line of Sight UCITS IV DIRECTIVE NEW ORGANIsATIONAL REQUIREMENTS FOR MANAGEMENT COMPANIES Effective 1 July 2011, new organisational requirements were imposed on management companies and self-managed investment companies (SICAVs) under the Undertakings for Collective Investment in Transferable Securities (UCITS) IV directive. A key element of the Commission Directive 2009/65/EC relates to the organisational structure and substance of the management company or SICAV, and how it and all its third-party delegates conduct their business. The following provides a summary of the changes and, as an example, how Northern Trust Luxembourg Management Company, S.A. has incorporated the changes into its operating model. Northern Trust is working with clients and their appointed investment managers to confirm the effects of the change and the new requirements needed to be fulfilled under UCITS IV. September 2011 northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 1 of 12
CONTENTS introduction... 3 key c hanges introduced under ucits iv... 3 northern trust s management company response to ucits iv... 4 permanent functions...4 increased governance and structure... 5 appendix... 7 investment managers not authorised under mifid... 7 procedures for compliance with requirements for best execution... 7 ongoing review and compliance...8 policies and procedures for handling recording and allocation of orders...8 policies and procedures for aggregation and allocation of orders within permitted exceptions...9 procedures for the monitoring and evaluating the effectiveness of the aggregation and allocation of orders...9 inducements, fees, rebates and soft commissions...9 procedures for compliance with policy on inducement, fees, rebates and soft commission... 10 procedures for review of costs and fees... 10 procedures for the monitoring and evaluating the effectiveness of the foregoing...11 northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 2 of 12
INTRODUCTION As of 1 July 2011, the requirements of European Commission Directive 2009/65/EC (the UCITS IV Directive) were transposed into Luxembourg law in Chapter 15 of the law dated 20 December 2010 regarding undertakings for collective investment (the 2010 Law). CSSF Circular 11/508 dated 15 April 2011 set out the main changes which management companies and SICAVs would have to comply with by 1 July 2011 in order to meet the requirements of the 2010 Law and CSSF Regulation 10-4 implementing Commission Directive 2010/43/EU of 1 July 2010. The 2010 Law and regulations (including Regulation 10-4 and 10-5 and the subsequent clarification provided by the CSSF in Circulars 11/508, 11/509 and 11/512), set out the organisational requirements and governance structure of management companies and SICAVs. The following outlines the additional obligations and organisational structures required to support Northern Trust management company services, and highlights the changes that affect our clients and third parties. KEY CHANGES INTRODUCED UNDER UCITS IV The UCITS IV Directive imposes increased governance and risk management requirements on UCITS management companies that undertake collective portfolio management services, and SICAVs. The key changes are: The addition of three permanent functions to support the management company s board of directors Compliance (article 11 of Regulation 10-04) Internal audit (article 12 of Regulation 10-04) Risk management (article 13 of Regulation 10-04) Increased governance and structure General principles of how the management company will function on a day-to-day basis (article 102(1)(e) of the 2010 Law, articles 5, 6, 8, 9, 15 and 16 of Regulation 10-4) The management company s initial and ongoing due diligence of delegated functions to ensure internal organisation and internal procedures enable access to all relevant information, allowing efficient control (article 5 of Regulation 10-4) Establishing a clear and precise procedures textbook (article 5 of Regulation 10-4) Complaints handling (article 7 of Regulation 10-4) Conflicts of interest Conflicts of interest policy (articles 18 to 22 of Regulation 10-4) Strategies for the exercise of voting rights (article 23 of Regulation 10-4) Enhanced rules of conduct (articles 25 to 32 of Regulation 10-4) Acting in investors best interests Execute investment decisions in accordance with the objectives, investment strategy and risk limits of the fund Best execution Personal account dealing Rapid and equitable execution of portfolio transactions northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 3 of 12
It should be noted that, for the first time, UCITS management companies and the funds they manage need to align with the Markets in Financial Instrument Directive (MiFID) regarding best execution, inducements, fees, rebates and commissions Oversight of the Key Investor Information Document (KIID) process Risk management (articles 42 to 50 of Regulation 10-4, Circular 11/512) Update risk management procedures to include market and counterparty risk Broader risk management scope that includes operational and liquidity risks as well as other material risks for the fund and management company. NORTHERN TRUST S MANAGEMENT COMPANY RESPONSE TO UCITS IV A working group was established to review the new UCITS IV regulations and implement any changes necessary to ensure our management companies, including Northern Trust Luxembourg Management Company, S.A. (NTLMC), meet the requirements of the regulations. We have been working on the following key areas: Permanent functions Compliance A permanent compliance manager has been appointed to NTLMC. This person s responsibilities include but are not limited to the following: Overseeing the management company and its third-party delegates to ensure they comply with the regulations; Producing and maintaining the procedures textbook including all policies and procedures of NTMLC; Developing review mechanisms and performing periodic reviews to ensure procedures and process are in place and meet the obligations set in the procedures textbook, and are in line with regulations. Internal Audit A permanent internal audit function has been appointed to NTLMC. This function s responsibilities include but are not limited to the following: A risk assessment process to describe and analyse risks inherent within NTLMC and each fund it manages; Establishing and maintaining an audit plan to examine and evaluate the adequacy and effectiveness of the management company s systems, internal controls and arrangements. Risk Management A permanent risk manager will be appointed to NTLMC. The role s responsibilities include but are not limited to the following: Documenting and implementing the risk management policy and procedures on behalf of NTLMC; Completing a risk assessment for each portfolio and third-party delegate, and assigning the appropriate oversight risk management approach and risk ratings; Performing checks on the adequacy of risk management systems and policies and procedures utilised by NTLMC and its third-party delegates; northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 4 of 12
All three permanent functions will report to the NTLMC s board of directors as appropriate but at a minimum on an annual basis. Increased governance and structure A procedures textbook has been completed detailing the day-to-day operational process, policies and procedures of NTLMC and its third-party delegates. As part of its updated authorisation file, NTLMC has satisfied the Luxembourg regulator that it has: (a) adequate management resources to conduct its activities effectively; (b) employed personnel with the skills, knowledge and expertise necessary for the discharge of their responsibilities; (c) adequate control systems, records and accounting procedures to facilitate effective management, and satisfies the regulators supervisory and reporting requirements in compliance with the regulations; and (d) where functions have been delegated to third parties, NTLMC has determined the delegate has satisfied points (a) to (c) above. The organisation of NTLMC has been structured so that no one person can decide on the direction of the management company without endorsement. In addition, the management company ensures that in the instance where multiple functions are performed by the same director or directors delegate, this will not prevent the director or directors delegate from discharging the particular function soundly, honestly and professionally. Enhanced rules of conduct (including new policies and procedures) Included in the procedures textbook are the rules of conduct for NTLMC which include but are not limited to the following: (a) NTLMC has identified late trading and market timing as being a key form of malpractice affecting the UCITS and has put procedures in place to prevent, monitor and evaluate any instances that may arise. (b) NTLMC has implemented a conflict-of-interest policy, defining the key areas of conflict that will be monitored against and reported to the Board of Directors. (c) NTLMC has implemented and will maintain an effective and transparent process for managing complaints received from the UCITS s investors maintaining records of all complaints (including NTLMC s response), any other relevant correspondence or records and the action taken to resolve. (d) NTLMC will ensure there are adequate procedures in place to record: portfolio transactions, subscriptions and redemptions calculation of the Net Asset Value, assets and liabilities delivery of the UCITS report and accounts which reflect a true and fair view of the financial position In addition NTLMC will also ensure there are systems in place to permit and support the proper recording of transactions. (e) NTLMC will ensure there are adequate systems and processes in place to retain documentation in line with local regulations. northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 5 of 12
(f) In the case of an interruption to the management company systems and procedures, NTLMC has established a business continuity policy to ensure essential data and functions are preserved or, where possible, the timely recovery of such data and functions. (g) Where NTLMC appoints a third party to perform a function of the management company it is required to perform initial and ongoing provider due diligence. This process will seek to ensure, inter alia, that each management company delegate has policies and procedures consistent with the management company s own code of conduct as outlined above. Alignment with Markets in Financial Instrument Directive (MiFID) As part of the new rules of conduct under UCITS IV, management companies (and SICAVs) and their appointed investment managers need to apply policies and procedures in alignment with MiFID. As NTLMC delegates portfolio management performance to third-party investment managers, we will require all appointed investment managers to confirm they have implemented policies and procedures in line with MiFID. They also must take all reasonable steps to obtain the best possible results when executing orders on behalf of the funds, and act in the best interests of the funds and its investors when executing decision to deal. In addition, NTLMC will also require all investment managers to maintain and implement an adequate inducements policy to cover all inducements, fees, rebates, soft commissions and personal transactions. Please refer to the Appendix for more details. IMPACT TO OUR CLIENTS AND INVESTMENT MANAGERS In completing our own updated authorisation file we have identified a number of areas which will affect our clients and investment managers. Risk Management For each UCITS and investment manager NTLMC appoints, a risk assessment and profile will be undertaken in line with the regulations and in liaison with the investment manager. This will cover all aspects of operational and investment risks including market, liquidity (both assets and liabilities) and counterparty risks. For a UCITS investing in financial derivative instruments NTLMC will need to amend the risk management process, and document and confirm whether Value at Risk (VaR) or the commitment approach to monitoring global exposure will be adopted. The outcome of the risk profiling will determine the basis adopted. It should be noted that daily portfolio market risk calculations are required under UCITS IV for all funds. Alignment with MIFID For each UCITS and investment manager, NTLMC will need to ensure there are adequate controls and processes in place to fulfil MiFID requirements (please refer to the Appendix for more details). northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 6 of 12
Delegation of third parties and requiring initial and ongoing due diligence NTLMC is obliged to perform, or ensure the performance of, initial and ongoing reviews of all third parties; this includes appointed investment managers and distributors as well as investment consultants appointed as appropriate. NTLMC will use a risk-based approach in service provider due diligence, which may involve on-site visits, review of internal policies and procedures, increased reporting requirements and other activities, as appropriate. Rules of conduct NTLMC will need to ensure any appointed third party has the appropriate rules of conduct in place. We will be working with our clients and their appointed investment managers on an individual basis to confirm the impact of the change and the new requirements we will need them to fulfil under UCITS IV. Attached in the Appendix is a sample of the policies and procedures that will support the alignment to MiFID. Appendix Suggested Policies and Procedures complying with best execution requirements Subject to any specific instructions received from the UCITS, when the investment manager: (i) transmits orders received from the UCITS to another dealer/or affiliate for execution; or (ii) places orders with other entities for execution that result from decisions by the management company to deal in financial instruments on the UCITS behalf. The investment manager is obligated to take all reasonable steps to obtain the best possible result for the UCITS. The investment manager will, therefore, either determine the ultimate execution venue/entity for the decision to deal on behalf of the UCITS on the basis of the order execution factors as described above (giving specific instructions to the other dealer/ affiliate) or the investment manager will determine the other dealer/affiliate has arrangements in place to enable the investment manager to comply with its obligations to the UCITS. Where the investment manager transmits orders to, or place orders with, other brokers/ affiliates, the investment managers shall monitor the standard of execution being provided by them and, where appropriate, look to correct any deficiencies. For each financial instrument class, the management company expects the investment manager will define key execution factors taken into account when executing orders and information, and the execution venues/entities that best suit its requirements. (Note the following list is not exhaustive.) northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 7 of 12
Money Market Instruments The key criteria in selecting a money market broker will generally be: ability to source products ability to settle the trade timely trading rating length of relationship ability to deal in very large volumes Foreign Exchange The key criteria in selecting an FX broker will generally be: clearance and settlement capability for the currencies involved; creditworthiness and financial stability timely trading broker rating long-standing relationships ability to deal in very large volumes An execution venue means a regulated market, multilateral trading facility (MTF), a systematic internaliser, a market maker, a transfer agent, other liquidity provider (or an entity that performs a similar function in a non-eea country to the functions performed by any of the foregoing) or on an over-the-counter basis. The investment manager will assess which venues are likely to provide the best possible result for the UCITS on a product-by-product basis. In the case of certain financial instruments, there may only be one execution venue. In executing a trade in such circumstances, the investment manager will presume the execution venue has provided the best possible result for these types of financial instruments. ongoing review and compliance The investment manager will monitor the effectiveness of order execution arrangements and the order execution policy in order to identify and, where appropriate, correct any deficiencies. The investment manager will assess, on a regular basis, whether the quality of the execution venues/entities included in the order execution policy provide for the best possible result for the UCITS, or whether the investment manager needs to make changes to the execution arrangements/correct any deficiencies. The management company will review investment manager reports on a periodic basis to demonstrate they have executed orders on behalf of the UCITS in line with the management company s best execution policy. The management company will review the order execution arrangements and order execution policy at least annually or whenever a material change occurs affecting the management company s ability to continue to obtain the best possible result for UCITS order execution on a consistent basis, using the venues included in this policy. northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 8 of 12
recording and allocating orders The investment manager has put in place the following procedures and arrangements to ensure prompt, fair and expeditious execution of orders. It shall ensure: Orders executed are promptly and accurately recorded Orders are executed sequentially unless prevailing market conditions or UCITS interests require otherwise Financial instruments/sums of money received in settling executed orders shall be promptly and correctly delivered to the appropriate account No misuse of information relating to pending orders aggregating and allocating orders, within permitted exceptions The investment manager shall ensure fair allocation of aggregated orders, including how the volume and order price determines allocations and the treatment of partial executions. In so doing, the investment manager shall consider the following factors: It must be unlikely they will work to the overall disadvantage of any UCITS and shareholders of the UCITS Where orders are aggregated but only partially executed, the related trades shall be allocated in accordance with the order allocation policy Where the investment manager aggregates an order of the UCITS or another client with a transaction for their own account, and it is partially executed, it allocates the related trades to the UCITS or other client in priority over their own. Aggregation in this manner should not occur; instances of aggregation must have pre-approval. monitoring and evaluating effectiveness of aggregating and allocating orders The investment manager s order allocation policy and the procedures in place as set out above are reviewed on an ongoing basis by an independent function within the investment manager. Should the procedures prove insufficient to ensure, with reasonable confidence, that risks of damage to the interests of the UCITS or shareholders are being prevented; the investment manager shall be promptly informed so their order allocation policy can be revised accordingly. Inducements, Fees, Rebates and Soft Commissions An inducement is any fee, commission or non-monetary benefit paid or provided to or by the management company for investment management or ancillary services to the UCITS. Where the investment manager is an investment firm authorised under national laws implementing MiFID, the investment manager is obligated to maintain an adequate inducements policy. The management company will not require further reports from such third parties, other than quarterly attestation of compliance. Where the investment manager or other third party provider is not authorised and regulated under MiFID, the third party is required to ensure the obligations described northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 9 of 12
below are met. Such third-party providers are further required to submit quarterly attestation of compliance with the below obligations. The management company is not permitted to pay or accept any fee or commission, or provide or receive any non-monetary benefit in relation to designated investment business or, in the case of MiFID business, another ancillary service on behalf of the UCITS other than: (i) A fee, commission or non-monetary benefit paid or provided to or by a third party or a person acting on behalf of a third party, if: The payment of the fee, commission or provision of a non-monetary benefit is designed to enhance the quality of the service to the UCITS and not impair the management company s duty to act in the best interests of the UCITS. The existence, nature and amount of the fee, commission or benefit is clearly disclosed to the UCITS and UCITS shareholders in a comprehensive, accurate and understandable manner; or (ii) Proper fees which enable or are necessary to provide the relevant service, including custody costs, settlement and exchange fees, regulatory levies or legal fees, and which, by their 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 the UCITS. Delegates of the management company are prohibited from offering, giving, soliciting or accepting an inducement, gift or benefit likely to materially conflict with any duty owed to the UCITS and its shareholders Should any delegate be in receipt of a gift of the equivalent or higher than the stated value, the item(s) must be immediately disclosed to the compliance officer. This rule must be strictly adhered to and there are no exceptions. The management company shall at all times work to prevent undue costs being charged to the UCITS and its shareholders. complying with policy on inducement, fees, rebates and soft commission Compliance with the management company s policies and procedures and with regulatory requirements is the responsibility of all relevant persons. Delegates of the management company are prohibited from offering, giving, soliciting or accepting an inducement, gift or benefit likely to materially conflict with any duty owed to the UCITS and its shareholders. All investment business fees charged by the management company are fully disclosed to shareholders of the UCITS it manages. Disclosures shall be made before the service is provided. Any soft commissions, retrocession fees and non-monetary benefits will be disclosed to the shareholders of the UCITS and all management company fees are designed to enhance the overall quality of service to the UCITS and the UCITS shareholders. Where the management company or any of its delegates successfully negotiates the recapture of a portion of broker/dealer commissions connected with the purchase and/or sale of securities for the UCITS, the rebated commission shall be paid to the UCITS. northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 10 of 12
review of costs and fees The Management Company has put the following procedures in place regarding the review of costs and fees: Gift/benefit declaration forms must be submitted for approval to compliance Third-party service contracts shall contain fee disclosures and suitable agreements Shareholder documentation shall fully disclose all fees are appropriate For providers not authorised under MiFID, all service agreements and other relevant documentation shall detail all fees in order to enhance the quality of service to the UCITS and the shareholders The management company is permitted to disclose fees in summary form provided it discloses further details at the specific request of the investor. monitoring and evaluating the effectiveness of the foregoing The management company will review agreements periodically and the compliance officer will be informed of any significant risk or change items. Any non-disclosure or other breaches of policy will be reported to the board of directors of the UCITS Delegates of the management company not authorised and regulated under MiFID will sign an annual declaration that they fully understand the gift policies above and are in compliance with these Any policy updates will be communicated to non-mifid delegates to ensure full understanding of requirements at all times Risk-based monitoring reviews are in place to ensure disclosures to shareholders are documented in a clear and understandable way It should be noted that under this policy, non-mifid delegates of the management company are required to align and update their local firm policies to be compliant with UCITS rules. The management company will also seek to monitor its delegates to ensure they adopt this policy. Non-MiFID delegates will be required to submit to the management company quarterly specific Key Risk Indicator reports (KRI) together with exceptions-based reporting on an occurrence basis. This material is directed to institutional investors, expert investors and professional investors only and should not be relied upon by retail investors. Northern Trust Global Investments Japan, K.K. is regulated by the Japan Financial Services Agency. Northern Trust operates in Australia as a foreign authorised deposit-taking institution (foreign ADI) and is regulated by the Australian Prudential Regulation Authority. Northern Trust in Hong Kong is a securities company regulated by the Securities and Futures Commission. Northern Trust in Singapore is a foreign wholesale bank regulated by the Monetary Authority of Singapore. The Northern Trust Company has a branch in China regulated by the China Banking Regulatory Commission. We hope you enjoy the latest presentation from Northern Trust s Line of Sight. By providing research, findings, analysis and insight on the effects and implications of our changing financial landscape, Line of Sight offers the clarity you need to make better informed decisions. northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 11 of 12
Northern Trust Corporation, Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A., incorporated with limited liability in the U.S. The Northern Trust Company, London Branch (reg. no. BR001960), Northern Trust Global Investments Limited (reg. no. 03929218) and Northern Trust Global Services Limited (reg. no. 04795756) are authorised and regulated by the Financial Services Authority. The material within and any linked material accessed via this communication is directed to eligible counterparties and professional clients only and should not be distributed to or relied upon by retail investors. For Asia Pacific markets, it is directed to institutional investors, expert investors and professional investors only and should not be relied upon by retail investors. Northern Trust (Guernsey) Limited, Northern Trust Fiduciary Services (Guernsey) Limited, and Northern Trust International Fund Administration Services (Guernsey) Limited are licensed by the Guernsey Financial Services Commission. Northern Trust International Fund Administrators (Jersey) Limited and Northern Trust Fiduciary Services (Jersey) Limited are regulated by the Jersey Financial Services Commission. Northern Trust International Fund Administration Services (Ireland) Limited, Northern Trust Securities Services (Ireland) Limited and Northern Trust Fiduciary Services (Ireland) Limited are regulated by the Central Bank of Ireland. Northern Trust Global Services Limited has a Luxembourg Branch, which is authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF). Northern Trust Luxembourg Management Company S.A. is regulated by the Commission de Surveillance du Secteur Financier (CSSF). Northern Trust Global Investments Limited has a Netherlands branch, which is authorised by the Financial Services Authority and subject to regulation in the Netherlands by the Autoriteit Financiële Markten. Northern Trust Global Services Limited has a Netherlands Branch, which is authorised and regulated in the Netherlands by De Nederlandsche Bank. Northern Trust Global Investments Limited has a Sweden branch, which is authorised by the Financial Services Authority and subject to regulation in Sweden by the Finansinspektionen. Northern Trust Global Services Ltd (UK) Sweden Filial is authorised by the Financial Services Authority and subject to regulation by the Finansinspektionen. Northern Trust Global Services Limited operates in Abu Dhabi as a Representative Office. Our registered office is authorised and regulated by the Central Bank of the United Arab Emirates. The Northern Trust Company operates in Australia as a foreign authorised deposit-taking institution (foreign ADI) and is regulated by the Australian Prudential Regulation Authority. The Northern Trust Company has a branch in China regulated by the China Banking Regulatory Commission. The Northern Trust Company of Hong Kong Limited is a securities dealing company regulated by the Securities and Futures Commission. Northern Trust Global Investments Japan, K.K. is regulated by the Japan Financial Services Agency. The Northern Trust Company has a Singapore Branch, which is a foreign wholesale bank regulated by the Monetary Authority of Singapore. The Northern Trust Company operates in Canada as The Northern Trust Company, Canada Branch, which is an authorised foreign bank branch under the Bank Act (Canada). Trustee related services in Canada are provided by the wholly owned subsidiary The Northern Trust Company, Canada, an authorised trust company under the Trust & Loans Companies Act (Canada). Deposits with The Northern Trust Company and its affiliates and subsidiaries are not insured by the Canada Deposit Insurance Corporation. IRS CIRCULAR 230 NOTICE: To the extent that this message or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see http://www.northerntrust.com/circular230. northerntrust.com Line of Sight: UCITS IV Requirements for Management Companies 12 of 12 Q32279 (1/12)