UCITS: organisational requirements and rules of conduct

KEY POINTS

Scope

The directive applies to:

• UCITS management companies;
• depositaries²;
• investment companies that have not designated a management company.

Administrative procedures and control mechanism

Management companies must:

• implement decision-making procedures and a clear, documented organisational structure;
• ensure that information is transmitted to the relevant persons⁴ in the proper way;
• implement appropriate internal control mechanisms;
• implement and maintain internal reporting and communication of information;
• maintain records of their business and internal organisation.

Management companies must safeguard the security, integrity and confidentiality of information. They implement transparent procedures for the handling of investors’ complaints.

They must put in place operational accounting procedures for the protection of unit-holders³. UCITS accounting must be kept in such a way that all assets and liabilities of the UCITS can be directly identified at all times. These procedures must be in accordance with the accounting rules of the UCITS’ home countries

Internal control mechanisms

The senior management of management companies:

• is responsible for general investment policy for each managed UCITS and oversees the approval of investment strategies for each UCITS;
• verifies that the general investment policy is properly implemented;
• approves periodically the adequacy of the internal procedures for investment decisions;
• approves periodically the risk management policy;
• ensure permanent compliance function.

A permanent compliance function, with the necessary authority and access to all relevant information, is responsible for:

• evaluating the adequacy and effectiveness of the measures, policies, procedures and actions taken to address any failures of the management company in complying with its obligations;
• advising and assisting the persons responsible for carrying out services and activities to comply with the management company’s obligations.

Management companies must have a permanent, operationally independent risk management function. This function must:

• implement the risk management policy and procedures;
• ensure compliance with the UCITS risk limit system;
• provide advice to the board of directors on the risk profile of each managed UCITS;
• provide reports to the board of directors on the risk management process;
• provide reports to the senior management regarding the current level of risk of its managed UCITS;
• review and support the arrangements and procedures for the valuation of over-the-counter (OTC) derivatives.

Management companies must put in place a procedure to prevent certain relevant persons from:

• performing a personal financial transaction or advising another person to perform such a transaction;
• divulging information that might influence the behaviour of other persons as regards the choice of their transactions.

Management companies must ensure that a record is kept of each portfolio transaction to provide future information on the details of the order and the executed transaction.

The subscription and redemption orders⁵ must also be centralised and recorded immediately. These records are then retained for at least 5 years.

Conflict of interests

The following situations may lead to conflicts of interest, where:

• the management company or a relevant person, or a person directly or indirectly related to the company is likely to make a financial gain, or avoid a financial loss, at the expense of the UCITS;
• the management company or that person has an interest in the outcome of a service provided to the UCITS or another client which does not share the interests of the UCITS;
• the management company or that person has an incentive to favour the interest of another client;
• the management company or that person carries out the same activities for the UCITS as for another client;
• the management company or that person receives money, goods or services illegally.

Management companies are therefore obliged to define in writing an effective policy as regards conflict of interest, which preserves the independence of the relevant persons.

Rules of conduct

Management companies must:

• act in the best interests of UCITS and their unit-holders;
• meet the due diligence requirement;
• notify the unit-holder in case of a subscription or redemption order, confirming execution of this order.

Regarding the due diligence requirements, they must:

• ensure a high level of diligence in the monitoring of investments in the best interests of UCITS and the integrity of the market;
• have adequate knowledge and understanding of the assets in which the UCITS are invested;
• ensure that investment decisions are carried out in compliance with the investment strategy and risk limits of the UCITS;
• perform analyses concerning the investment contribution to the UCITS portfolio.

Management companies must:

• establish procedures which provide for fair execution of portfolio transactions on behalf of the UCITS;
• not be permitted to carry out a UCITS order
  • in aggregate with an order of another UCITS or another client or
  • with an order on their own account.

Particulars of the agreement between a depositary and a management company

The ‘parties to the agreement’ must include in the agreement elements related to:

• the procedures to be followed;
• the exchange of information and obligations concerning confidentiality and money-laundering;
• the appointment of third parties;
• potential amendments and the termination of the agreement.

Risk management policy

Management companies must:

• implement an effective and documented risk management policy including operational risks;
• assess and review the effectiveness of the risk management policy and the level of compliance by the management company with the risk policy;
• measure and manage at any time the risks which the UCITS they manage are, or might be, exposed to;
• calculate the global exposure to risk of the UCITS at least once a day.

Counterparty risk exposure

Management companies must:

• use the positive mark-to-market value of the over-the-counter derivative contract with the counterparty⁶ when calculating the UCITS risk exposure to that counterparty;
• reduce the UCITS exposure to a counterparty of an OTC derivative transaction through accepting a sufficiently liquid collateral that may be sold quickly without losing value.