexity of its activity may also be taken into account in the application of the general requirements regarding procedures and organisation, its operating staff and its conflict of interest policy.the application of the proportionality principle must be duly motivated and authorised by the CSSF. Consider nature, scale and complexity of activities Identify risk points which can lead to inadequate investor protection Identify organisational measures to mitigate/ control these risk points in an optimal manner Implement best solution within management company or self-managed UCITS Scenario 1 Nature Scale Scenario 2 Choose best implementation scenario based on circumstances Complexity Scenario 3 Risk point Control mechanism

20 18 KPMG Executive Briefing UCITS Management Companies Organisational requirements A UCITS management company must have a head office in Luxembourg, consisting of a decision-making centre and an administrative centre. It is further required to have a permanent compliance function, a risk management function and an internal audit function. Board Board of Directors Senior management Conducting Officers Other functions Compliance Risk Management Internal Audit Administrative centre Body/Function Description Board of Directors The board is the governance body with ultimate responsibility for the activities carried out by the management company. Its members (at least three) must be of sufficiently good repute and experience, and must dedicate the required time and attention to their duties, potentially limiting the number of other professional engagements. Its constitution must follow robust governance arrangements. Senior Management/ Conducting Officers Central Administration For the protection of investors, it is necessary to guarantee the internal overview of every management company in particular by means of a (minimum) two-person management system and by adequate internal control mechanisms. The conducting officers must be of sufficiently good repute and experience. They must, in principle, be in Luxembourg on a permanent basis. The conducting officers form a Management Committee and work together in close partnership to fulfill their responsibilities. They must be regularly in contact and hold periodic meetings documented in written minutes available in Luxembourg. These meetings have to include a discussion about the management information. Each conducting officer shall be assigned specific areas of responsibility whilst avoiding conflicts of interest. The concept of central administration implies that the management company must have its own office in Luxembourg. The decision-making centre comprises the activity of the conducting officers as well as of those persons responsible for the different administrative and control functions or different departments or occupations. The administrative centre comprises a sound administrative and accounting organization. A back-up solution in line with a business continuity plan must be in place.

21 KPMG Executive Briefing UCITS Management Companies 19 Management company duties and associated board responsibilities Meeting the legal and regulatory requirements for management companies are ultimately the responsibility of the board of directors. The main responsibilities of the board are therefore linked to the proper performance by the management company of its activities. This requires the board to have oversight of the following areas: Area Set up Monitoring Reporting Overall conduct Supervision Clear allocation of responsibilities of senior management and the supervisory function Organisational requirements Conflicts of interest, rules of conduct (best execution, trade allocation, inducements) and personal transactions Insider dealing and market abuse Voting rights Remuneration Relationship between management company and foreign depositary Risk management process Review of information reported by various functions, incl. senior management Valuation of portfolio instruments General regulatory compliance Supervision of delegated functions Investment performance Complaints handling Communication with investors Reporting to regulatory and tax authorities Acting honestly and fairly, and with due skill, care and diligence in the best interests of the UCITS Supervising senior management Overseeing the allocation of responsibilities clearly between senior management and the supervisory function, as it is central for the implementation of appropriate internal control mechanisms Overseeing the implementation of policies and procedures, internal control mechanisms, compliance function, internal audit function, risk management function, employment of personnel with appropriate skills, knowledge and expertise Overseeing the implementation of policies and procedures, internal control mechanisms, and the resolution of conflicts and exceptions Adopting a strategy to prevent insider dealing and market abuse Adopting a strategy for exercise of voting rights attached to portfolio instruments Ensuring the implementation of a remuneration policy Signing a legal agreement including minimum contract terms and modus operandi as given in the implementing directive Overseeing the identification, measurement, treatment and reporting of risk exposures Reviewing information received, incl. written minutes produced by the Management Committee, discussing and deciding on relevant follow up action to be taken Overseeing the valuation process Overseeing the regulatory compliance process, taking prompt action when deficiencies occur Establishing a structure for initial and ongoing due diligence and monitoring of delegated functions Reviewing portfolio performance Overseeing the implementation of procedures for the handling of investor complaints Overseeing information communicated to investors Overseeing the reporting process

22 20 KPMG Executive Briefing UCITS Management Companies Responsibilities of senior management The management committee is among other things responsible - under the ultimate responsibility of the board of directors, for: Area Set up Monitoring Reporting Overall compliance Establishing and maintaining adequate policies, procedures and arrangements designed to achieve compliance with legal and regulatory requirements Periodical assessment of the effectiveness Report exceptions to the board Central administration and internal governance Implementing the strategies and principles for central administration and internal governance Periodical assessment of the effectiveness Report exceptions to the board Internal control mechanisms Ensuring a permanent and effective compliance, internal audit and risk management function are in place Periodical assessment of the effectiveness Report exceptions to the board Resources Ensuring the necessary technical infrastructure and human resources are provided Periodical review and, if any, analysis and follow-up of incidents and gaps Report incidents and gaps to the board Investment policy and strategy Implementing the investment policy and supervising the adoption of the investment strategy for each managed UCITS Periodical review and assessment of the effectiveness Report deviations from the investment policy and/or strategy to the board Risk management Approving and implementing the risk management policy, the provisions, procedures and implementing techniques, and in particular the risk limits for each UCITS managed Review the effectiveness and compliance with risk limits Report exceptions to the board Marketing and distribution Implementing the marketing policy and distribution network Follow-up for each managed UCITS Report incidents to the board Conflicts of interest Establishing a policy and procedures for preventing/ managing conflicts of interest Identify and assess situations of unavoidable conflicts, ensuring the action taken is in the best interests of the UCITS and its unit-holders Report exceptions to the board Report conflicts and measures taken to investors Reporting Establishing mechanisms for a frequent reporting Receive (at least annually) written reports on matters of compliance, internal audit and risk management incl. remedial measures taken, and on the implementation of investment strategies and procedures for taking investment decisions Report to the board

23 KPMG Executive Briefing UCITS Management Companies 21 Internal governance UCITS management companies must promote an internal culture of control and risk, which aims to ensure that all members of staff actively take part in the detection, declaration and control of risks incurred. Procedures Manual Internal procedures Allocation of tasks amongst staff Hierarchical reporting lines Exchange of information with delegates Controls on delegated activities Business Continuity Plan (BCP) Disaster recovery Regular testing of BCP BCP of service providers to assess Management Information Results over controls on the activities of delegates Risk management analysis Execution policy Complaints Minutes of meetings Incidents linked to collective management

24 22 KPMG Executive Briefing UCITS Management Companies Compliance, internal audit and risk management function The responsibilities and set up arrangements for each of the functions required are given in the table below. Overall responsibilities Independence from operations Compliance Risk management Internal audit Monitor adequacy and effectiveness of measures, policies and procedures put in place to comply with UCITS IV Directive Advise /assist management and employees to comply with the management company obligations Cover the activity of branches, representative offices, agencies and subsidiaries Implement risk management policy and procedures Ensure compliance with UCITS risk limit system Review and support arrangements for valuation of OTC derivatives Yes, but proportionate Yes, but proportionate Yes Establish, implement and maintain an audit plan to examine and evaluate internal control Issue recommendations and verify implementation Cover the activity of branches, representative offices, agencies and subsidiaries Authority, resources, skills Appoint a compliance officer Can take into account proportionality principle In line with proportionality principle In line with proportionality principle Reporting to senior management Report on a frequent basis, and at least annually on exceptions and remedial measures taken Advise board on risk profile of UCITS and report on (a) discrepancies between actual and target risk profile (b) limit excesses (c) remedial measures Report to Conducting Officers on actual or foreseen limit breaches Report on deficiencies and remedial measures, at least on an annual basis Delegation to third party Yes, if the activity is limited to collective management Yes Yes, but must be independent from the statutory auditor No, if the management company has branches Restrictions Not performed by a member of the Board of Directors Not combined with internal audit function May be combined with risk management function subject to proportionality principle Not performed by a member of the Board of Directors Not combined with internal audit function or compliance Not performed by a member of the Board of Directors Not combined with risk management function May be combined with compliance function subject to proportionality principle

25 KPMG Executive Briefing UCITS Management Companies 23 Policies and procedures Management companies shall establish, implement and maintain adequate policies and procedures designed to detect any risk of failure by the management company to comply with its obligations under Directive 2009/65/EC, as well as the associated risks, and put in place adequate measures and procedures designed to minimise such risk. Source: Implementing Directive 2010/43/EU The following tables give an overview of specific policies and procedures to be implemented. Policies/procedures to be implemented Risk management policy Business continuity policy Disclose to investors Specific procedures to be set up Complaints handling Description Record each complaint, and action taken. Disclose handling of complaints procedure to investors Conflicts of interest policy Best execution policy Order allocation policy Electronic data processing Accounting procedures Record all transactions, and ensure integrity and confidentiality of data Selection of appropriate accounting policies, and appropriate valuation methods Complaints procedure Remuneration policy Personal transactions Portfolio and share/unit transactions Specify when personal transactions are prohibited, and record and monitor all personal transactions Prompt recording and reporting of transactions Recordkeeping Keeping records for a minimum of 5 years, making records available to a successor management company

26 24 KPMG Executive Briefing UCITS Management Companies Internal control framework Management companies shall establish, implement and maintain adequate internal control mechanisms designed to secure compliance with decisions and procedures at all levels of the management company. Source: Implementing Directive 2010/43/EU COSO* internal control framework components The COSO components are : Control environment Risk assessment Control activities Information/ communication Monitoring *The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Senior management s involvement in ongoing monitoring Senior management s role is fundamental in achieving an effective internal control system. Besides the initial design and implementation of internal control mechanisms, senior management time is required in performing ongoing effective monitoring. The monitoring process should be constructed along the following COSO guidelines: COSO s fundamentals of effective monitoring Establish a foundation for monitoring Proper tone at the top Assign monitoring roles to persons with appropriate capabilities, objectivity, authority A baseline of effective internal control from which ongoing monitoring and evaluations can be implemented Design and execute monitoring procedures Focus on persuasive information Operation of key controls ** which address meaningful risks Assess and report results Evaluate severity of identified deficiencies Report monitoring results to board Timely action and follow up ** Focusing on key controls allows the management company to be both effective in addressing risks, and efficient in allocating company resources to the right places. The following diagrams show two examples of process risk points and key controls over the investment management process, and the outsourcing process.

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28 26 KPMG Executive Briefing UCITS Management Companies Internal control framework - An illustrative example: Investment management process risk points and key controls Pricing/valuation controls Authorisation Approved venues, brokers, counterparties Income / Dividend controls Counterparty risk Voting not in client interests Unauthorised transactions Failed trades Incorrect order allocation Market risk / Global exposure Incorrect NAV Investment decision Best execution Deal execution Trade matching Fund records Client reporting Investment policy breach Personal transactions Portfolio instruments incorrectly recorded Liquidity risk Fees / inducements incorrectly recorded Not best execution Conflicts of interest Incomplete documentation of control performance Pre-deal exceptions Failed trade exceptions Cash, security, derivatives reconciliations NAV review Post-deal breaches/exceptions Fee controls Investment limits Risk limits Management reviews / KPIs / exception reports IT access/interfacing/configuration controls, Business Continuity arrangements Segregation of duties Verifications / Tests / Analyses performed by: Compliance - Internal Audit - Risk Management

29 KPMG Executive Briefing UCITS Management Companies 27 Legend Risk point Key controls Outsourcing process risk points and key controls Approval of service provider selection Signed and legally enforceable contract Outsourcing policy Adequate due diligence on capabilities, resilience, strength Confidentiality controls/set up Service level reviews Country risk Counterparty risk Provider s own activities take priority Undefined scope / responsibilities Poor service received Operational errors Reputation risk Oversight failure Fraud risk Poor customer interaction Define scope Due diligence Contract execution Information flows Contingency plans Ongoing monitoring Undefined service levels Weak control environment Confidentiality of client data not maintained Not capable of delivering quality services No business continuity if services fail Not financially strong to compensate for errors Lack of segregation of duties/functions at service provider Incomplete documentation of control performance Risk assessment and key control design Regulatory status of service provider Controls to ensure prompt access to data Reporting timetables Daily task execution supervision controls Follow up of errors Control over provider s fees Exit strategy Management reviews / KPIs / exception reports IT access/interfacing/configuration controls, Business Continuity arrangements Segregation of duties Verifications / Tests / Analyses performed by: Compliance - Internal Audit - Risk Management

30 28 KPMG Executive Briefing UCITS Management Companies Conflicts of interest and rules of conduct

31 KPMG Executive Briefing UCITS Management Companies 29 Conflicts of interest Establishing a conflicts of interest management process Management companies must establish a conflict of interest policy. The process should consist of establishing criteria for identifying conflicts of interest, implementing a policy, managing conflicts in accordance with the policy, and reporting and disclosure towards relevant parties. Criteria Policy Management Reporting and Disclosure Criteria for identifying conflicts of interest The management company is likely to make a financial gain, or avoid a financial loss, at the expense of the UCITS The management company has an interest in the outcome of a service provided to the UCITS, which is distinct from the UCITS interest in that outcome The management company has a financial or other incentive to favour the interest of another client over the interests of the UCITS The management company carries on the same activities for the UCITS and for other clients which are non UCITS The management company receives an inducement in relation to collective portfolio management activities provided to the UCITS Example policy contents 1- Definitions 2- Criteria for identification of conflicts 3- Identified potential material conflicts 4- Procedure when a conflict arises, including escalation to senior management 5- Managing a conflict 6- Disclosure to affected investors 7- Ongoing monitoring and review of policy Management of conflicts Procedures and measures should avoid exchange of information between relevant persons engaged in portfolio management if this exchange could harm client interests Relevant persons providing services to clients whose interests may conflict should be separately supervised If the remuneration of relevant persons performing different activities for the client are linked to factors which may give rise to a conflict of interest, these links should be removed Measures should prevent any person from exercising inappropriate influence over the way in which a person carries out portfolio management activities Measures should prevent the simultaneous or sequential involvement of one person in separate portfolio management activities, where such involvement can lead to a conflict of interest Reporting and Disclosure When organisational or administrative arrangements are not sufficient to prevent a risk of damage to the interests of the UCITS, senior management should be promptly informed to take action Such cases are then reported to the investors, informing them of the situation, and the decisions taken Potential sources of conflict of interest It is not possible for the permanent risk management function to be hierarchically and functionally independent from operating units The depositary bank has a direct or indirect qualifying holding in a management company The management company employs staff on secondments or made available by an undertaking belonging to the same group or by a non-affiliated company Potential risk of conflict of interest related to the outsourced activities

32 30 KPMG Executive Briefing UCITS Management Companies Rules of conduct Implementing rules of conduct The following diagram and tables give an overview of the rules of conduct to be implemented by the management company. Client best interests Best execution Order aggregation/ allocation Subscriptions/ Redemptions processing Portfolio transaction processing Inducements Duty to act in best interests of the client Handling of subscription and redemption orders Best execution Handling of orders Order aggregation/ allocation Disclose to investors duty to act in the best interests of the UCITS and their unit holders High level of due diligence in the selection and ongoing monitoring of investments, and in the selection and monitoring of arrangements with third parties performing risk management activities Reporting on the execution of subscription and redemption orders to clients no later than the first business day following execution Taking all reasonable steps to obtain the best possible result for the UCITS, taking into account price, costs, speed, likelihood of execution and settlement, order size and nature, or other relevant considerations Establishing a best execution policy Prompt, fair and expedition execution of portfolio transactions on behalf of the UCITS Prompt and accurate recording of executed transactions Prompt delivery of sums received in settlement of executed orders, to the appropriate UCITS Aggregation of orders must not work to the disadvantage of any UCITS An order allocation policy must be established to ensure fair allocation of aggregated orders If the management company has aggregated own account transactions with transactions of UCITS, and the order is partially executed, then trades are allocated in priority to the UCITS Inducements Types of fees which the management company is allowed to pay or receive in connection with its investment management or administration activities: 1) Fees, commissions and non-monetary benefits paid to or by the UCITS 2) Fees, commissions and non-monetary benefits paid to or by a third party a) existence, nature, amount must be clearly disclosed to the UCITS prior to the provision of relevant service b) designed to enhance the quality of the service and not impair management company s compliance with duty to act in best interests of UCITS 3) Proper fees e.g. custody costs, settlement and exchange fees, regulatory levies, legal fees etc

33 KPMG Executive Briefing UCITS Management Companies 31 Inducements Implementing an inducements process Management companies need to have a process in place in relation to the classification, evaluation and recordkeeping of all fee flows. Classification Payments received or made Non-monetary benefits Evaluation Enhancing quality of service Acting in best interests of UCITS Prior disclosure to investors Recordkeeping Information disclosed to UCITS regarding inducements Information showing management company s compliance with inducements rules Involvement of Senior Management and Compliance Function Implications for management companies Typical inducements can include items such as trailer fees, fee retrocessions, and soft commissions. Fees received or paid which do not meet the respective criteria given in the directive are prohibited. It is therefore important that all such flows are analysed, and the justification for why each type of fees meet the relevant criteria is properly documented. Decision trees for both fees received by or paid by a management company are shown hereafter.

34 32 KPMG Executive Briefing UCITS Management Companies Decision tree for a fee, commission or non-monetary benefit received by a management company in connection with a service provided to its client Is the fee, commission or non-monetary benefit (item) being paid by the client or a person on behalf of the client? Yes Not prohibited No Is the fee, commission or non-monetary benefit a proper fee which enables or is necessary for the provision of investment services, such as custody costs, settlement and exchange fees, regulatory levies or legal fees, and which, by its nature, cannot give rise to conflicts with the management company s duties to act honestly, fairly and professionally in accordance with the best interests of its clients. Yes No Has the existence, nature and amount of the fee, commission or benefit, been clearly disclosed? No Prohibited Yes Is the receipt of the fee or commission, or non-monetary benefit designed to enhance the quality of the relevant service to the client and will it not impair compliance with the management company s duty to act in the best interests of the client? No Yes

35 KPMG Executive Briefing UCITS Management Companies 33 Decision tree for a fee, commission or non-monetary benefit paid by a management company in connection with a service provided to its client Is the fee, commission or non-monetary benefit (item) being paid by the client or a person on behalf of the client? Yes Not prohibited No Is the fee, commission or non-monetary benefit (item) being paid to the client or a person acting on behalf of the client? Yes No Is the fee, commission or non-monetary benefit a proper fee which enables or is necessary for the provision of investment services, such as custody costs, settlement and exchange fees, regulatory levies or legal fees, and which, by its nature, cannot give rise to conflicts with the management company s duties to act honestly, fairly and professionally in accordance with the best interests of its clients. Yes No Has the existence, nature and amount of the fee, commission or benefit, been clearly disclosed? No Prohibited Yes Is the payment of the fee or commission, or the provision of the nonmonetary benefit designed to enhance the quality of the relevant service to the client and will it not impair compliance. No Yes

36 34 KPMG Executive Briefing UCITS Management Companies Remuneration policy Management companies are required to put in place a remuneration policy in accordance with CSSF Circular 10/437. Structure The structure of the remuneration policy should comply with the following requirements: Appropriate balance between fixed and variable remuneration components, with a maximum limit on the variable component The fixed component shall represent a sufficiently high proportion Flexible bonus policy with possibility to withhold in case of performance criteria not being met or financial situation of the company deteriorating significantly Deferral of the main part of the bonus when significant bonuses are awarded, with minimum deferment period Possibility for the company to recover full or part of a bonus initially awarded on the basis of fraudulent criteria Updated in accordance with the company s financial situation. Performance measurement Performance measurement should comply with the following criteria: The remuneration policy should align the personal objectives of staff members with the long-term interests of the financial undertaking concerned Performance based remunerations are based on a combination of the performance of the individual and the financial results of the company Longer term performance basis with multi-year framework.

37 KPMG Executive Briefing UCITS Management Companies 35 Governance In terms of governance, the following requirements should be met: Measures to avoid conflict of interest Board of Directors shall fix the remuneration of the members of the administrative and management bodies Possibility for the Board of Directors to be assisted by a remuneration committee Control functions and HR department shall be part of the design of the policy. Disclosure Disclosures may take the form of an independent remuneration policy statement, a periodic disclosure in annual financial statements or any other form: Decision-making process used for determining the remuneration policy, including if applicable, information about the composition and the mandate of a remuneration committee, the name of the external consultant whose services have been used for the determination of the remuneration policy and the role of the relevant stakeholders Link between pay and performance Criteria used for performance measurement and risk adjustment Performance criteria on which the entitlement to shares, options or variable components of remuneration is based Main parameters and rationale for any annual bonus scheme and any other non-cash benefits.

38 36 KPMG Executive Briefing UCITS Management Companies Exercise of voting rights Establishing a strategy for exercising voting rights Management companies also need to have a strategy in place in relation to the exercise of voting rights attached to instruments in managed portfolios. Develop voting strategy When and how to exercise voting rights attached to portfolio instruments To the exclusive benefit of UCITS Monitor and exercise Monitor corporate events Voting in accordance with investment objectives and policy Preventing / managing conflicts of interest Make available to investors Summary description of voting strategies Details of actions taken to be made available free of charge, and on investor request

39 KPMG Executive Briefing UCITS Management Companies 37 Delegation A management company may choose to delegate some activities to third parties as follows: Activities that can not be delegated Determination of general investment policy of UCITS FCPs Determination of the risk profile of each UCITS Interpretation of the risk management analysis Activities that can be delegated Functions included in the activity of collective portfolio management: Portfolio management Administration Marketing Risk management Implementation and monitoring of conflicts of interest policy Implementation and monitoring of best execution policy Ensuring that governing bodies have taken decision on fair value Choice of service providers to be appointed Complaints handling Compliance function Internal audit Operation of the IT system Monitoring and control of delegated functions

40 38 KPMG Executive Briefing UCITS Management Companies General conditions for delegation - CSSF must be informed of the functions to delegate, the undertakings acting as delegates, the procedures to control the activities delegated. - CSSF must be informed if the delegates proceed with partial or total sub-delegation. - A written contract must be concluded between the management company and the delegate. - A written due diligence must be performed prior to any delegation. - Delegation must not prevent the management company from acting or the UCITS for being managed properly. - A business continuity plan must be in place at the delegate. - Prospectus of the UCITS must list the delegated functions. - Delegation does not affect the management company s liability. - Conducting officers must be able to give additional instructions to the delegate at any time. - Measures must be in place permitting the conducting officers to perform an effective control over the activities of the delegate. Specific conditions for delegation of the administration function A Luxembourg management company acting for a Luxembourg UCITS can further delegate the administrative function only to another service provider based in Luxembourg. Specific conditions for delegation of the investment management function Delegate must be: authorised or registered for the purpose of portfolio management and subject to prudential supervision authorised under its national law subject to permanent supervision in a third country in which cooperation exists between its supervisory authority and CSSF. - No mandate can be given to the depositary. - Delegate must respect investment policy, investment restricitions and the specific asset allocation criteria. - Management company must ensure that decisions are taken based on quantitative, qualitative and reliable up-to-date research.

41 Risk Management KPMG Executive Briefing UCITS Management Companies 39 Risk management process A management or investment company shall employ a risk-management process which enables it to monitor and measure at any time the risk of the positions and their contribution to the overall risk profile of the portfolio. Governance Roles of Board and Conducting Officer Risk Management policy Skilled resources and independence Source: Implementing Directive 2010/43/EU Risk Management Framework The risk management policy and procedures should reflect a proper risk management framework. Areas to be covered under each framework component (governance, identification, measurement, treatment and reporting) are summarised in the following diagram on the right-hand side. For each risk exposure identified, it is best practice to consider how the risk is covered by the relevant component of the framework. Identification Assess all risk exposures of UCITS Assess all risk exposures of the management company Measurement Risk measurement techniques specified Model risk considered Link with asset valuation Treatment Actual risk level vs. approved risk profile Risk limit system Decisions to reduce risk to acceptable level Timely remedial action Reporting Monitoring risk indicators, limit excesses and breaches Escalation to Board and conducting officers

42 40 KPMG Executive Briefing UCITS Management Companies Risk management principles in relation to risk exposures of the UCITS The risk management process of the management company needs to take into account the ESMA/CESR risk management principles regarding UCITS. Guidance Overview 1. Supervision The adequacy and effectiveness of the risk management process should be supervised 2. Governance and organisation The Board of Directors should be held responsible for the appropriateness and effectiveness of the risk management process A proper risk management policy should be established The risk management function should be properly resourced, be competent and efficient, and be independent of operational units Outsourcing of risk management activities does not exempt funds from retaining full responsibility for the process, and appropriate oversight measures should exist 3. Identification and measurement of risks The risk management process should assess and address all risk exposures of the UCITS The risk measurement techniques should be specified in the risk management policy, and should allow assessment of concentration and interaction of risks Model risk should be properly considered The link between risk measurement and asset valuation should be established 4. Risk Management The actual level of risks should be consistent with the risk profile of the UCITS approved by the Board Appropriate risk limits, approved by the Board, should be used to monitor and control relevant risks The risk management policy should provide for timely remedial actions 5. Monitoring and reporting Periodic written reports should be submitted to the Board, providing in-depth analysis of actual risk profile compared to approved risk profile The Board should receive periodic written reports on the adequacy and effectiveness of the risk management process, any deficiencies identified, and remedial action taken Senior management should receive regular reports highlighting the current level of risks, and actual or foreseeable breaches of limits

43 KPMG Executive Briefing UCITS Management Companies 41 Risk governance and identification Responsibilities of the Board CESR/ Risk Management Principles for UCITS mentions the following responsibilities of the Board of Directors of the management company or self-managed UCITS: The risk management policy is approved, reviewed on a regular basis and, if necessary, revised by the Board of Directors. The Board of Directors should be held responsible for the appropriateness and effectiveness of the risk management process... and for the establishment and implementation of a robust and pervasive risk culture within the Company. Identification of risks The risk management policy should identify all the risks to which the UCITS and management company are exposed. An example diagram showing risk exposures by the probability of occurrence and impact is given below. The relevant risk exposures for each management company needs to be agreed by the governance bodies, in order for adequate controls to be implemented, and then monitored by one or more of the compliance, risk management and internal audit functions. High Liquidity risk Market risk Concentration risk Significance Counterparty risk Operational risk Other risks Low Low Probability High

44 42 KPMG Executive Briefing UCITS Management Companies Risk measurement Market risk / Global exposure (derivatives) Market risk or global exposure needs to be measured daily, and should not exceed risk limits per the directive 2009/65/EC, the implementing directive 2010/43/EU and CESR guidelines on risk measurement and the calculation of global exposure and counterparty risk for UCITS. Risk Measurement Limits Market risk / Global exposure Global exposure needs to be calculated daily, using either of the following methods: Commitment approach Value at Risk (VaR) approach Other advanced risk measurement methodologies The method must be appropriate taking into account the investment strategy of the UCITS, and the proportion, types and complexities of financial derivative instruments used. The use of techniques and instruments (including repurchase agreements or securities lending transactions to generate additional leverage/exposure to market risk), should be taken into account in calculating the global exposure. Under the commitment approach, the global exposure relating to derivative instruments should not exceed the total net asset value of the portfolio. Under the Value at Risk approach, the following limits apply: Relative VaR: the UCITS VaR cannot exceed twice the VaR of the reference portfolio Absolute VaR: the UCITS VaR cannot exceed 20% of its net asset value. Commitment approach Global exposure Other methodology VAR

45 KPMG Executive Briefing UCITS Management Companies 43 Counterparty risk and issuer concentration risk (derivatives) Counterparty risk and issuer concentration risk need to be measured and kept within regulatory limits as follows: Risk Measurement Risk limits Counterparty risk Issuer concentration risk Counterparty risk exposure is calculated by using the positive markto-market value of the OTC derivative contract with that counterparty. Netting of OTC derivative positions with a given counterparty is possible, provided that there are legally enforceable netting contracts with that counterparty. However, it is not possible to net OTC derivative positions with any other exposures towards the same counterparty. Collateral received can be taken into account to reduce the counterparty risk exposure. Collateral needs to be sufficiently liquid and quickly saleable at a price close to the pre-sale valuation. Collateral provided by the UCITS to a company is also taken into account in calculating exposure. For derivative instruments, the exposure is calculated using the commitment approach. For OTC derivative instruments, the exposure needs to also take into account the counterparty risk exposure. Counterparty risk for a derivative transaction cannot exceed 10% of net assets (where counterparty is a credit institution) or 5% in other cases. For the same counterparty or group, the sum of counterparty risk on derivatives and issuer risk on other portfolio instruments cannot exceed 20% of net assets. Issuer concentration risk should not exceed limits given in article 52 of the Directive 2009/65/EC.

46 44 KPMG Executive Briefing UCITS Management Companies Risk treatment - Examples of practical ways to manage risk The following tables provide examples of possible ways in which risks can be managed. Credit risk management Avoid over-reliance on credit ratings, and perform proper due diligence procedures on creditworthiness of issuers/ counterparties to be used by the UCITS Avoid excessive concentration of assets towards any one issuer this is normally addressed through UCITS investment restrictions rules Review limit excesses, and take timely remedial action Monitor significant exposures to issuers/counterparties in difficulty, and discuss and take remedial action early Obtain appropriate collateral where relevant (e.g. securities lending transactions), and perform proper collateral management so as to be able to realise collateral in a timely manner in case of counterparty default Pay attention to the legal enforceability of risk mitigation techniques used (e.g. guarantees, collateral, netting off clauses etc) Market risk management Use appropriate market risk model and limits (e.g. Value at Risk, commitment approach) Perform stress testing, back testing and analyse results Take prompt remedial action if market risk profile no longer corresponds to initial objective set Operational risk management Implement a proper organisation structure with adequate segregation of duties and proper back up support Implement adequate systems to optimise straight through processing, and reduce manual re-inputs Implement a sound internal control framework, with key controls linked to specific risks identified Monitor indicators which show when processes or internal controls are not operating as designed, and taking prompt action to resolve any issue Document performance of key controls, to be able to demonstrate proper discharge of management company duties in case of litigation or dispute. Build capital buffers to protect from operational risk financial losses Liquidity risk management Assess liquidity of instrument at the time of purchase, and assess how it will affect liquidity of the overall portfolio Set up contingency liquidity arrangements to cover temporary needs Monitor liquidity of the portfolio on a regular basis. Consider whether the overall liquidity profile is consistent with that approved by the Board, and enables compliance with UCITS requirements Custody risk management Perform adequate due diligence over the custodian of the fund s assets, and of the network of subcustodians to be used for safekeeping of the fund s assets Perform adequate due diligence over adequate segregation of the fund s assets at the custodian and within its subcustodian network Include a component of periodic re-evaluation of custody risk, via information requests, and audit reports such as ISAE 3402 reports For issues highlighted, discuss on a timely basis at Board level, together with remedial action to be taken

47 KPMG Executive Briefing UCITS Management Companies 45 Risk reporting The following diagram provides examples of risk indicators which can be monitored by senior management and/or the Board of Directors on a periodic basis. Market risk/ Global exposure Global exposure figure (using VaR or Commitment approach) Exposure limit excesses Issuer concentration risk Issuer financial deterioration (ratings downgrade, financial difficulties or other indicators) Investment limit excesses Liquidity risk Significant redemption requests or trends Liquidity deterioration indicators for instruments Non-liquid positions in portfolio Illiquidity limit excesses Operational risk Aged reconciling items Investor claims Control weaknesses identified Regulatory compliance breaches identified Unsigned contracts/slas NAV errors Financial losses incurred Counterparty risk Top 10 counterparty exposures Counterparty credit deterioration (ratings downgrade or other indicators) Counterparty limit excesses

48 46 KPMG Executive Briefing UCITS Management Companies Relationship with the depositary

49 KPMG Executive Briefing UCITS Management Companies 47 Agreement contents Standard agreement particulars A standard agreement is required between a management company and the depositary when the UCITS is not located in the same jurisdiction as the management company. The agreement needs to cover the following items*: Description of procedures to be followed by each party Procedures for safekeeping of each asset class Procedures for prospectus/rule modifications Procedures for two way transmission of relevant information, and providing access to relevant information Procedures for depositary to enquire into conduct of management company Procedures for management company to review the performance of the depositary Confidentiality and anti-money laundering Information which needs to be exchanged between UCITS, management company and depositary relating to subscriptions/redemptions Confidentiality obligations applicable to all parties Tasks and responsibilities of each party with respect to antimoney laundering obligations Competent authorities of management company and of UCITS to have access to relevant documents and information as necessary Appointment of third parties Provide details of third parties appointed by either the management company or the depositary Information on criteria used for selecting third party, and for monitoring the activities Statement that depositary s liability is not affected by the fact that it has entrusted to a third party all or some of the assets in its safe-keeping Amendments and termination of agreement Period of validity Termination conditions Transition arrangements for change of depositary Applicable law Law of the member state where the UCITS is domiciled Scope of agreement List of all UCITS covered by the agreement Service level agreement Details and procedures can be part of a separate service level agreement (*) In accordance with articles 18 (3) and 18 (4) of the Law of 17 December 2010 on undertakings for collective investment. The content of such agreement is prescribed in the CSSF regulation No

50 48 KPMG Executive Briefing UCITS Management Companies Reporting and taxation

51 KPMG Executive Briefing UCITS Management Companies 49 Financial Reporting Financial statements Financial statements are usually prepared using Luxembourg Generally Accepted Accounting Principles (Luxembourg GAAP). The financial statements need to be audited by a registered auditor. Audited financial statements need to be filed with the registrar (Registre de Commerce et des Sociétés) within 1 month of their approval and at the latest within 7 months of the period/year end. On incorporation, the first financial statements period can last up to 18 months. In general, the tax basis used to calculate the company s tax charge matches the accounting basis. International Financial Reporting Standards (IFRS) Financial statements can also be prepared under IFRS, in accordance with the Law of 10 December Luxembourg GAAP a few comments For commercial companies, Luxembourg GAAP generally uses the historical cost method of accounting. Formation costs can be capitalised and amortised over a maximum period of 5 years. Unrealised gains are not recognised whereas unrealised losses are provided for. Capital currency The capital of the management company can be denominated in any major currency specified in the articles of association. The financial statements to be filed with the registrar need to be prepared using the capital currency.

52 50 KPMG Executive Briefing UCITS Management Companies Regulatory Reporting Prudential reporting Prudential reporting should be transmitted electronically via transmission channels used by the regulator, such as e-file or SOFIE. Quarterly reporting : Balance Sheet Profit and loss account Information on UCIs being managed by the management company Information on services provided by the management company Information on staff Management companies with foreign branches are required to report the same type of information as given above in two additional versions the first one representing the figures pertaining to each branch, and the second one representing the consolidated figures of the head office and all its branches The reporting deadline is on the 20 th of the month following the reporting date (31 March, 30 June, 30 September, 31 December). Annual reporting : Final versions of the year end balance sheet and profit and loss accounts, information on UCIs being managed, services delivered, and staff Audited financial statements Annual return of the number of complaints filed by investors. Compliance and internal audit report. Report on the assessment of the effectiveness of the risk management. The reporting deadline is one month after the Annual General Meeting approving the financial statements Risk management process - at least once a year (one month after year end) and in case of significant amendments - and a report containing information on financial derivative instruments used.

53 KPMG Executive Briefing UCITS Management Companies 51 Taxation Corporate taxation of a management company Luxembourg Management companies are taxable in Luxembourg on their worldwide income, unless income is exempt under the provisions of applicable tax treaties. These companies should be fully subject to Luxembourg corporate income tax ( CIT ) and municipal business tax ( MBT ) at a rate of 29.22% as well as Luxembourg net wealth tax ( NWT ) at a rate of 0.5%. The income is reduced by tax deductible costs, charges or amortizations. No capital duty is due in Luxembourg. Only a fixed registration duty of 75 is due on the incorporation or modification of the bylaws of a management company. Luxembourg corporations that have aggregate financial assets, securities and bank deposits exceeding 90% of their total balance sheet are subject to a minimum tax of EUR 3,000 (EUR 3,210 including the 7% solidarity surcharge). If the 90% threshold is not exceeded, corporate tax payers are subject to a minimum taxation which is determined on the basis of the total balance sheet of the tax year concerned. The minimum taxation will range from EUR 500 (EUR 535 including the 7% solidarity surcharge) for a total balance sheet inferior to EUR 350,000, to EUR 20,000 (EUR 21,400 including the 7% solidarity surcharge) for a total balance sheet exceeding EUR 20,000,000. That minimum taxation is an advance tax payment on the corporate tax due in the future. Tax considerations when the management company is managing cross border funds As of 1 January 2011, the non-attraction principle was confirmed. The draft law for the implementation of the AIFM Directive into Luxembourg law forsees the same principle. Hence, no tax should be due in Luxembourg for foreign UCIs administered by a management company situated in Luxembourg. Moreover, one cannot exclude that a Luxembourg fund managed by a foreign management company would become liable to foreign tax. No attraction of tax residency France UCI Luxembourg Management Company UCI No attraction of tax residence in Luxembourg Corporate taxation of a foreign branch of the management company Luxembourg has bilateral tax treaties with all EU Member States (except Cyprus) and with a number of other countries (including almost all OECD Member States). In presence of a tax treaty, the taxation rights are usually given to the country where the foreign branch is located. Thus, profits, capital gains and income of a foreign branch of a Luxembourg resident management company should, in most cases, be exempt from Luxembourg CIT and MBT.

54 52 KPMG Executive Briefing UCITS Management Companies VAT All investment vehicles or similar bodies cited under Article 44, 1 d) VATL (SICAV, SICAF, SICAR, SIF, pension funds subject to Luxembourg financial and insurance supervisory bodies and securitization vehicles governed by the law of 22 March 2004) are taxable persons for VAT purposes. In the particular case of a FCP, the management company invests the capital raised from the subscribers and is the taxable person for VAT purposes. The FCP is only regarded as a single grouping of securities. Pursuant to the specifications of the VAT authorities, investment vehicles carry out VAT exempt activities according to Article 44, 1 d) VATL with no input VAT recovery right. Hence, the investment vehicle is only required to register for VAT purposes in Luxembourg if it receives non- VAT exempt services from abroad and/or performs intra-community acquisitions of goods for an annual amount above EUR 10,000. Luxembourg benefits from a broad exemption of investment management services. Based on Article 44, 1d) VATL, the scope of the VAT exemption for the management of investment vehicles covers the operations which are specific and essentials to the activities of the investment vehicles such as investment management and administration activities of such vehicles. Supervisory services and marketing (except distribution of units in some cases) are however not covered by an exemption. Supervisory services rendered through the depositary bank function to investment vehicles are taxable at the intermediary VAT rate of 12% in Luxembourg. VAT exempt management of Luxembourg investment vehicles as well as of investment vehicles subject to a prudential control by a regulatory authority in one of the EU Member States does not entitle the management company to recover input VAT. Hence, in the absence of any other activities, the management company is only required to register for VAT purposes in Luxembourg if it receives non-vat exempt services from abroad. Any other activities taxable in Luxembourg or abroad (e.g. discretionary management under private wealth management mandates) entitle the management company to recover input VAT. Hence, if it provides such services, the management company would be required to register for VAT purposes in Luxembourg. VAT considerations when management company is managing cross border funds The UCITS IV Directive is the source of challenging VAT questions. Cross-border fund structures within the EU require a harmonized VAT treatment. If a common position has been reached on the VAT status of SICAVs, this is not the case for FCPs. Some Member States (including Luxembourg) consider a FCP and its management company as a single legal entity and taxable person and that any VAT requirements are devoted to the management company. Others might regard a FCP and its management company as two separate legal entities and in some cases as two taxable persons, what could imply VAT compliance obligations for the FCP and which could impact the VAT treatment of the services it receives in cross-border situations, leading potentially to double taxation. In the expectation of an EU-wide consistent approach, the current VAT framework represents a challenge in the development of cross-border fund structures within the EU.

55 KPMG Executive Briefing UCITS Management Companies 53 Taxation aspects in relation to UCITS The following topics relate to self-managed UCITS, however, management companies are likely to get involved in these areas on behalf of the UCITS they are managing. Aberdeen In 2009, ECJ s decision in the Aberdeen case (C-303/07) was a milestone judgement for the abolishment of discriminatory taxation of cross-border dividends. This decision provides a solid basis for all Luxembourg investment funds, UCITS or non-ucits, to reclaim withholding taxes unduly suffered in the Member States where they have made investments. KPMG believes that now is the right time to reclaim withholding taxes by immediately filing protective claims, which will allow you to safeguard your rights in order to benefit from positive decisions of the local authorities and courts. Claim viable No Claim viable Outside EU/EEE

56 54 KPMG Executive Briefing UCITS Management Companies Future developments FATCA Under the standard Foreign Account Tax Compliance Act (FATCA), signed on 18 March 2010, 30% withholding tax is applied on any withholdable payment made to a foreign financial institution (FFI), including funds and their management companies, banks and insurance companies, unless the FFI agrees to inter alia identify U.S. accounts and perform annual reporting. An FFI will also be obliged to deduct and withhold 30% from any payment that is made to a recalcitrant account holder (i.e. one who refuses to be disclosed) or another financial institution (i.e. bank, fund, insurance company, etc.) that is required but does not enter into an agreement with the US Internal Revenue Service. Impacted funds are those invested in the US market including, but not limited to, funds of funds, exchange-traded funds, hedge funds, private equity and venture capital funds, other managed funds, commodity pools, and other investment vehicles. As an alternative to standard FATCA, the U.S. Treasury published two Model Intergovernmental Agreements (IGAs). Under the final regulations (released on 17 January 2013) or the Model II IGA, an FFI will need to sign a contractual agreement with the IRS and will have direct reporting obligations to the IRS. In contrast, FFIs resident in a country that has signed the Model I IGA will only need to register with the IRS and report to their local tax authorities, followed by automatic exchange of such information with the US. U.S. Withholding Agent Custodian Investment Fund (compliant) Investment Fund (non-compliant) Investment Fund (compliant) Investment Fund (non-compliant) Transfer agent Identified non-u.s. Investor Identified U.S. Investor Unidentified recalcitrant investor Non US-owned foreign entities US-owned foreign entities Distributor (compliant) Distributor (non-compliant) Institutional investor (compliant) Institutional investor (non-compliant) Identified non-u.s. Investor Identified U.S. Investor Unidentified recalcitrant investor Non US-owned foreign entities US-owned foreign entities Recalcitrant Entities 30% withholding tax No withholding tax

57 Our Investment Management Team KPMG Executive Briefing UCITS Management Companies 55

58 56 KPMG Executive Briefing UCITS Management Companies Head of Investment Management Nathalie Dogniez Partner T: E: Lutfije Aktan Director UCITS Master Feeder ETF s Swing Pricing Management Company Passport T: E: [email protected] Antoine Badot Director Real Estate T: E: [email protected] Audit Ravi Beegun Partner T: E: [email protected] Victor Chan Yin Partner AIFMD Microfinance Private Equity Restructuring Offshore funds IFRS T: E: [email protected] Advisory Vincent Heymans Partner T: E: [email protected] Sandrine Degreve Director Real Estate T: E: [email protected] Wolfgang Ernst Director Private Equity UCITS T: E: [email protected] Tax Georges Bock Managing Partner T: E: [email protected] Marc Haan Director Fund Distribution Product set-up T: E: [email protected]

59 KPMG Executive Briefing UCITS Management Companies 57 Stéphane Haot Partner AIFMD Real Estate T: E: Pierre Kreemer Partner AIFMD Real Estate T: E: Michael Hofmann Partner ISAE 3402 T: E: Sébastien Labbé Partner UCITS Aberdeen Reclaims T: E: Darren Judge Director UCITS Fund Distribution KIIDs T: E: Gérard Laures Partner UCITS FATCA Aberdeen Reclaims T: E: Jan Klopp Director UCITS ETFs Private Equity T: E: Pascale Leroy Partner UCITS ETFs Risk Management & Valuation T: E: Vincent Köller Partner Management Consulting T: E: Laurence Lhote Partner VAT T: E: Walter Koob Partner UCITS Private Equity T: E: Alison Macleod Partner AIFMD Real Estate T: E:

60 58 KPMG Executive Briefing UCITS Management Companies Anne-Sophie Minaldo Director Internal Audit Risk Compliance T: E: Sandrine Periot Director UCITS AML/KYC T: E: Sven Mühlenbrock Partner UCITS Structured Products AIFMD Solvency II Risk Management & Valuation T: E: Charles Muller Partner European Investment Management Regulation Center of Excellence T: E: Claude Poncelet Partner UCITS Structured Products Private Equity FATCA Aberdeen Claims T: E: Thierry Ravasio Partner Private Equity IFRS AIFMD T: E: Stephen Nye Partner Real Estate Private Equity T: E: Emmanuelle Ramponi Director AIFMD Real Estate T: E: Frauke Oddone Partner Real Estate and Infrastructure T: E: Estefania Rizzo Director ISAE 3402 IT Regulatory Compliance IT Advisory T: E: Patrice Perichon Director ETFs UCITS T: E: Dennis Robertson Partner UCITS T: E:

61 KPMG Executive Briefing UCITS Management Companies 59 Jörg Roth Partner International Fund Taxation T: E: Mickael Tabart Director UCITS Microfinance IFRS ISAE 3402 T: E: Björn Ruppenthal Director International Fund Taxation T: E: Harald Thönes Partner Restructuring Risk Management & Valuation UCITS T: E: Pia Schanz Director UCITS ISAE 3402 T: E: Petra Schreiner Partner UCITS Structured Products ETFs Solvency II T: E: Chrystelle Veeckmans Partner UCITS Structured Products Solvency II Pension Fund/ Life Settlement Business T: E: Jane Wilkinson Director Private Equity Responsible Investment Microfinance T: E: Stéphanie Smets Director UCITS ETFs Corporate Governance T: E: Monika Wirtz Director UCITS SIF T: E:

62 60 KPMG Executive Briefing UCITS Management Companies About KPMG in Luxembourg KPMG in Luxembourg, with over 1,100 staff, is a leading provider of professional services including audit, tax and advisory services. As part of KPMG Europe LLP, it is part of the largest integrated accounting firm in Europe. KPMG is a global network of legally independent professional firms with 145,000 employees in 153 countries. Services provided by KPMG to the investment management industry We aim to provide you with a tailored service of the highest standard. Our Audit services include statutory audits, contribution in kind/merger reports, ISAE 3402 reports. Our Tax services include processing withholding tax reclaims, operational tax reporting, VAT services, Tax structuring in relation with Private Equity and Real Estate investments, analysis of transfer pricing arrangements, corporate tax returns by. Our Management Consulting services support asset management players in improving their operational efficiency, aligning their business and their IT strategies and running transformation projects. Value for Funds is our platform of services dedicated to Management Companies and funds including the following services: Set up and engineering Investment funds set up, re-domiciliation, liquidation Draft and maintenance of the prospectus Asset Servicers selection & migration Accounting and regulatory reporting Accounting and domiciliation of SPVs Corporate secretarial services Financial statements compilation, including IFRS Tax reporting European countries tax preparation (Germany, Austria, Switzerland, Italy, UK, etc.) German tax certification Risk management Risk Management reporting (including VaR, and Commitments approaches) Eligible assets and investment restrictions monitoring Asset valuation review Distribution Cross-border registration with foreign regulators KIIDs: narratives - compilation - SRRI calculation- dissemination Factsheets compilation Risk & compliance Internal Audit insourcing Compliance insourcing AML & KYC compliance review

63 Editorial Committee Ravi Beegun Lutfije Aktan Stéphanie Smets Dorothea Mevissen

64 For more information, please contact: Georges Bock Managing Partner T: E: Nathalie Dogniez Partner T: E: Ravi Beegun Partner T: E: Vincent Heymans Partner T: E: Claude Poncelet Partner T: E: Charles Muller Partner Head of EMA Investment Management Regulation T: E: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG Luxembourg S.à r.l., a Luxembourg private limited company, is a subsidiary of KPMG Europe LLP and a member of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Luxembourg.