European Fiduciary Services NEWS & VIEWS - Citibank · European Fiduciary Services NEWS & VIEWS 06 European Financial Transaction Tax: What it Means for Investors ... Partner, Asset

European Fiduciary Services News and Views | Second Edition | 2013

European Fiduciary Services

NEWS & VIEWS

06European Financial Transaction Tax: What it Means for Investors and Financial MarketsAn analysis of what the impact of the FTT may be, what the final proposal may look like and how cilents can prepare for it.

11Capital Requirements Directive IV and RegulationAn overview of CRD IV, its scope, UK implementation and key issues for consideration by UK asset managers.

15After the AIFMD, What Can We Possibly Expect from UCITS V?A detailed look at the changes we might expect to see carried across from the AIFMD and AIFMR in the final UCITS V text. Includes a comparative table of the remuneration requirements of both Directives.

27EMIR: Latest Developments, Timelines and Pitfalls for the UninitiatedA focus on the EU Regulation, its scope, requirements, the implications for derivatives users and what is still to come.

ContributorsCatherine Davidson Director, European Government Affairs, Citi [email protected] +44 (0) 20 7986 7136

Laurent Fessmann Partner Baker & McKenzie, Luxembourg [email protected] +352 26 18 44 205

Glenn G Fox Partner Baker & McKenzie, New York [email protected] +1 212 626 4689

Anne H Gibson Adjunct Professor, University of Oklahoma College of Law, Norman [email protected] +41 44 384 1336

Frank G B Graaf Partner Clifford Chance LLP, Amsterdam [email protected] +31 (20) 711 9150

Kees Groffen Partner De Brauw Blackstone Westbroek N.V. [email protected] +31 20 577 1025

Amanda Hale Head of EMEA Fiduciary Technical, Securities and Fund Services, Citi [email protected] +44 (0) 20 7508 0178

Irving Henry Prudential Specialist Investment Management Association [email protected] +44 (0) 20 7831 0898

Sandrine Leclercq Counsel Baker & McKenzie, Luxembourg [email protected] +352 26 1844 261

Marnin J Michaels Partner Baker & McKenzie, Zurich [email protected] +41 44 384 1208

Patricia Taylor Partner, Asset Management and Investment Funds William Fry, Ireland [email protected] +353 1 639 5000

Nadine Teychenne Director, Global Product Development, Custody and Clearing Securities and Fund Services, Citi [email protected] +44 (0) 20 7986 5714

Gregory C Walsh Associate Baker & McKenzie, Zurich [email protected] +41 44 384 12 91

Johan Wigh Chief Operating Officer East Capital AB [email protected] +46 8 505 97 701

European Fiduciary Services News and Views | Second Edition 2013 1

Contents23

27

32

35

38

46

04

02

06

11

15

20

LUxEMBOURG

AIFMD Implementation: Challenges for Funds of Funds Servicing

Laurent Fessmann and Sandrine Leclercq

THE NETHERLANDS

EMIR: Latest Developments, Timelines and Pitfalls for the Uninitiated

Frank G.B. Graaf

THE NETHERLANDS

The AIFMD in the Netherlands

Kees Groffen

SWEDEN

Retrocession Ban

Johan Wigh

INTERNATIONAL

FATCA and Non-US Trusts and Trust Structures: Compliance Options Exist

Marnin J Michaels, Gregory C Walsh, Glenn G Fox and Anne H Gibson

GLOSSARY

EUROPE

Inside Brussels

Catherine Davidson

INTRODUCTION

David Morrison

EUROPE

European Financial Transaction Tax: What it Means for Investors and Financial Markets

Nadine Teychenne

UNITED KINGDOM

Capital Requirements Directive IV and Regulation

Irving Henry

UNITED KINGDOM

After the AIFMD, What Can We Possibly Expect from UCITS V?

Amanda Hale

IRELAND

AIFM Authorisation: Ireland’s Approach

Patricia Taylor

Securities and Fund Services | Introduction2

Welcome to our latest issue of European Fiduciary Services News and Views. The European summer hiatus is now a distant memory and much progress has been made on the regulatory agenda.

In our first 2013 publication, we focused purely on AIFMD, and while we take a deeper look at local AIFMD implementation in this edition, we also cover a much broader range of topics.

There appears to be little sign of a slowing down in the world of regulation. In our first article, “Inside Brussels”, we discuss how policymakers must try to finalise as much financial services legislation as possible before the European Parliament elections next May. This article touches on key political priorities, such as how to progress the European Banking Union, establishing a Single Resolution Mechanism, the EU Bank Recovery and Resolution Directive, MiFID II and the Financial Transaction Tax (FTT).

There has been much publicity surrounding the FTT and, most recently, the press reported that a top legal adviser to European finance ministers concluded that the proposed tax exceeds national jurisdiction, infringes on EU treaties and “is discriminatory” to non-participating states. Our article on the FTT explains what the proposals mean for clients and financial markets in general.

The next article discusses the Capital Requirements Directive (CRD IV), which needs to be implemented by 1 January 2014. We are still waiting (at the time of writing) for the FCA, HM Treasury and the European Banking Authority to publish final (and much needed) details, which, it is hoped, will assist with the implementation of the Directive and Regulation into national legislation.

CRD IV will impact firms in different ways and the article looks specifically at UK implementation issues. This Directive has been contentious in parts with the UK government having launched a legal challenge in the European Court of Justice regarding bonuses specifically. The government has expressed fears that the new bonus rules will undermine responsibility in the banking system rather than promote it.

This edition also contains articles looking at AIFMD authorisation, marketing and implementation approaches and challenges in Ireland, Luxembourg and the Netherlands. We also look at the latest draft of UCITS V as adopted at the EU Parliament plenary session on 3 July 2013 and compare and contrast this to the equivalent requirements under AIFMD. Recently, it has been reported that Lithuania, the current holder of the EU’s rotating presidency, is to schedule a working group on UCITS V for the 21 October (also at the time of writing), which has raised expectations that a draft directive could be finalised by the spring.

Another piece of regulation that has been of much interest to our clients is the European Market Infrastructure Regulation (EMIR). The article on this subject talks about the latest developments, timelines, requirements and potential pitfalls.

The penultimate article discusses distribution and the potential effects of a retrocession ban in Sweden, and finally, we are pleased to include an article on FATCA, non-US trusts and trust structures in terms of entity classifications, and how this may result in different outcomes for FATCA compliance, which was originally published in the Journal of Taxation, in August 2013.

We would like to thank all of our contributors to this publication and hope that you enjoy reading it.

If you have any questions or would like to know more about other regulatory matters not covered in this edition, we invite you to contact our European Fiduciary Technical Team (see contact details at the back), who will be happy to help.

Introduction

David Morrison

Head of Fiduciary Services, EMEA, Securities and Fund Services, Citi


Securities and Fund Services | Europe4

Unlike the US, which legislated through the Dodd-Frank Act, the European Union (EU) is dealing with regulatory reform through many separate pieces of legislation. To date, there has been some agreement on a few of these: the AIFMD (Alternative Investment Fund Managers Directive); EMIR (the European Market Infrastructure Regulation) dealing with the central clearing of OTC derivatives and trade repositories; and, more recently, CRD4 (the Capital Requirements Directive). Despite these “successes”, many legislative files in this extensive reform programme have yet to be finalised, let alone implemented.

The current EU legislative cycle will draw to an end with the European Parliament elections at the end of May 2014. So there is now a palpable sense of urgency to try and get as many key pieces of legislation agreed as possible before this deadline. Moreover, the European Parliament’s own secretariat has set an internal deadline of 18 February for political agreements to be reached in order to formally approve the legislation. While uncompleted legislation can be rolled over to the next parliamentary session, this would mean a significant delay, particularly since the new European Parliament will be initially focused on internal administration and conducting hearings for the new European Commission, which will be appointed on 1 November 2014.

Given this legislative backlog, what are the priorities?

The biggest political priority is progressing the Banking Union, something seen as essential to increasing economic and monetary union, breaking the link between banks and sovereigns

and so restoring confidence in banks and in the euro. The Banking Union will cover the euro area and those Member States that want to participate (N.B. the UK has ruled itself out).

The EU has just agreed the first step, the Single Supervisory Mechanism, which will make the European Central Bank (ECB) the prudential supervisor of all banks and the principle supervisor of systemically important banks within the Banking Union. The ECB is expected to take up this role in September 2014.

The second step is the proposal to establish a Single Resolution Mechanism (SRM) for those banks within the Banking Union. This is proving contentious, with Member States (particularly Germany) raising concerns about the centralisation of power in the European Commission; the creation of a single resolution fund and the legal soundness of the proposal. There is political pressure to agree the SRM in this legislative cycle, but it is unclear whether this will be achieved and, if it is, whether the final outcome will be substantially different from the current proposal. Discussions may speed up following the elections in Germany on 22 September 2013.

Linked to the SRM is the EU Bank Recovery and Resolution Directive, which would provide the resolution framework for all 28 EU Member States. This is regarded as the cornerstone of the regulatory reform programme, and many policymakers are dismayed that so long after the crisis this has still not been agreed. The Cyprus bailout highlighted the importance of getting a European resolution framework in place, and, given the political momentum, it now looks likely there will be an agreement

Inside BrusselsThe next six to nine months will be crucial in Brussels, as policymakers try to agree on as many pieces of financial services legislation as possible before the European Parliament elections in May next year.

It has been five years since the G20 leaders first met in Washington to agree common principles to reform financial markets in response to the crisis. Since then much has been achieved. Despite the agreed G20 roadmap, however, there have been inconsistencies between jurisdictions in the implementation and timing of the reforms.


before the end of the year. But there are still divergences on key issues, e.g. the design and the scope of the bail-in regime (including the treatment of depositors); resolution financing arrangements; the powers of home and host authorities; and the role of the European Banking Authority.

Another key plank of the regulatory reform programme that has not progressed quickly since the original proposal was presented in 2011 is “MiFID2”. The review of the Markets in Financial Instruments Directive (MiFID) is one of the most significant pieces of financial services legislation, representing a market structure overhaul and delivering the G20 commitment to increase the electronic platform trading of standardised derivatives where appropriate. Both the Council (Member States) and the European Parliament have agreed their positions on the proposal, and they are now beginning talks to negotiate an agreement. This will be far from straightforward, as there are some fundamental differences of opinion, e.g. on the new Organised Trading Facility category, transparency obligations, high-frequency trading, inducements and third-country access.

One topic that has been making the headlines is the Financial Transaction Tax (FTT), which 11 EU Member States have been proceeding with through a rarely used “enhanced cooperation procedure”. Little progress has been made given the differences of opinion between Member States and a recent opinion from the Council’s Legal Service, which questioned the legality of the “establishment principle” (i.e. charging the FTT on the basis of a financial institution’s or its customers’ place of establishment) suggests there will be a reduction in the scope of the original proposal. Even if the proposal shifts to an “issuance principle”’ (i.e. charging FTT on the basis of where a financial instrument is issued) contentious issues still remain, e.g. the application of the FTT to repos, government bonds and pension funds.

Other dossiers that are progressing include: the Central Securities Depositories Regulation; the Market Abuse package; Packaged Retail Investment Products (PRIPs) legislation; and the Retail Banking package (which includes comparability of fees related to payment accounts, payment account switching and access to payment accounts with basic features). Recent proposals,

which are unlikely to be completed in this legislative cycle, include a Regulation to cap multilateral interchange fees, a review of the Payment Services Directive and a Money Market Funds Regulation.

While these are some of the dossiers currently on the table, we are, of course, still awaiting several other important proposals. In October, the European Commission is expected to present its proposal on EU bank structural reform (following recommendations made by the Liikanen expert group). The content of this proposal is not yet known, although this will set out a framework that may or may not be compatible with national initiatives such as the Vickers ring-fencing reforms in the UK. Other proposals expected before the end of the year include: a resolution framework for central counterparties and other non-bank entities, including Central Securities Depositaries (CSDs), Securities Law Legislation and a UCITS VI proposal.

There will be a rush to finalise the key priorities before the European Parliament elections, that much is clear. But it is also clear that there will be no let-up in the regulatory reform agenda for the foreseeable future. It should also be noted that once these dossiers are agreed at a political level, there will still be a lot of work for the European Supervisory Authorities, which are mandated to prepare many of the implementing technical standards.

Catherine Davidson Director, European Government Affairs, Citi

The review of MiFID is one of the most significant pieces of financial services legislation, representing a market structure overhaul and delivering the G20 commitment to increase the electronic platform trading of standardised derivatives where appropriate.


European Financial Transaction Tax: What it Means for Investors and Financial MarketsEurope’s proposed financial transaction tax (FTT) has been widely analysed within the financial community, though its implications are less widely understood by investors, corporates and consumers. We look at what its impact may be, what the final proposal may look like and how clients can prepare for it.

Where we’ve come from . . . European Commission President Jose Barroso first proposed the FTT in September 2011. The European Parliament voted in favour in May 2012 despite strong opposition from a number of Member States. The proposal was then passed to ECOFIN, the European Council body responsible for deciding tax matters.

In October 2012, after a lack of unanimity in ECOFIN, 11 countries (EU11) agreed to proceed with the FTT under the “enhanced cooperation” procedure, which is open to a minimum of nine Member States. The EU11 are Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovenia, Slovakia and Spain (FTT Zone). The Commission subsequently issued substantive proposals in February 2013 that are being negotiated and that will eventually be implemented by the EU11. Although the European Parliament’s role in the enhanced cooperation procedure is minimal, it supported the proposal, with suggested amendments, in July this year.

Separately, France and Italy have both introduced an FTT on equities. These taxes came into effect on 1 August 2012 in France and on 1 March 2013 in Italy. On 1 September, Italy extended the tax to equity derivatives.

. . . and where we are nowThe situation remains fluid. In April 2013, the British government filed a legal challenge to the decision authorising the use of enhanced cooperation with the European Court of Justice. In June, the Commission tacitly admitted that the January 2014 launch date was no longer realistic but the FTT could still enter into force towards the middle of 2014. Tax commissioner Algirdas

Semeta subsequently said the Commission was prepared to consider lower tax rates in certain market segments, including government bonds and pension funds.1

The impact on the marketsThe European Commission expects the FTT to reduce trading in derivatives by 75% and cash equities and bonds by 15%.2 This is supported by trends in French and Italian equity turnover since the two countries introduced their own FTTs. According to Tabb Group, France’s share of European equity market volume fell from 21% before the introduction of the FTT to 12% in July 2013, while Italian equity turnover halved.3 Citi’s Hans Lorenzen, Head of European Investment Grade Credit Product Strategy, says the proposed tax has big implications for liquidity. The impact is likely to be “particularly pronounced in fixed income, reflecting higher transaction costs relative to likely volatility.” 4 Short duration products are expected to be most affected. Bank of America Merrill Lynch argues that “the FTT as currently constructed would render a whole range of current financial products and practices uneconomic.” 5

Prime among them is repo, a EUR1 trillion market. Lorenzen says: “The proposals would have an enormous impact on repo markets, where overnight rolling costs would amount to no less than 22% annually. In all probability, all repos would have to be re-documented as some form of loan transaction, which is not straightforward as it creates a host of other problems associated with the transfer of ultimate ownership.” The International Capital Markets Association (ICMA) has warned that the Commission’s proposals put the “economic viability of the industry at risk.” 6


There are concerns, too, about the securities lending market. According to the International Securities Lending Association (ISLA), this generated incremental revenues of EUR3 billion for long-term investors in Europe in the year to May 2013. ISLA predicts that applying the FTT as envisaged would reduce the market to about a third of its current size. “Securities lending fee levels would need to increase by over 400% just to maintain current revenue streams,” it says.7

Operational and infrastructure issuesThe FTT has wide operational implications. ISLA suggests the tax could result in the removal of close to EUR500 billion of government bonds from the lending/collateral markets. “The growing demand to borrow high-quality collateral for the purposes of collateralising centrally cleared and other derivative transactions will be substantially undermined by the FTT with pools of potentially eligible collateral effectively left immobilised by the tax”, it says.8

Entities other than those party to the transactions — such as central counterparties (CCPs), central securities depositories (CSDs), international central securities depositories (ICSDs) and by default their members — under Article 10 of the proposal could be held jointly and severally liable for collection of the FTT. Clearing members have a principal relationship with a CCP. As such, central clearing will also incur an FTT charge. At present, they and a CCP only take counterparty risk on each other. However, the introduction of joint and several liability for the payment of the tax on all participants in a transaction chain — as envisaged in the Commission proposal — could introduce anonymous counterparty risk.

The costs to market participantsGoldman Sachs has estimated the impact on Europe’s top 42 banks, on a 2012 pro forma basis, at EUR170 billion, assuming no move to mitigate the tax by, for instance, exiting affected businesses. The FTT would also reduce the profitability of Europe’s

According to Tabb Group, France’s share of European equity market volume fell from 21% before the introduction of the FTT to 12% in July 2013, while Italian equity turnover halved. Citi’s Hans Lorenzen, Head of European Investment Grade Credit Product Strategy, says the proposed tax has big implications for liquidity. The impact is likely to be “particularly pronounced in fixed income, reflecting higher transaction costs relative to likely volatility.”

An outline of the Commission’s proposals

All markets, all instruments, all actors! The proposal is intended to capture the vast majority of financial instruments and financial transactions, including all securities (equity and debt), all derivatives, repos, stock lending, all types of fund units, money market instruments, structured products, swaps and possibly collateral. Key exclusions are loans, spot Fx transactions, spot commodities, new issues and transactions with the European Central Bank.

The FTT is payable by financial institutions. But the definition of “financial institution” is broad and includes investment firms, credit institutions, insurers, regulated markets, SPVs, UCITS/AIF funds and their managers, retail investment funds and pension funds. It is also likely to include the treasury entities set up by many corporates.

The proposed FTT would apply to all transactions globally where at least one party is a financial institution “established” in one of the FTT Zone countries. “Establishment” is widely defined (and does not follow usual tax residence rules). The establishment of that financial institution would deem the same establishment on a non-FTT Zone counterparty, which is itself a financial institution, making both parties liable for tax.

To deter business relocation, the FTT will also apply to transactions by financial institutions “established” outside the FTT zone if:

• FTT Zone instrument — the instrument is issued within the FTT zone, regardless of where their counterparties are established.

• FTT Zone counterparty — the instrument is issued outside the FTT zone but their counterparty is “established” in the FTT Zone.

While the headline rates (0.1% on securities and 0.01% on derivatives) sound less than threatening, the effective rates will be much higher. Because the tax will be applied at every leg of a transaction, where a financial institution is party, with only CCPs, CSDs and ICSDs exempt, the tax will be multiplied many times over. This has been called the “cascade effect”. For a transaction involving executing brokers and a clearing member on both sides, the tax paid could be multiplied eight-fold.



exchanges and inter-dealer brokers, it suggests, by around a fifth on average. Derivatives exchanges would be more severely affected.9

The consultancy Oliver Wyman says: “Non-bank financial institutions such as pension funds, insurers and asset managers are hit as they bear a direct tax levy as well as any portion passed through by the dealer, potentially doubling the tax burden for these users.” 10

Under the Commission proposal, asset managers will incur the FTT at two levels: on transactions undertaken at the portfolio level and in the trading of fund units. Goldman estimates that Europe’s fund managers could find themselves contributing around EUR17 billion a year in FTT: “Our top-down analysis implies that investors based in FTT countries could face an annual tax of 17-23 bps on their equity and bond portfolios”.11

Some wider implicationsThe proposed FTT has implications at government, corporate and individual levels.

The Commission expects the economic impact to be either slightly negative or slightly positive, depending on how the tax revenues are used. The original impact assessment suggested a very significant impact on GDP.12 One uncertainty is the extent to which the FTT would increase government bond yields. Lorenzen has pointed to a number of factors — the cost of “cascading”, wider bid-offer spreads and a probable decline in the number of primary dealers — that would not only lead investors to demand higher yields but oblige sovereign issuers to syndicate their issuance at a higher cost. “This likelihood is reflected in the comparatively outspoken comments against the FTT made by several national debt management agencies,” he says.13 Another impact may be the disappearance of some contracts or products altogether, not an increase in spreads, if the effect is too great.

The Commission expects trading in government debt to raise EUR6.5 billion in tax annually. This would more than offset an estimated EUR2 billion increase in debt funding costs. By contrast, Bank of America Merrill Lynch puts the added funding cost for just Germany, Italy and France at a minimum of EUR6.5 billion in the first year.14

Higher debt costs are also predicted for corporate issuers. Business Europe, an umbrella organisation representing industry associations across Europe, claims “the tax will raise the cost of financing for firms and hence undermine investment.” It also

warns that by making essential risk management activities more difficult, it will damage European companies’ competitiveness.15

End-investors will most likely bear a lot of the added cost, says Oliver Wyman: “Prior studies have shown that as much as 90% of the additional tax burden on financial institutions is generally passed on to end-users.” 16

Where to next?There are signs — both from the Council Working Group and from the European Parliament (which only has a consultative role) — that some of the difficulties are now recognised.

Among the Parliament’s suggested amendments in July were a reduced rate (0.01%) on repos and lower transitional rates on government bonds (0.05%) and transactions involving pension funds (0.05% for equities and 0.005% for derivatives). They also suggested a limited exemption for market makers. These amendments appear to chime with the remarks of Commissioner Semeta, mentioned earlier, and recent calls for a scaling back of the proposal from French Finance Minister Pierre Moscovici.17 Reuters has reported that some countries want all fixed income exempted; leaving a tax that would primarily have an impact on equities and derivatives.18

Another key compromise may be a focus on either the issuance or the residence principle, but not to require both. This debate is causing division among the EU11. The European Commission and/or Member States may undertake a further impact assessment on this aspect.

Some reduction in scope, therefore, looks likely. Widely reported debate 19 between the EU11 over the final shape of the tax makes it highly probable the start date will be formally postponed. The final decision to go forward rests with the EU11 and requires their unanimous agreement to do so; that is, all must agree on the final text. It is also worth noting there is currently no method in place for the collection of the tax, and systems would need to be reconfigured to identify the “establishment” of counterparties.

Just to sow further confusion, in an Opinion dated 6 September 2013, the EU Council legal service advises EU finance ministers that Article 4 (1) of the proposal “deemed establishment” principal is illegal because it “exceeds Member States’ jurisdiction for taxation under the norms of international customary law”. The Opinion also

Under the Commission proposal, asset managers will incur the FTT at two levels: on transactions undertaken at the portfolio level and in the trading of fund units. Goldman estimates that Europe’s fund managers could find themselves contributing around EUR17 billion a year in FTT: “Our top-down analysis implies that investors based in FTT countries could face an annual tax of 17-23 bps on their equity and bond portfolios”.


1 Speech to European Parliament, 2 July 2013.

2 European Commission Staff Working Document Impact Assessment, 2 February 2013.

3 Tabb Group European Equities Market: 2013 Mid-Year Review, 3 September 2013.

4 Citi Research, 10 April 2013.

5 “Financial Transaction Tax — Toll or Roadblock?”, Bank of America Merrill Lynch, 25 March 2013.

6 International Capital Markets Association press release, 11 March 2013.

7 International Securities Lending Association, Impact of the Financial Transaction Tax on Europe’s Securities Lending Market, 3 June 2013.

8 Ibid.

9 Goldman Sachs Equity Research, “Europe: Financial Services, Financial Transfer Tax: How Severe?”, 1 May 2013.

10 Proposed European Commission Financial Transaction Tax Impact Analysis on Foreign Exchange Markets, Oliver Wyman, January 2012.

11 Goldman Sachs Equity Research, “Europe: Financial Services, Financial Transfer Tax: How Severe?”, 1 May 2013.

12 European Commission Executive Summary of the Impact Assessment, 28 September 2011.

13 Citi Research, 10 April 2013.

14 “Financial Transaction Tax — Toll or Roadblock?”, Bank of America Merrill Lynch, 25 March 2013.

15 Letter from Business Europe Director General, Markus J Beyrer, 6 May 2013.

16 Proposed European Commission Financial Transaction Tax Impact Analysis on Foreign Exchange Markets, Oliver Wyman, January 2012.

17 Reuters report, 11 July 2013.

18 Reuters report, 30 May 2013.

19 Ibid.

20 Reuters report, 10 September 2013.

maintains it would not be compatible with EU treaties “as it infringes upon the competences of non-participating Member States”.20

How can financial institutions prepare?Clients should plan on the basis that some variant of the Commission’s proposal will take effect. It is widely thought the German election in September will be an important determinant to the course of the current proposal and, if the current coalition remains, there is expected to be a narrower FTT. Institutions need to monitor developments in Brussels and assess the potential impact of the tax on their operations.

What is clear is that the impact of the FTT will be widely felt. Firms need to assess the fallout on two levels. First, what is the impact on each business line? There may be some areas of trading or investment where the very viability of an operation is called into question. Second, what is the impact on the business model as a whole? Does FTT require a change in strategy, a shift of resources, investment in new businesses, activities or geographies?

While the final shape of the FTT remains uncertain, planning needs to be done sooner rather than later.

Nadine Teychenne Director, Global Product Development, Custody and Clearing, Securities and Fund Services, Citi

Questions our clients have asked

Would all collateral substitutions in a repo be subject to FTT?This has not been dealt with clearly to date. But any change of ownership or material modification, such as moving assets internally within a corporation or modifying a derivative, are caught in the scope of the tax.

Would the London branch of an FTT zone bank dealing in non-EU securities be liable for FTT?Yes. But if it were a subsidiary, it could possibly be exempt (but only if its customer was not “established” in the FTT Zone). Changing from one to the other could be viewed as an anti-avoidance measure.

What is your best bet for the final outcome?Repo and government bonds will most likely be exempted, while the lending of equity securities is taxed. Given the disagreements between Member States, it is possible that FTT will start with a narrow scope and more markets — such as securities lending — will be brought in later. It is possible that an FTT on an issuance basis only will be considered a more readily achievable objective, although such a compromise does not appear to have been reached as yet.


Basel III and CRD IV strengthen capital requirements, introduce a mandatory capital conservation buffer and a discretionary countercyclical buffer, and foresee a framework for new regulatory requirements on liquidity and leverage, as well as additional capital surcharges for systemically important financial institutions (SIFIs).

CRD covers access to deposit-taking activities plus four new elements, enhanced governance, capital buffers, enhanced supervision and sanctions. CRR addresses how the activities of credit institutions and investment firms are carried out, and contains the prudential requirements for credit institutions and investment firms.

The European Supervisory Authorities (ESAs) are drafting technical standards, templates and guidelines to help implement many measures, including the harmonised reporting known as COREP and FINREP.

Please note that CRD IV mandates a review of the rules for investment firms in 2014–2015 and the issue of a more appropriate new rulebook.

ScopeThe Investment Management Association’s (IMA’s) members are MiFID firms, either BIPRU 125k 4 or 50K 5 firms, and regulated by the Financial Conduct Authority (FCA). Since these firms differ principally with regard to the holding of client money, they are also broadly expected to be the groups in scope of the full CRD and out of scope, respectively, as per Article 4 (2) (c) of CRR.

The definition of an investment firm, as defined in CRR, excludes firms only authorised to carry on one or more of the following MiFID investment activities or services: (a) reception and transmission of orders; (b) execution of orders on behalf of clients; (c) discretionary portfolio management; and

(d) investment advice provided that they do not safeguard and administer assets or hold client money or assets and place themselves in debt with clients.

While this narrower definition is likely to exclude discretionary portfolio managers and agency brokers who would typically only be authorised to carry on the narrower range of MiFID activities, there is a risk that such firms will fall within the scope of CRD IV if their FCA permissions include “arranging” or “dealing”, as these regulated activities could include the MiFID investment activity of “placing on a non-firm commitment basis”.

UK implementationAt the time of writing, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA)(a subsidiary of the Bank of England) were consulting on their implementation of the Directive, i.e. on aspects where local regulators have some discretion. HM Treasury is also due to consult in the autumn.

The impact on asset managers

The new prudential sourcebook for investment firms (IFPRU)As the CRD contains some national discretions, national regulators need to say how they will approach them. The FCA’s consultation paper 13-06 (CP 13-06) aims to do that.

As the CP explains, the FCA will create a new sourcebook, IFPRU, to transpose the relevant directive provisions and implement the discretions afforded to competent authorities. It will apply to the investment firms subject to CRD IV that are presently subject to GENPRU (General Prudential Sourcebook) and BIPRU (Prudential Sourcebook for BIPRU firms) with the effect that GENPRU and BIPRU will no longer apply to these firms (although IFPRU will refer to these sourcebooks). Not all existing CRD firms that presently follow BIPRU will be caught by IFPRU. Section 3 below describes the new categorisation.

Capital Requirements Directive IV and RegulationThe Capital Requirements Directive (CRD) IV 1 and Regulation (CRR) 2 were published in the official journal of the European Union (EU) on 26 June 2013. The framework, which comes into force on 1 January 2014, is the EU’s version of Basel III,3 and is split between the Directive, which requires transposition by national authorities, and the Regulations, which applies directly to firms.

Securities and Fund Services | United Kingdom12

Key issues for considerationBIPRU firms 6 (if the firms do not hold client money or securities — see “Determination of prudential changes” for more detail)

If a firm is a BIPRU firm, then the high-level impact of the proposals under consultation is to leave the firm as it is now. It is unchanged in relation to:

1. The amount and nature of capital.

2. The UK “simplified” approach to calculating credit risk.

3. Liquidity management and ILAS 7 status.

4. Reporting requirements.

5. The ICAAP 8 and SREP 9 processes.

6. The remuneration code.

7. SYSC controls.

8. Recovery and resolution plans.

9. And existing waivers.

IFPRU investment firms 10 (if the firms do hold client money or securities — see “Determination of prudential changes” for more detail)

If a firm is an IFPRU investment firm, then:

1. Regarding the amount and nature of capital, there are increases in absolute amounts, new deductions and a more limited set of qualifying capital assets; and the UK “simplified” approach to calculating credit risk is no longer permitted (see section 4.48 of CP13-06 — this is stark, but legally correct).

2. With regard to liquidity management, investment firms are exempt from the need to maintain a buffer, i.e. be able to sell assets to meet liabilities as the latter fall due, but firms in receipt of an FSA waiver on intra-group liquidity risk management need to check with their FCA supervisor whether the waiver’s terms remain unchanged until expiry or have to apply for a new one effective from 1 January 2014.

3. Regarding reporting requirements, COREP and FINREP replace Gabriel.

4. The ICAAP and SREP processes are essentially unchanged.

5. Concerning the remuneration code, a 1:1 or 2:1 bonus cap limit on bonuses applies, but there is some flexibility in terms of national discretion and the possible use of proportionality in connection with bonus caps.

6. There are some changes to SYSC controls, but given that proportionality applies, this is probably not an issue (see page 29 of CP13-06). It is unchanged UNLESS a firm is “significant” (see Table 10 on page 46 of CP13-06, where any one threshold makes a firm “significant”).

7. Regarding recovery and resolution plans, it has yet to be determined if one is needed (see section 3.27 of CP13-06).

8. Existing waivers end as a matter of law, but are likely to be within the grandfathering provisions. However, this must be checked (see Table 12 on page 54 and Table 13 on page 57 of CP13-06).

Treatment of groupsThe own funds waiver on a consolidated basis continues.

Determination of prudential categories

Authorisation arising from MiFIDFor firms that carry out the MIFID activity of portfolio management, it is expected that the permissions have to be consistent with the following two statements:


• The firm may (and so equally may not) carry out the MIFID activities of: (1) the reception/transmission of orders related to financial instruments; and/or (2) the execution of orders on behalf of clients; and/or (5) investment advice.

• The firm does not carry out MIFID activities, such as: (3) dealing on own account; (6) underwriting financial instruments and/or placing financial instruments on a firm commitment basis; and (8) the operation of Multilateral Trading Facilities.11

Holding client money or securities On that basis, if the firm does hold client money or securities for the investment services that it provides or is authorised to do so, then it is:

1. An IFPRU 125K investment firm.

2. An IFPRU investment firm.

3. A limited licence firm (whether preceded by the IFPRU identifier or not).

4. And an investment firm in GENPRU, BIPRU and IFPRU.

This category maps to the existing BIPRU 125K category.

Not holding client money or securities However, if such a MiFID manager is not permitted to hold money or securities belonging to clients, then, after 1 January 2014, an existing BIPRU 50K firm (as such firms are presently defined) will not necessarily map to an equivalent IFPRU category.

A MiFID manager not permitted to hold money or securities belonging to clients will be:

1. An IFPRU 50K investment firm.

2. An IFPRU investment firm.

3. A limited licence firm 12 (whether preceded by the IFPRU identifier or not).

4. And investment firm in GENPRU, BIPRU and IFPRU unless both of the following statements are true:

Unless:

• The firm does not carry out MIFID activity (7) (placing financial instruments without a firm commitment basis).

• The firm does not carry out a MIFID ancillary service (1) (the safekeeping and administration


of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management).

If these two statements are both true, so that the firm does not carry on MiFID activity (7) and ancillary service (1),13 then the firm will be:

1. A BIPRU firm.

2. And an investment firm in GENPRU and also in BIPRU with the exception of BIPRU 12.

3. (And for the avoidance of doubt it is neither an IFPRU firm of any sort nor a limited licence firm.)

Authorisation from AIFMD 14 or UCITS 15 Collective portfolio management investment firms (CPMIs) are covered by their PRU (Prudential) Handbooks, but please note that CRD IV alters certain definitions used in these Directives, and these will apply from 1 January 2014.

These can be found at:

• “Initial capital” in article 4 (51) of the Regulation.

• “Own funds” in article 4 (118) of the Regulation (supplemented by a European Banking Authority (EBA) technical standard).

• And the “fixed overheads” requirement in article 97 of the Regulation (supplemented by an EBA technical standard).

Generally, IFPRU only applies to a CPMI’s MiFID business. However, IFPRU 2.2 (internal capital adequacy assessment process) and IFPRU 2.3 (supervisory review and evaluation process: internal capital adequacy standards) apply to the whole of its business.

Other issuesSome banking groups may choose to impose group-wide approaches to these requirements.

Capital buffers and leverage limitsThe fixed and variable capital buffers and leverage rules do not apply to limited licence firms or BIPRU firms. These buffers are the Capital Conservation Buffer (CCoB); the Countercyclical Buffer (CCyB); the Globally Systemically Important Institutions Buffer (G-SIIB); the Other Systemically Important Institutions Buffer (O-SIIB); and the Systemic Risk Buffer (SRB).

Large exposure requirementsThey no longer apply.

The designation of some branches as “significant”The ability of the FCA to designate some branches does not apply.

1 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC.

2 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012.

3 Basel Committee on Banking Supervision reforms — Basel III.

4 A BIPRU 125k firm, in summary, is a BIPRU investment firm that satisfies the following conditions: (1) it does not deal on own account or underwrite issues of financial instruments on a firm commitment basis; (2) it holds clients’ money or securities in relation to investment services it provides or is authorised to do so; (3) it offers one or more of certain specified services; (4) it is not a collective portfolio management investment firm; and (5) it does not operate a multilateral trading facility.

5 A BIPRU 50k firm, in summary, is a BIPRU investment firm that satisfies the following conditions: (1) it does not deal on own account or underwrite issues of financial instruments on a firm commitment basis and offers one or more of certain specified services; (2) it does not hold clients’ money or securities in relation to investment services it provides and is not authorised to do so; (3) it is not a collective portfolio management investment firm; and (4) it does not operate a multilateral trading facility.

6 If the firms do not hold client money or securities, but see Section 3.

7 Individual Liquidity Adequacy Standard.

8 Internal Capital Adequacy Assessment Process.

9 Supervisory Review and Evaluation Process.

10 If the firms do hold client money or securities, but see Section 3.

11 Annex 1, Section A, Markets in Financial Instruments Directive (MiFID), 2004/39/EC.

12 A limited licence firm means (as specified by Article 20(2) of the Capital Adequacy Directive (Exemptions from operational risk)) a CAD investment firm that is not authorised to: (1) deal on own account; or (2) provide the investment services of underwriting or placing financial instruments (as referred to in point 6 of Section A of Annex I of MiFID) on a firm commitment basis.

13 Annex 1, Section B, Markets in Financial Instruments Directve (MiFID), 2004/39/EC.

14 Alternative Investment Fund Managers Directive.

15 Undertakings for Collective Investment in Transferable Securities.

As the CP explains, the FCA will create a new sourcebook, IFPRU, to transpose the relevant directive provisions and implement the discretions afforded to competent authorities. It will apply to the investment firms subject to CRD IV that are presently subject to GENPRU (General Prudential Sourcebook) and BIPRU (Prudential Sourcebook for BIPRU firms) with the effect that GENPRU and BIPRU will no longer apply to these firms (although IFPRU will refer to these sourcebooks). Not all existing CRD firms that presently follow BIPRU will be caught by IFPRU.

Global implementationThe CRD IV/R package follows the timelines agreed by the Basel Committee on Banking Supervision (BCBS), where the entry into force of the new legislation will be 1 January 2014, a year later than initially agreed, and the full implementation 1 January 2019.

Irving Henry Prudential Specialist Investment Management Association


After the AIFMD, What Can We Possibly Expect from UCITS V? The latest text of amendments relating to the UCITS Directive (2009/65/EC) (known as UCITS V) was adopted by the European Parliament on the 3 July 2013.1 But what changes might we expect to see carried across from the final drafts of the Alternative Investment Fund Managers Directive (AIFMD) 2 and Alternative Investment Funds Managers Regulation (AIFMR)? 3

The suggested changes look to make amendments to the most recent UCITS Directive in three areas:

• Remuneration policies.

• Alignment of depositary functions with AIFMD.

• And harmonising the implementation of financial sanctions across European Member States.

A new Annex has also been included for efficient transposition monitoring, which means Member States will need to prepare transition tables clearly identifying which provisions of the UCITS V rules are implemented into which legal act(s) at national level.

The changes are to be made to take account of market developments and the experiences of market participants and supervisors gathered so far. The European Commission is also looking to address discrepancies between national provisions in the three main areas above.

This process actually began back in July 2009 and the target entry into force is currently estimated to be Q3 2014. A full timeline of events so far is shown in the diagram opposite.In summary, the key changes can be described at a high-level as follows.

UCITS managers’ remunerationManagement companies will be expected to establish and apply remuneration policies and practices consistent with both sound and effective risk management. These policies should not encourage risk taking that would be inconsistent with risk profiles, rules or instruments of incorporation.

These policies must cover both fixed and variable remuneration. As an additional control, EU Member States’ competent authorities will have

the power to scrutinise bonus levels of UCITS management companies to ensure consistency with the principles of sound and effective risk management and appropriate levels of risk taking.

At least 50% of any variable remuneration must consist of units of the UCITS and at least 25% of the variable remuneration must be deferred, over a period of at least three to five years, unless the life cycle of the relevant UCITS is shorter.

The categories of staff to which the policies must be applied have increased substantially from those that might be familiar from current remuneration practices and policies. The latest text as adopted on 3 July 2013 suggests they should now cover all of the following:

START July 2009

EU Commission consultation

January 2010

Mapping exercises of depositaries duties

December 2010

EU Commission second consultation

3 July 2013

Amendments adopted by the European

Parliament

END Q3 2014?

Target entry into force


• Employees and other members of staff such as temporary or contractual staff at fund or sub-fund level.

• Fund managers.

• Persons (other than fund managers) who take investment decisions that affect the risk position of the fund.

• Persons, other than fund managers, who have the power to exercise influence on staff, including investment policy advisers and analysts.

• Senior management, risk takers and personnel in control functions.

• Any other employee or member of staff such as temporary or contractual staff receiving total remuneration that falls within the remuneration bracket of senior management and decision takers and whose professional activities have a material impact on the risk profiles of the management companies or of the UCITS they manage.

In relation to UCITS V amendments, ESMA will be required to issue guidelines that take into account: the principles on sound remuneration policies set out in Recommendation 2009/384/EC (on remuneration policies in financial sectors); the size of the UCITS managed; internal organisation; and the nature scope and complexity of activities carried out. In developing these guidelines, ESMA will work closely with the European Banking Authority (EBA) to ensure consistency with other sectors of the financial services industry, in particular credit institutions and investment firms.

Many will have been relieved to see that an earlier proposal to cap fund manager bonuses to 100% of fixed salary was rejected at the plenary session on 3 July 2013. Instead, bonuses should correspond to fund performance so that they reflect reduced bonus levels when the fund has a “subdued or negative financial performance”.

Depositary functionsThe proposals contained within the latest text (3 July 2013) are almost identical to those contained within AIFMD, with just some exceptions:

• UCITS will be expected to appoint a single depositary (either a credit institution or an investment firm) to oversee investor payments to the fund and act as a custodian for the funds’ assets. A new requirement has been inserted which states that depositaries may also be “national central banks and any other category of institution that is subject to prudential regulation and ongoing supervision provided that it is subject to capital requirements as well as to prudential and organisational requirements of the same effect as” credit institutions and investment firms.

• Depositaries would need to keep investors’ assets clearly separated from their own assets and they would not be able to act without authorisation.

• They would be barred from using investor funds/assets as collateral in other transactions or from investing in them on their own account.


• Depositaries would also be deemed liable for any loss of assets, even if they delegate custody of them to a third party. This deviates from AIFMD requirements where a depositary may contractually discharge its liability in specific and limited circumstances.

• The Commission will also look at the conditions for a depositary to fulfil independence requirements.

SanctionsAll EU Member States will have to make provisions in their laws for harmonised administrative penalties for funds that fail to comply with national UCITS authorisation and reporting rules.

Penalties could include the following:

• A public warning.

• Temporarily or permanently banning the perpetrators from fund management.

• Administrative fees of up to 10 times of any profits made while breaking the rules.

• And Member States could also choose to provide for criminal penalties if they wish.

UCITS V vs Annex IILet’s consider how the latest UCITS V remuneration proposals compare to what we know about the Annex II requirements under the AIFMD and the associated ESMA remuneration guidelines (as consulted on by the FCA in CP13/9 — Quarterly Consultation Paper No.2).4

UCITS V Remuneration (draft 3 July

2013)

AIFMD Annex II Remuneration

Policy

ESMA final report: Guidelines on sound

remuneration policies under the AIFMD

(ESMA/2013/201) dated 11 February 2013

Comparing the latest key changes in the 3 July 2013 text

UCITS V Amendments adopted by the European Parliament and the Council, 3 July 2013

AIFMD Remuneration Guidance FCA CP 13/9, published September 2013 (closes for comments 6 November 2013)

Remuneration: application

Remuneration: proportionality Recital (3)

Applies to any employee and any other member of staff at fund or sub-fund level who are decision-takers, fund managers and persons who take real investment decisions, persons who have the power to influence such employees or members of staff, including investment policy advisers and analysts, senior management and any employees receiving total remuneration that takes them into the same remuneration bracket as senior management and decision-takers. Those rules should also apply to UCITS investment companies that do not designate a management company.

Principles governing remuneration policies should recognise that UCITS management companies are able to apply those policies in different ways according to their size and the size of the UCITS they manage, their internal organisation and the nature, scope and complexity of their activities. However, UCITS management companies should, in any event, ensure they apply all those principles simultaneously.

Applies to full-scope UK AIFMs only (but small authorised UK AIFMs, small registered UK AIFMs, non-EEA AIFMs and small non-EEA AIFMs can choose to comply voluntarily).

Full-scope UK AIFMs should comply in a way that is appropriate to size, internal organisation and nature, scope and complexity of activities — the proportionality test proposed in CP13/9 is a two-stage process looking at assets under management (which excludes non-AIFs and assets managed under delegation) to a specified threshold. Different thresholds are suggested dependent on whether the AIF portfolio includes assets acquired through leverage and whether the AIFs are open-ended or closed-ended. The AIFM is then expected to consider other factors that might override the original presumption as to whether to apply all requirements or not, such as whether an AIF is listed and traded on a regulated market, what the nature of delegation arrangements are between the AIFM and its delegate, if performing portfolio or risk management, and the nature of certain fee structures such as carried interest.

Control The remuneration system must not be primarily controlled by the CEO and the management team. Relevant body members and employees involved in setting the remuneration policy and its implementation shall be independent and shall have expertise in risk management and remuneration. Details of those remuneration policies and the basis on which they have been decided shall be included in the Key Investor Information Document, including demonstrating adherence to the principles set out in Article 14a.

The supervisory function should be responsible for approving and maintaining the remuneration policy of the AIFM. This should not be primarily controlled by executive members of the supervisory function. The remuneration policy should take into account input provided by all corporate functions (risk management, compliance, HR, strategic planning, etc.).


Disclosure Comprehensive, accurate and timely information about remuneration practices is disclosed to all stakeholders in a durable medium or by means of a website and a paper copy is delivered free of charge upon request.

FCA CP13/9 does not really address this issue, but it does attempt to resolve some points in respect of disclosure, particularly around consideration firms must have been giving as to whether remuneration can be apportioned for this purpose.

Performance-related remuneration

Where remuneration is performance related, the total amount of remuneration is based on a combination of the assessment of the risk-adjusted performance of the individual and of the business unit or UCITS concerned and of the risk-adjusted overall results of the management company and when assessing individual performance, financial as well as non-financial criteria are taken into account.

Where remuneration is performance related, the total amount of remuneration is based on a combination of the assessment of the performance of the individual and of the business unit or AIF concerned and of the overall results of the AIFM, and when assessing individual performance, financial as well as non-financial criteria are taken into account.

Assessment period or applicable date

The assessment of performance is set in a multi-year framework appropriate to the life cycle of the UCITS managed by the management company in order to ensure that the assessment process is based on a longer term performance and that the actual payment of performance-based components of remuneration is spread over a period which takes account of the redemption policy of the UCITS it manages, the long-term performance of the UCITS and their investment risks.

Only to apply to the first full performance period after a firm becomes authorised as a full scope AIFM.

What is not entirely clear is whether this is the performance period of the fund or the fund managers’ bonus year. If the latter, with a calendar year end company, it is possible that the AIFM Remuneration Code would not take effect for that manager until 1 January 2015.

Remuneration: consistency The revised Directive should be consistent with and be complemented by principles set out in 2009/384/EC (Commission Recommendation on remuneration policies in the financial services sector) and by the work of the Financial Stability Board and G20 commitments to mitigate risk in the financial services sector.

ESMA had to take into account the principles on sound remuneration policies set out in Recommendation 2009/384/EC, the size of the AIFMs and the size of the AIFs they manage, their internal organisation and the nature, the scope and the complexity of their activities.

Remuneration: guaranteed variable remuneration

Guaranteed variable remuneration should be exceptional because it is not consistent with sound risk management or the pay-for-performance principle and should not be part of prospective compensation plans.

The FCA consults on an individual remuneration threshold under which they do not consider it necessary to apply the rules on guaranteed variable remuneration, retained units, shares or other instruments, deferral and performance adjustment. The thresholds are that the individual’s variable remuneration is no more than 33 per cent of total remuneration and the individual’s total remuneration is no more than sterling 500,000; and a variable remuneration component of a “particularly high amount” (for which at least 60 per cent must be deferred under SYSC 19B.1.18) is sterling 500,000. However, lower sums may also be considered a “particularly high amount” in some circumstances.

Conditions for variable remuneration

The variable remuneration component is subject to conditions which provide that the variable remuneration shall be considerably contracted where subdued or negative financial performance of the management company or of the UCITS concerned occurs, taking into account both current compensation and reductions in payouts of amounts previously earned, including through malus or clawback arrangements. “Malus” and “clawback” mean malus and clawback as defined in ESMA Guidelines 2013/201.

Variable remuneration should decrease as a result of negative performance, but could also go down to zero in some cases.

Deferral A substantial portion, and in any event at least 25% of the variable remuneration component, is deferred over a period which is appropriate in view of the life cycle and redemption policy of the UCITS concerned.

Subject to the legal structure of the AIF and its rules of instruments of incorporation, a substantial portion, and in any event at least 50% of any variable remuneration component, is deferred over a period which is appropriate in view of the life cycle and redemption policy of the UCITS concerned. There should be an appropriate retention policy designed to align incentives with the interests of the AIFM and AIFs it manages and the investors of such AIFs. The period referred to in this point shall be at least three to five years, unless the life cycle of the AIF concerned is shorter.


Remuneration: paid from the fund to management companies

Remuneration paid from the fund to management companies should, like the remuneration paid by management companies to their staff, be consistent with sound and effective risk management and with the interests of investors.

Silent

Remuneration: charges to the fund

In addition to pro rata remuneration, it should be possible for costs and expenses directly linked to the maintenance and safeguarding of investments, such as those for legal action, protection or enforcement of the rights of the unit holder or for the retrieval of or compensation for lost assets, to be charged to the fund by the management company. The Commission should assess which are the common product related costs and expenses in the Member States for retail investment products. The Commission should conduct a consultation exercise and impact assessment, and should put forward a legislative proposal if there is a need for harmonisation.

Silent

Remuneration: supervisory convergence

The European Banking Authority has been tasked with assisting ESMA in elaborating such guidelines. Those guidelines should, in particular, provide further instructions on partial neutralisation of the remuneration principles reconcilable with the risk profile, risk appetite and the strategy of the management company and the UCITS it manages. ESMA’s guidelines on remuneration policies should, where appropriate, be aligned, to the extent possible, with those for funds regulated under Directive 2011/61/EU (AIFMD). Furthermore, ESMA should supervise the adequate enforcement of those guidelines by competent authorities. Deficiencies should be addressed promptly with supervisory action in order to safeguard the level playing field across the internal market.

See ESMA Final Report Guidelines on sound remuneration policies under the AIFMD (ESMA/2013/201)(dated 11 February 2013) for full details. ESMA were asked to cooperate with the EBA in devising their Guidelines.

1 http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TExT+TA+P7-TA-2013-0309+0+DOC+xML+V0//EN#BKMD-10, last accessed on 21 September 2013.

2 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2011:174:0001:0073:EN:PDF, last accessed on 21 September 2013.

3 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:083:0001:0095:EN:PDF, last accessed on 21 September 2013.

4 http://www.fca.org.uk/your-fca/documents/consultation-papers/cp13-09, last accessed on 21 September 2013.

5 Financial Times Monday September 16 2013, “London hedge funds secure victory over Brussels pay rules“.

Next stepsNow that the European Parliament has voted and adopted the draft amendments (3 July 2013), it has provided a mandate for three-party negotiations (known as trialogue) with EU Member States and the Commission.

This process will start in full only once the Council has reached its own position and shared this with the EU Member States. This is currently expected in the autumn of this year, but may be subject to delay.

The text may be adopted at the earliest by Quarter 4, 2013, but this can only happen once an agreement has been reached between the institutions. At that point, the proposed Directive will be adopted formally by the Parliament and the Council. Once the final text is agreed, Member States are likely to have a period of two years to transpose the Directive into national law.

In terms of FCA CP13/9, the closing date for responses is 6 November 2013. Industry feedback to the CP appears to be mostly positive so far and in an article in the FTfm, published on 16 September 2013,5 the approach adopted by the FCA is described as: “FCA guidelines are a ‘big relief”, and “probably as good an outcome as the industry could have hoped for”.

We will continue to follow developments as they occur and will update you as part of our catalogue of regulatory notifications. If you would like to receive further information on any of the issues discussed, please do not hesitate to contact the EMEA Fiduciary Technical Team who will be pleased to assist.

Amanda Hale Head of EMEA Fiduciary Technical, Securities and Fund Services, Citi

Securities and Fund Services | Ireland20

Article 61 of the AIFMD provides that AIFMs existing before 23 July 2013 must take all necessary measures to comply with national law stemming from the AIFMD and submit an application for authorisation before 22 July 2014. The European Commission has stated, as its interpretation of Article 61, that during the one-year transitional period, AIFMs are expected to comply on a best-efforts basis with national law. The Central Bank of Ireland (Central Bank) has indicated that there will be a deadline set for the receipt of applications for authorisation as an AIFM before 22 July 2014, and it intends to write to AIFs/AIF management companies that it regulates in January 2014 to notify those who have not yet submitted an application for authorisation as an AIFM to do so. Firms not in compliance with the AIFMD would ultimately be liable to sanctions. The Central Bank will allow a partial transition benefit to non-EU AIFMs of Irish AIFs for a two-year period. It intends to keep the extent of the transitional benefits under review with a view to extending the transitional period to align with the coming into effect of Article 37 of the AIFMD, unless there are strong reasons not to do so in the light of intervening experience in relation to the regulation of AIFs that have non-EU AIFM.

The AIFMD prohibits a MiFID firm from acting as an AIFM. However, a firm is entitled to have a dual authorisation as an AIFM and a UCITS management company. Under Article 6 of the AIFMD, an AIFM may: (a) act as an AIFM for AIFs (essentially the activities involved are portfolio management, risk management, fund administration, marketing and related activities) and manage UCITS funds; and (b) provide some MiFID-type services, i.e. portfolio management services in accordance with mandates given by investors on a discretionary client-by-client basis, non-core services including investment advice, safekeeping and administration in relation

to shares of collective investment schemes, and reception and transmission of orders in relation to financial instruments. The EU Commission has indicated that AIFMs cannot passport the MiFID-type services at (b) in other jurisdictions under MiFID. Nevertheless, the prospect of being able to act as an AIFM and UCITS manager and passport this activity is very attractive for large asset managers managing UCITS and non-UCITS funds. At the time of writing, two firms received an AIFM authorisation in Ireland, both of which now have a UCITS/AIFM dual authorisation. Likewise, the first recipient of an AIFM authorisation in Luxembourg opted for a dual AIFM/UCITS authorisation. These firms, all large industry players taking advantage of the logistical, operational and cost benefits offered by using a single, dual-authorised passporting entity, are now being labelled as “Super ManCos”.

UK firms that are investment managers to regulated Irish AIFs are, in many cases, designating a UK group company as the AIFM of the fund. Although the UK FCA has taken a different view to the European Commission on the rights of an AIFM to passport the MiFID-type AIFM services into other jurisdictions, the current general view is that UK asset management groups that do not have a UCITS management company within their group or are passporting services through a MiFID firm should consider using another group entity to act as the AIFM of AIFs. Additionally, many MiFID companies carry out activities that cannot be passported under AIFMD (e.g. executing orders) so maintaining a MiFID company within the group for these activities is a sensible approach.

The Central Bank has published a form of application for the authorisation of an AIFM, and it has given a clear indication of documentation that it expects to be filed with the application. In our view, key to a successful application is

AIFM Authorisation: Ireland’s Approach Promoters of alternative investment funds (AIFs) domiciled in the EU face the challenge of ensuring that the managers of those funds (AIFMs) comply with the transitional arrangement deadlines under the AIFMD. This article focuses on AIFM compliance requirements for promoters of Irish-regulated AIFs.


the manner in which the AIFMD delegation requirements are addressed. The topic of AIFM function delegation represented one of the more contentious and difficult aspects of the AIFMD. Article 20 provides that an AIFM must be able to justify its entire delegation structure on objective reasons. The AIFM’s liability towards the AIF and its investors is not affected by the fact that the AIFM has delegated functions to a third party or by any further sub-delegations, nor may the AIFM delegate its functions to the extent that, in essence, it can no longer be considered to be the manager of the AIF and to the extent that it becomes a letter-box entity.

The AIFMD envisages that investment management functions comprise both portfolio management and risk management. AIFMs are required to functionally and hierarchically separate the functions of risk management from the operating units, including from the functions of portfolio management. With regards to delegation of investment management, Article 82 of the Commission Regulation provides that an AIFM shall be deemed to be a letter-box entity where it delegates investment management functions to an extent that it exceeds by a “substantial margin” the investment functions performed by the AIFM itself. A permanent risk management function must be established and the preparation of a documented risk management policy, prepared, implemented and maintained. The AIFM must also establish and implement quantitative or qualitative risk limits (or both) for each AIF it manages, taking into account all relevant risks. It must take into account the strategies and assets employed in

respect of its AIFs when setting risk limits and requires that the risk limits at least cover market risks, credit risks, liquidity risks, counterparty risks and operational risks. Periodic reviews (at least annual) must be carried out in relation to risk management systems.

In Ireland, most funds adopt the outsourced model whereby the fund itself (if a corporate) or its “agency management company” outsources the day-to-day activities to third parties, e.g. asset management and fund administration. The Central Bank, in its Q&A document,1 has indicated that an AIFM cannot delegate either of the portfolio management or risk management functions in its entirety nor delegate the tasks in its AIF Rulebook,2 which must be exercised directly by the board or its “designated persons”. The proposed extent of delegation must be set out clearly for the Central Bank in the documentation submitted with the AIFM application and the Central Bank will review each such proposed delegation arrangement.

The Central Bank has identified 16 managerial functions in its AIF Rulebook for which the AIFM is responsible in accordance with good corporate governance principles. This is similar to the approach adopted by the Central Bank in relation to UCITS management companies where 10 managerial functions are specified. The first 10 functions listed below are the same as those required for a UCITS management company.

1. Decision making: the board must have clear responsibility and competence in relation to all material decisions affecting the operation and conduct of business of the AIFM.

Securities and Fund Services | Ireland22

2. Monitoring investment policy, investment strategies and performance: the board must put in place procedures to ensure and verify that the investment policies and strategies of each AIF are complied with and to ensure availability of up-to-date information on portfolio performance.

3. Monitoring compliance: the board must put in place procedures designed to ensure compliance with all applicable legal and regulatory requirements of the AIFM itself and all AIFs under management.

4. Risk management.

5. Supervision of delegates.

6. Financial control.

7. Monitoring of capital.

8. Internal audit.

9. Complaints handling.

10. Accounting policies and procedures.

11. Liquidity management: the board must put in place procedures designed to ensure that all applicable liquidity risks pertaining to the AIFs under management can be identified, monitored and managed at all times.

12. Operational risks: the board must put in place procedures designated to ensure that all applicable operational risks pertaining to the AIFM can be identified, monitored and managed at all times.

13. Conflicts of interest: the board must put in place procedures designed to ensure that all applicable conflicts of interest pertaining to the AIFM and to the AIFs under management can be identified, monitored and managed at all times.

14. Recordkeeping: the board must put in place procedures designed to ensure that all recordkeeping requirements pertaining to the AIFM and to the AIFs under management can be complied with at all times.

15. Remuneration: the board must put in place remuneration policies designed to ensure that any relevant conflicts of interest can be managed appropriately at all times.

16. AIFMD reporting process: the board must put in place procedures designed to ensure that the AIFM complies with its obligations under the AIFM Regulations to report to the Central Bank.

Where an AIFM delegates activities, its programme of activity (its business plan) must identify the board member or other individual (“designated person”) who will, on a day-to-day basis, monitor and control each of the above 16 individual functions. The board of the AIFM must formally adopt a statement of responsibility in relation to the functions and the procedures that will apply in each case.

Promoters of Irish-regulated AIFs, which either intend that the AIFs (if corporate) will continue to be self-managed or continue to use an agency manager-type model in Ireland, are likely to follow the type of approach of UCITS promoters when the UCITS “Management Company” Directive and UCITS IV were implemented. This might involve the establishment of some on-the-ground operations in Ireland. Another possibility would be for a third-party service provider to be appointed as the AIFM. Given the level of responsibility involved and the fact that the AIFM is liable to investors, regardless of delegation, this is likely to be an expensive option, particularly if the fund engages in high-risk asset management strategies. A more likely approach for many AIFs (particularly self-managed AIFs) would be for the directors to undertake certain specific functions with support from, for example, the investment manager and other service providers and/or engaging the services of Irish resident support service providers to undertake some of the functions (particularly in relation to risk support) through secondees to be appointed as “designated persons”.

In any event, the experience of UCITS IV would indicate that there is sufficient flexibility within the Central Bank regime for fund promoters to meet their AIFM compliance requirements in a manner suitable to their organisation and structure.

Patricia Taylor Partner, Asset Management and Investment Funds, William Fry, Ireland

1 Central Bank of Ireland AIFMD Q&A, published May 2013, which is frequently updated. The Q&A can be found at: http://www.centralbank.ie/regulation/industry-sectors/funds/aifmd/Pages/default.aspx.

2 Central Bank of Ireland AIF Rulebook, published May 2013. The Rulebook can be found at: http://www.centralbank.ie/regulation/industry-sectors/funds/aifmd/Pages/default.aspx.


1 Classification of fund shares/units into custody assets versus other assets: the stakes

1.1 Various safekeeping duties depending on the AIF’s asset classification between custody assets versus other assetsThe AIFM Law provides a distinction between two categories of assets, each being subject to a different set of safekeeping obligations. It differentiates between the so-called “custody assets” relating to the AIF’s financial instruments that can be held in custody and the “other assets” being all other assets not corresponding to the definition of the first category.

With respect to custody assets, the depositary has the safekeeping duty to hold them in custody, which means that they are registered or capable of being registered in its books in segregated accounts, whereas for the other assets, safekeeping obligations are restricted to ownership verification and record keeping (i.e. maintaining an up-to-date record of these assets and of their notional amounts).

Custody assets are subject to a strict liability regime, which means that in the event of a loss of assets, the depositary must return to the AIF assets of an identical type or the corresponding amount, unless the depositary is able to demonstrate that “the loss is the result of an external event beyond its reasonable control, the consequences of which could not be avoided despite all reasonable efforts to the contrary.”

With respect to other assets, whenever a loss occurs, the depositary shall bear responsibility towards the AIF or its investors, and indemnify them for all the losses suffered by them as a result of the depositary’s negligent or intentional failure to properly fulfil its obligations. It means, in this case, that the investors or the AIF have to prove that the damage/loss resulted from the depositary not having exercised the appropriate due care in the execution of its obligations.

1.2 In which category shall we classify holdings in funds?When an AIF or the AIFM acting on behalf of the AIF is holding units in funds, those units should normally fall under the category of custody assets.

Indeed, assets shall qualify as custody assets as soon as they meet two conditions, these are: (i) that they are units issued by a collective investment undertaking; and (ii) these units are capable of being registered or held in an account directly or indirectly opened in the name of the depositary.5

Furthermore, Article 4 definitions say that the financial instruments referred to under Article 21(8)(a) AIFMD are the ones that are listed under Section C of Annex 1 of MiFID 6, which under (c) contain “units in collective investment undertakings.” Further, shares/units in collective investment undertakings are generally capable of being held in an account in the name of the depositary.

However, factors of ambiguity arise.

AIFMD Implementation: Challenges for Funds of Funds Servicing The Luxembourg Law implementing the AIFMD (AIFM Law) 1 is now in force. ESMA’s efforts to clarify key concepts of the texts 2 and the further FAQs of the Commission 3 and CSSF 4 have dispelled some grey areas. The industry is now using transition periods to smoothly manage the shift to a fully compliant regime. For depositaries, the practical steps to comply with the new principles regarding the safekeeping obligations raise fundamental issues. Various options are available, but not all are practical. The safekeeping duties for fund units of collective investment schemes and the potential “look-through” application provide a striking example of how difficult it is to interpret certain AIFMD legal provisions and why these uncertainties may cause hesitation and delay in introducing new organisational arrangements.

Securities and Fund Services | Luxembourg24

1.2.1 The non-uniform concept of collective investment undertakingsThe answer as to whether the units held by the AIF(s) in UCITS do effectively qualify as “units issued by Collective Investment Undertakings (CIU)” is very straightforward, but it is less obvious for units issued by limited partnership structures and trusts, and even more so for units of other types of authorised funds.

Indeed, the reference to “CIUs” under Section C of Annex 1 of MiFID and Article 88(1)(a) of the AIFMD Commission Delegated Regulation (AIFM-CDR) differs from the concept proposed by ESMA in its guidelines for interpreting “Alternative Investment Fund” under Article 4(1)(a).7 The only reference that can be used in classifying assets is in the MiFID Question & Answer ID 285, relating to the scope of transferable securities published by the European Commission, which attempted to determine whether a unit of a Limited Partnership (LP) structure can be deemed a transferable security.8

It is regretful that neither ESMA nor EU lawmakers have sought to harmonise the definition of a CIU throughout the whole of the AIFMD.

1.2.2 Units CAPABLE of being registered or held in an account directly or indirectly in the name of the depositaryUnits of collective investment undertakings as financial instruments 9 shall, in principle, be classified as custody assets, provided that they are capable of being registered in an account opened directly or indirectly, in the name of the depositary.

However, Article 88 (2) of AIFM-CDR further provides that “financial instruments, which in accordance with applicable national laws are only directly registered with the issuer itself or its agent shall not be held in custody.” The debate as to whether the option is available only where the local laws mandatorily oblige direct holdings seems to have been settled in Luxembourg. The CSSF has specified that “these shall comprise not only assets which are mandatorily registered with the issuer according to local laws but also, where local laws so authorise.” Interestingly, the CSSF added that direct registration is also permitted when optional, but upon mutual agreement between AIF/AIFM and the depositary. We understand that direct holding of CIU units cannot be imposed on the depositary.

This leaves the depositary to evaluate and mitigate potential operational conflicts, risks and commercial considerations.

1.3 Practical impact of direct holding of CIU units

1.3.1 Wide diversity of existing operating modelsThere are two dominant safekeeping models in the industry at present:

Nominee holding (custody assets) Reception and transmission of orders services are often associated with the depositary opening the account with the registrar in its name, either on a segregated or omnibus basis; this option notably will facilitate the exercise of its rights against client assets (right of pledge).

Direct holding (other assets) Other depositaries only will act as agent by registering their clients directly with the targeted issuers on segregated client accounts, and they will secure the operational view and control over the positions by requiring exclusive power to instruct over such accounts.

This model generally prevails when the AIFM has a global relationship and, possibly, agreements in place with underlying investment managers, as well as, and in any case, every time local legislation does not allow for a nominee system.

1.3.2 What is really at stake?The direct holding versus nominee holding is a key factor in determining the intensity and nature of the depositary’s safekeeping duties. At this stage, best practice is not obvious, especially because some interpretation issues remain unsettled. In particular, from a practical standpoint, the direct holding model raises questions over the nature and extent that due diligence and verification should be undertaken by the depositary over the lifetime of the AIF on the issuers or their agents.

Still, from a pure liability perspective, the difference between the two models is certainly less critical.

Indeed, although in case of loss of the CIU units considered custody assets, the agent of the CIU is not considered the delegate of the depositary; hence, in case of fraud or misbehaviour of the agent, the depositary could argue an “external event”. Still, in order to be exempted, the depositary has to prove that it could not have prevented the loss despite all reasonable efforts to the contrary. This raises the question of the level of attention/due diligence that the depositary needs ultimately to perform on the agent.

The AIFM Law provides a distinction between two categories of assets, each being subject to a different set of safekeeping obligations. It differentiates between the so-called “custody assets” relating to the AIF’s financial instruments that can be held in custody and the “other assets” being all other assets not corresponding to the definition of the first category.


Under the direct holding model, the depositary is liable only if its negligence is proved. However, in practice, a defaulting agent would reveal a defaulting verification routine by the depositary.

2 Debate around the “look-through” principleThe AIFMD obliges the depositary to look through the AIF’s portfolio in the context of its safekeeping duties.

The look-through applies to both the custody assets (Article 89 (3) of AIFM-CDR 10) and the other assets (Article 90 (5) of AIFM-CDR 11), and only when the underlying assets are held by financial or legal structures controlled directly or indirectly by the AIF.

The duty to look through shall ensure that investor protection is not weakened by the fact that the AIF uses intermediary vehicles to invest in certain assets.

A practical consequence of these provisions is that the depositary shall ensure that the same safekeeping duties listed under Articles 89 and 90 of AIFMD-CDR are replicated at the level of the underlying controlled fund. However, there is no provision expressly mandating a depositary, when the AIF acquires “control” over the underlying fund, to contact the manager or the managing body of that underlying fund and request that the custody assets of the latter be wired and registered in a securities account opened with that depositary (or any of its delegates). Although it would certainly be a sound and advisable practice for the financial instruments held by SPVs, it is more difficult to impose this prescription to a target fund.

Stated differently, it means that Article 89(1)(a) requesting the financial instruments are properly registered in accordance with Article 21(8)(a)(ii) shall be understood to mean that financial instruments of the underlying fund (and not the AIF) are registered in segregated accounts so that they can be clearly identified as belonging to the underlying fund (and not the AIF). Similarly, in respect of other assets, the depositary will have to establish the necessary links with such assets, whereby it will be able to perform proper recordkeeping on the latter.

2.1 The concept of controlAccording to a consensus view of the industry, the concept of control shall be regarded with reference to voting rights or exercising dominant influence over the underlying target fund. However, the Luxembourg regulator, for example, has decided to leave this question open and is being fact-specific: “the definition of a controlled entity is a matter of professional judgement and will depend on the specific structure in question.” The determination of control is the responsibility of the AIFM/AIF, which offers some relief as well.

2.2 Liability issuesWhile the look-through provisions are fully applicable, the nature and level of the liability in case of loss of the assets held by the controlled structures have not been clearly determined.

Several interpretations have been brought forward.

Custody assets held by the controlled structure are subject to restitution duty by the depositary in the same way that AIF assets are (including the units in the CIU). This approach seems supported

Securities and Fund Services | Luxembourg26

by Recital (102) of AIFM-CDR, according to which the look-through provisions should apply to “avoid circumvention of the requirements of the AIFMD” meant “in its entirety”.

A more narrowed reading of the look-through provisions will lead to a different interpretation. When viewing solely the relevant sections of the AIFM-CDR, it seems that only those safekeeping duties referred to under Article 89 (1)-(2) of AIFM-CDR and Article 90 (1)-(4) of AIFM-CDR shall apply on a look-through basis (with the exception of any other provision), as if these assets were registered or capable of being registered in the name of the depositary (even if they do NOT belong to the AIF).

It is our opinion that depositaries cannot be held liable for the restitution of AIF’s non-owned assets when, as service providers to the AIFM, they have no decision-making powers on AIFs/AIFMs regarding the fund structuring (including the decision to interpose intermediate vehicles or acquire a controlling interest in the underlying funds) in order to mitigate the depositary’s level of liability. It would be particularly confusing to consider a fund-of-funds-AIF’s depositary liable in restitution for the loss of financial instruments belonging to an underlying fund with whom the depositary has not entered into any contractual relationship while permitting the same depositary to shift its liability with delegates as provided for under Article 21(13) of the AIFMD.

To date, it is hard to predict what view the courts will take, it can only be hoped that a sensible and strict legal analysis as outlined under Recital (113) of AIFMD-CDR will prevail i.e. the depositary is liable in restitution in case of loss of financial instruments held in custody by the depositary itself or by a third party to whom the custody has been delegated.

Like for the cash monitoring provisions, the “look-through” principle of Article 89(3) shall apply as risk mitigator and should not extend the depositary’s new strict liability duty beyond the scope of the AIF’s assets. Should a court decide otherwise, it would be prudent for depositaries to agree on the direct holding model by the AIF/AIFM in order to perform safekeeping duties on other assets, under Article 90(5) of AIFM-CDR.

It is interesting to note that the look-through principle applying to the principle for safekeeping duties of fund units considered as other assets provides for an additional obligation

1 Law of 12 July 2013 on alternative investment fund managers.

2 The European Securities and Markets Authority final guidelines on key concepts of the Alternative Investment Fund Managers Directive.

3 The European Commission Questions and Answers on the Alternative Investment Fund Managers Directive, which can be accessed here: http://ec.europa.eu/yqol/index.cfm?fuseaction=legislation.show&lexId=9.

4 Frequently Asked Questions concerning the Luxembourg Law of 12 July 2013 on alternative investment fund managers as well as the Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage transparency and supervision.

5 Article 88(1) AIFM-CDR.

6 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments.

7 Point 12 of ESMA 2013/600 Guidelines on key concepts of the AIFMD.

8 http://ec.europa.eu/yqol/index.cfm?fuseaction=question.show&questionId=285, last accessed on 16 September 2013.

9 Article 1 (9) of the Law of 13 July 2007 on markets in financial instruments.

10 A depositary’s safekeeping duties as referred to in paragraphs 1 and 2 shall apply on a look-through basis to underlying assets held by financial and, as the case may be, or legal structures controlled directly or indirectly by the AIF or the AIFM acting on behalf of the AIF.

11 A depositary’s safekeeping duties referred to in paragraphs 1 to 4 shall apply on a look-through basis to underlying assets held by financial and, as the case may be, or legal structures established by the AIF or by the AIFM acting on behalf of the AIF for the purposes of investing in the underlying assets and which are controlled directly or indirectly by the AIF or by the AIFM acting on behalf of the AIF.

to the controlling element, namely the prior establishment of said controlled structures by the AIF or the AIFM (which is rarely the case for real estate or private equity fund of funds).

Irrespective of the court’s interpretation, and as a result of Private Placement Regimes potentially being repealed at the latest in 2018, it should be clear that in the long run, all AIFs that are marketed to investors based in the EU will have to meet the full AIFMD regime (and hence, appoint a depositary). On this point, Article 90 (5) §2 of AIFM-CDR only anticipates the result that the AIFMD aims to achieve, which means that fund managers should now start reviewing their target funds and make sure that they have appointed a depositary.

Laurent Fessmann Partner

Sandrine Leclercq Counsel Baker & McKenzie Luxembourg


What does EMIR require?

ClearingMost counterparties (swap dealers and their buy-side clients) must clear OTC derivative contracts of a type declared subject to the clearing obligation by the European Securities and Markets Authority (ESMA) once an EU clearing house (central counterparty or CCP) has been authorised for that type of contract.

Risk mitigation including bilateral collateralisationFor uncleared transactions: all counterparties must comply with operational risk management requirements (including timely confirmation, valuation, reconciliation, compression and dispute resolution); and financial counterparties and qualifying non-financial counterparties (both described in

“Who is within EMIR’s scope” below) must mark-to-market and collateralise their trades.

ReportingAll counterparties must report details — 60 data fields! — of all their OTC and exchange-traded derivative transactions to a registered (or recognised) trade repository, i.e. a commercial data warehouse, or to ESMA. The timeframe is extremely short: T+1 and the obligation applies not only to new contracts but to any modification or termination of an existing contract.

Who is within EMIR’s scope?EMIR applies to any of the following entities that has been established in the EU and that has entered into (is a legal counterparty to) a derivatives contract, and applies indirectly to non-EU counterparties trading with EU parties:

EMIR: Latest Developments, Timelines and Pitfalls for the Uninitiated The EU Regulation on OTC derivatives, central counterparties and trade repositories came into force on 16 August 2012. It is commonly called EMIR (the European Market Infrastructure Regulation) and its rules will gradually take effect during 2013, 2014 and 2015, with some already starting to bite earlier this year.

As a reminder, OTC derivatives, which include interest-rate swaps, FX swaps, credit default swaps, etc., are not traded on exchanges like futures and options are. They are more often than not documented under commonly used master agreements promoted by industry associations such as the International Swaps and Derivatives Association (ISDA), the European Federation of Energy Traders (EFET), the International Emissions Trading Association (IETA) and local banking associations such as the Bundesverband deutscher Banken (which promotes the DRV).

In the US, the equivalent of EMIR is formed by part of the Dodd-Frank Act, which may also affect European-based companies, especially where they transact with US “persons”. The EMIR and Dodd-Frank rules for OTC derivatives are broadly similar but far from harmonised, and over the last year the regulators on both sides of the ocean have fought a bureaucratic battle over whose rules apply in cross-border situations, such as where a European party does swaps business with a US bank acting through its London branch office.

Securities and Fund Services | The Netherlands28

Financial counterparties (FCs)These include licensed banks, insurers, investment firms, regular and alternative fund managers and pension schemes.

Non-financial counterparties (NFCs)These cover any counterparty that is not a financial counterparty, but qualifies as an “undertaking”. This includes all corporates and other business entities (such as partnerships and so on) but excludes private individuals. All NFCs are, or will shortly become, subject to EMIR’s reporting and risk mitigation requirements. But only a small group will be subject to clearing and bilateral collateralisation requirements. These are the “upperclass” (known affectionately as the NFC+), whose aggregate OTC derivatives positions across their consolidated group (worldwide) excluding hedges exceed certain gross notional thresholds over a 30-day period. In essence, this means that their speculative derivatives positions are so large that they are systemically relevant in the eyes of Brussels and therefore need to be isolated from other market participants through the obligatory interposition of a CCP. These NFC+ corporates needed to have taken stock of their non-hedging derivatives positions by 15 March 2013 and then should have notified their home regulators if they exceeded the clearing threshold. The entire NFC+ population should therefore have been identified by all EU regulators by March of this year.

Once an NFC group crosses the clearing threshold, all the EU-based NFC entities in that group are contaminated and need to comply with the NFC+ obligations. Nevertheless, in such a situation, intragroup transactions may qualify for exemptions from the NFC+ clearing obligation and bilateral collateralisation requirements provided certain conditions are met. There is also a three-year exemption from the clearing obligation available to the hedge transactions of certain qualifying EU pension schemes.

For many non-financial businesses being subject to financial regulatory rules and supervision purely because of the use of a single financial instrument will come as a shock. Many will not have realised this was coming until their banks started sending them documentation to amend or supplement their existing derivatives contracts over the summer (for more about this massive mailing exercise; see “Portfolio reconciliation” under “What did and does this mean to derivatives users?”).

However, even NFCs below the threshold are likely to be affected if their counterparties are FCs that hedge transactions with the NFC through derivatives with other FCs; the clearing and/or margin costs arising from the hedge are likely to be passed to the NFC.

The EMIR timeline for 2013 and beyondStarting this year, the key dates in the EMIR implementation timetable are as follows:

Operational risk mitigation requirements for non-cleared OTC derivatives15 March 2013 (for the timely confirmation requirement [all FCs and NFCs] and for mark-to-market/model [FCs and NFC+s]) and 15 September 2013 (for portfolio reconciliation, portfolio compression and dispute resolution [all FCs and NFCs]). This meant that from Q2 2013 many derivatives users in Europe needed to have implemented upgraded confirmation practices in line with the shorter deadlines prescribed by the new standards.

Margin requirements for uncleared tradesOn 2 September BCBS/IOSCO published their final proposals for the global regime and this now needs to be implemented in draft RTS by ESMA for approval by the Commission. The earliest date that these new rules (which will affect uncleared OTC derivatives between FC’s and NFC+’s) will take effect is Q1 2015 with a phased implementation being the likely scenario.

Transaction reporting obligationUnder current estimates, this obligation will begin no earlier than 24 February 2014, but this depends on the actual date of registration of the first trade repository in the EU. Reporting of exchange traded derivatives may well be postponed for one year after that.

Clearing obligationAccording to ESMA’s website this is likely to come into effect during Q2 or Q3 of 2014.

What did and does this mean to derivatives users?The NFC notification dateIt is obvious that since at least early January 2013 financial and non-financial counterparties should have been assessing their EMIR readiness. In the first quarter of 2013, a particular point of concern for any NFC was the difficulty in determining with certainty whether it qualified as an NFC+ or not. The background to this was that EMIR’s definition of OTC derivatives hinged on what constituted a derivative under another EU Directive, MiFID I,



one notoriously difficult to apply when it came to commodity and Fx derivatives. So many were unsure what and what not to count.

The other issue was that what qualified as a hedge for purposes of the threshold calculation was somewhat vague (unless the transactions qualified for IFRS hedge accounting, the simple safe harbour). And finally, it was uncertain if NFC’s had to include any exchange-traded derivatives entered into by themselves and their affiliates on non-EU exchanges. This came about because, under EMIR, exchange-traded derivatives (ETDs) entered into on non-EU exchanges should be counted as OTC derivatives (and hence towards the clearing threshold) if those exchanges were not equivalent with EU exchanges for such products. But no one knew which exchanges were equivalent. It was only on 5 August 2013 that ESMA issued guidance that all such non-EU ETDs should be counted. Obviously those need to be non-hedges to do any damage.

Other guidance that would have been helpful, had it been available earlier, related to the common use of central treasury vehicles engaging in portfolio or macro-hedging for their affiliated entities. Finally, in respect of rolling spot Fx transactions, the European Commission only very recently amended its MiFID guidance to state that those contracts are covered by MiFID (and hence should be counted for the purposes of EMIR). It is only to be hoped that very few NFCs that miscalculated their aggregate derivatives position for the NFC+ notification will be dealt with harshly by their regulators.

Portfolio reconciliation, dispute resolution and portfolio compressionEMIR essentially required counterparties to have a written agreement in place by 15 September on procedures and processes in relation to portfolio reconciliation (i.e. the practice of periodically matching up the key terms of existing contracts for the purpose of identifying any discrepancies in the parties’ records of such contracts); the frequency of portfolio reconciliation depends on the number of outstanding uncleared derivatives contracts between them.

An ordinary NFC with less than 100 contracts is only required to reconcile those with its counterparties once every year. On a strict reading of the rules: the written agreement must be in place before parties can enter into new derivatives; and the requirement also applies to intra-group derivatives.

Apart from the requirement for a written agreement, the same is basically true for “dispute resolution”: counterparties must have agreed detailed procedures for identifying, recording and monitoring disputes, and for the timely resolution of any disputes with a specific process for those that could not be resolved within 5 business days. Reconciliation and dispute resolution are connected: in the case of material discrepancies a written dispute notice may be delivered. As regards “portfolio compression”, it is enough to have procedures in place to regularly analyse the possibility of conducting a portfolio compression and to be able to explain to one’s regulators why a compression was not possible or appropriate.

Documentation for complianceDocumentation to comply with EMIR’s 2013 crop of rules became available to the market from mid-February onwards. This consisted mainly of the following:

The ISDA NFC Representation ProtocolThis allows adhering parties to incorporate representations into their existing master agreements with other adhering parties as to their classification under EMIR to determine whether or not the clearing obligation and/or the tougher risk mitigation techniques apply to their contracts. This Protocol requires a change in status to be notified to the other party and has a mechanism for dealing with transactions that should have been cleared or subject to different risk mitigation but weren’t due to reliance on an incorrect classification. The take-up for this Protocol is disappointing, only about 250 parties have adhered at the time of writing, which is indicative of how poorly the market has dealt with the very first round of EMIR compliance.

The ISDA Timely Confirmation Amendment AgreementParties can use this on a bilateral basis to insert provisions into their ISDA Master Agreement for the purpose of complying with EMIR’s timely confirmation requirements. In line with ESMA’s guidance, a silent consent mechanism is applied.

The ISDA Portfolio Reconciliation, Dispute Resolution and Disclosure ProtocolIssued on 19 July 2013, this is also available as an Amendment Agreement for those who wish to deviate from the Protocol language. The Protocol provides for the incorporation of portfolio reconciliation and dispute resolution mechanisms into parties’ master agreements.

The next deadline that will lead to further contractual and operational adjustments is already on the horizon. With effect from no earlier than 24 February 2014, EMIR will require that both counterparties (if based in the EU) report details of their derivatives transactions (both exchange-traded and OTC; no exception for intra-group transactions) to an EU trade repository. If one counterparty only is based in the EU, it must still report its “leg” of the transaction.


It also includes a confidentiality waiver. At the time of writing, about 1,500 parties have adhered to this Protocol.

Other publicationsThe organisation behind the German Rahmenvertrag (DRV) also published an EMIR Addendum (July 12) as did the French bankers association (Fédération Bancaire Française (FBF)) for their FBF master agreement (June 25).

Many of the larger international and domestic banks (including Citi) prepared their own EMIR supplements (typically tailored to clients that were either NFCs or FCs) and sent these out to their clients during the summer in preparation for the 15 September deadline.

Transaction reportingThe next deadline that will lead to further contractual and operational adjustments is already on the horizon. With effect from no earlier than 24 February 2014, EMIR will require that both counterparties (if based in the EU) report details of their derivatives transactions (both exchange-traded and OTC; no exception for intra-group transactions) to an EU trade repository. If one counterparty only is based in the EU, it must still report its “leg” of the transaction.

This reporting is on a T+1 basis, which is somewhat strange in that the confirmation process is by that time still not finalised, i.e. the parties may well need to correct their reports one or more times if they only agree the confirmation for that particular trade later than T+1.

Only FCs and NFC+s are required to report exposures (i.e. mark-to-market or mark-to-model valuations and collateral value). Transaction reporting may be delegated by one party to the other, or to a third party, and it is likely that banks will offer this service to their NFC clients, in which case contracts will have to be entered into to deal with potential liabilities for late reporting, late data verification, systems disruption, etc.

Also in need of careful drafting are the data privacy and confidentiality waivers that are necessary for both ordinary and delegated transaction reporting to work. This is because each party also needs to report data on the other party’s side of the transaction. Any party planning to perform its own transaction reporting will need to establish a connection with a trade repository. In addition, for purposes of reporting derivatives

transactions under EMIR, any party must obtain a temporary or final “legal entity identifier” (LEI), which is a unique 20-digit ID code. At present, it is uncertain which service providers will be designated by the regulators to issue LEIs or pre-LEIs. To assist market participants with their reporting obligations, ISDA released a Reporting Guidance Note on 19 July 2013.1

What to expect for 2014? Firstly, it is anticipated that the cross-border effect of these reforms will be put to rest during 2014 with the EU equivalency determinations for non-EU countries and certain other regulations being finalised.

Secondly, with the clearing obligation going live during 2014, even though on a phased, multi-year basis for NFC+s, qualifying parties should be calculating compliance costs, examining CCP margin requirements, choosing between individual or omnibus segregation and selecting clearing brokers. Some advice: don’t wait until everyone needs to sign up a broker. You might find yourself at the bottom of the pile. Some NFC+ corporates may decide that, on a cost-benefit basis, using futures contracts is a more attractive alternative than staying in the cleared OTC space. There is a marked shift in the direction of “swaps futurisation” as a perhaps unintended displacement effect of the new regulations and various exchange operators are capitalising on this trend. If one does decide to opt for OTC clearing, the documentation aspects may require considerable effort and negotiation.

Frank G.B. Graaf Partner Clifford Chance LLP, Amsterdam

1 ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol and Reporting Guidance Note, published on 19 July 2013.


The AIFMD for Dutch fund structures

The depositary regimeThe Netherlands has transposed the AIFMD without major deviations. This has resulted in a major shift in the depositary regime for Dutch funds.

Pre-AIFMD, a depositary was required to hold legal title to the assets of an investment fund. Dutch law required that an investment fund (of the contractual type) had a separate dedicated depositary if a cross liability risk existed. A cross-liability risk has been defined as a real risk arising from the fund’s investment policy in which the fund’s assets would not be sufficient to satisfy claims in relation to: obligations relating to the management and custody of the fund’s assets; and the units in the fund.

Post-AIFMD, the requirement for the depositary to be the legal owner of the assets was abolished and replaced by an obligation for an investment fund (of the contractual type) to have legal ownership of the assets of the fund, which should be held by a separate legal entity if a cross-liability risk exists.

Given the pre-AIFMD requirement that the depositary must be the legal owner of the assets and that a separate depositary must be established for each investment fund in respect of which cross-liability could occur, many special purpose depositaries have been established in the Netherlands. These depositaries only have to meet a relatively low capital requirement of EUR112,500 and have delegated the custody function. Sometimes depositaries are part of the same group as the manager. It remains to be seen whether the substance requirements in respect of special purpose depositaries will be increased.

Currently, many special purpose depositaries are being set up as entities that only own the legal title to the investment fund’s assets. In these cases, the depositary function is

transferred to third-party depositaries, which will often perform the custody function.

Asset pooling structuresIn terms of value, Dutch pension funds are the most significant investors in Dutch investment funds. At the end of 2011, Dutch pension funds collectively held EUR383.6 billion in units in Dutch funds constituting 80.1% of all units issued by Dutch funds.1 Many Dutch pension funds have created investment funds themselves, in the form of funds for joint accounts (fondsen voor gemene rekening or FGRs), for the purpose of pooling pension fund investments. An FGR is a contractual arrangement and not a legal entity. The qualification of an FGR for civil law purposes will differ, depending on the provisions of the contract. The contract is usually called “conditions of management and custody” (voorwaarden van beheer en bewaring).

In the Netherlands, some pension funds requested further explanation from the Ministry of Finance on the scope of the AIFMD. According to these pension funds, only funds offering units to pension funds should be able to make use of the exemption for institutions for occupational retirement. The Ministry of Finance’s response was non-committal and referred the question to the European Commission. However, an amendment to the Financial Markets Supervision Act (FMSA) was adopted in the Second Chamber of the Dutch Parliament to the effect that managers of such funds do not require a licence. The Ministry of Finance later announced that it received feedback from the European Commission indicating that an exemption for funds in which only pension funds invest is not in accordance with the AIFMD. The FMSA has been amended accordingly. As a result, FGRs used for the purpose of pooling assets of pension funds generally are not exempt from the AIFMD.

But alternative structures are being investigated. According to the Explanatory Memorandum to the FMSA, “administrative

The AIFMD in the Netherlands The Alternative Investment Funds Managers Directive (AIFMD) was transposed into Dutch law on 22 July 2013. This article deals with the consequences of the transposition for Dutch fund structures and for the marketing of funds in the Netherlands.


pooling” used in the performance of an individual asset management mandate by an investment firm, does not qualify as an investment fund within the meaning of the AIFMD. As there are many types of asset pooling in practice, it cannot be said with certainty whether or not each type qualifies as an investment fund within the meaning of the AIFMD. The Explanatory Memorandum states that, in case of doubt, the Dutch regulator (AFM) can be requested to give its point of view. It could be argued that an administration office (administratiekantoor) that owns the assets for the pension funds does not qualify as a fund within the meaning of the AIFMD if the investment policy is determined at the level of the pension funds or the investment firm the pension fund has engaged.

Marketing investment funds in the Netherlands

Transition periodThe Netherlands has applied a transition period ending on 22 July 2014 to fund managers (regardless of their residency) who have marketed investment funds in the Netherlands

under the applicable private placement regime before 22 July 2013. Until 22 July 2014, such fund managers may continue to rely on the private placement regime applicable before 22 July 2013. However, if they undertake new activities in the Netherlands during this transition period, they may not rely on the private placement regime applicable on 21 July 2013 for those new activities. Marketing a new investment fund is generally not seen as a new activity as long as the same type of investors (e.g. professional investors) are targeted. If a fund manager that has only targeted professional investors before 22 July 2013 wishes to market to retail investors, this is regarded as a new activity.

Under the pre-AIFMD regime, private placement was allowed if:

• Investment funds were marketed in the Netherlands to professional investors only.

• Investment funds were marketed in the Netherlands to fewer than 100 persons not being professional investors.


• Or the nominal value per share or the total consideration paid by an investor amounted to at least EUR100,000.

No registration requirements apply under this regime.

Private placement: marketing to professionalsUntil July 2018, marketing by non-EEA fund managers is allowed if: shares are only offered to professional investors; the state of residency of the non-EEA fund manager is not listed on the FATF list; and a cooperation agreement is in place between the Netherlands and the state of residency of the non-EEA fund manager.2 However, several information requirements apply towards the Dutch Central Bank, and continuing obligations apply relating to the provision of (promotional) information, change of investment policy, reporting requirements and the publication of financial statements.

Designated countries regimeIn addition to the transition period, the Dutch pre-AIFMD “designated countries regime” remains in place until July 2018, allowing fund managers established in non-EEA states designated by the Dutch Minister of Finance to market investment funds to professional and non-professional investors in the Netherlands without authorisation. The designated states are Guernsey, Jersey and the USA (if registered with the SEC). Fund managers relying on this regime must comply with a number of continuing obligations, including obligations relating to the provision of (promotional) information,3 change of investment policy and the publication of financial statements. In addition, in the case of a closed-ended investment fund with tradable shares, a Prospectus Directive prospectus should be made available when offering these shares to the public in the Netherlands. An amendment of the FMSA currently proposes requiring a fund manager relying on the designated countries regime to have a representative in the Netherlands. The objective of this amendment is to provide the AFM with a contact person of the fund manager in the Netherlands.

To rely on the designated countries regime, a fund manager must notify the AFM of its intention to offer shares in the Netherlands prior to making such an offer. For this purpose, the fund manager must file a notification form

1 Newsletter of the DCB dated 26 April 2012.

2 Reference is in this respect made to article 42 of the AIFMD.

3 Please refer to article 23 of the AIFMD.

with the AFM, including a declaration from its home state regulator that it is under adequate supervision in that state. Eight weeks after this notification, the fund manager may offer its shares in the Netherlands, unless the AFM has informed the fund manager that the intention to offer the shares or the way in which the shares are to be offered is contrary to Dutch law. Usually this period is much shorter, as the AFM includes the fund manager in its register within several days after receipt of the notification.

A fund manager cannot rely on the designated country regime if it concerns the marketing of investment funds where the relevant designated state imposed a limitation on the persons to whom they may be marketed. This basically means that the designated country regime applies to investment funds and managers falling under full supervision in the designated state, i.e. those eligible for retail offering.

Marketing by a non-EEA fund manager A non-EEA fund manager who is not established in a designated state (and is not eligible to use the transition period) is not allowed to market shares in an investment fund to retail investors in the Netherlands, unless it has obtained a Dutch AIFMD licence. Such managers must comply with all relevant provisions under Dutch law. Under the current rules it will be very cumbersome for non-Dutch parties to meet all the requirements.

Kees Groffen De Brauw Blackstone Westbroek N.V.


Retrocession Ban On the whole, EU policymakers are in agreement that the typical retail investor is often overpaying when investing in funds because distributors (from independent financial advisers to large banks) make more money distributing funds that levy high fees. They also agree that something needs to be done about this. But there the consensus appears to end.

On the one hand, policymakers in the majority of Member States are calling for restrictions on the use of the term “independent adviser”, increased disclosure on fees charged and remuneration structures. The remainder (which includes the UK and the Netherlands) are of the opinion that such initiatives are not sufficient and that the only solution is to ban the retrocession model altogether.

The new MiFID II proposals, which will set out the rules for these practices in Europe, now seem to advocate a disclosure model, but with an option for individual Member States to introduce a ban, at least in “exceptional cases”. 1

This means that it will be the responsibility of local policymakers to set viable rules that are compatible with local market conditions. A retrocession ban could be negative for investors, particularly in Sweden and in other markets that share a similar structure — a high concentration of a few banks — and Swedish policymakers should consider the effects and consequences of a ban before introducing it.

In Sweden, and in many other markets in Europe, funds are sold by big banks or insurance companies. Such funds not only have the capacity for distribution, but also their own asset management services and fund ranges.2

In this model, the adviser, or the company that speaks to the investor, is remunerated by the asset manager if the investor selects one of the funds provided by the manager. This payment is often structured as a “trail commission”, which basically means that the distributor gets a share of the investment management fee that the asset manager levies on the fund. The size of the fee is negotiated between distributor and asset manager, but often the distributor is entitled to around 50% of the management fee. This business practice means that the distributor can make more money (at least in the short term) by distributing funds with higher management

fees. This demonstrates the conflict of interest that the policymakers are concerned about.

While this can be a problem, it may not be as great as some policymakers see it. A distributor needs the client’s trust to stay in business and would not jeopardise this trust by short-term profit maximisation. The fact that the conflict is there and that there are probably distributors with poor advice and judgment validates regulation, but then the question is which model has the most positive affect for the investor: a retrocession ban or one of increased disclosure and information?

A ban is a radical solution that will almost definitely extinguish the conflict of interest. If you prohibit a payment from the fund house to the distributor, the distributor will have to charge the costs for its services to the client and there would be no incentive per se to sell funds with a high management fee. It is clear who charges what and the asset manager can potentially lower its fees, which ultimately will result in better performing funds.

The problem of imposing a ban is that it might hurt the retail clients it has been designed to protect. While solving the conflict of interest, it risks reducing competition dramatically.

Securities and Fund Services | Sweden36

The above scenario is a real possibility and needs to be considered by policymakers.

In 1999, when large banks did not distribute external funds, the four big banks’ market share in Sweden represented 85% of all assets, compared to their combined market share in 2012, which was 61%.3 This data shows that the retrocession model has favoured competition. Investors have increasingly been offered and chosen to invest in better funds.

In June this year, the Swedish Competition Authority (SCA) issued a report on the market for funds. The SCA commented on the proposal for a ban as follows: “Banks and insurance companies with strong distribution networks would once again grow strong and take market shares as well as fund platforms that have built its activities around distribution, rather than advice.” 4

So what can be done? Increase disclosure at the point of distribution. If you are not “independent” you should not be allowed to label yourself as that. This part of the MiFID II proposal makes perfect sense, as does the introduction of rules that compel distributors to explain to their clients how they make a profit. If the distributor uses the prevailing business model and is commissioned with a trail fee, he or she should be comfortable talking about the model with clients. However, if a distributor is

unable to explain this to its clients, it is likely that the distributor will need to change its model or advice to better match the needs of the client.

I was recently asked by a senior Swedish policymaker whether I would exclusively opt for increased disclosure. Before I had a chance to answer the question, he said, “Well, we all know that doesn’t work . . . ”, and he subsequently cut the discussion short. Disclosure and information alone will not solve the problem. In fact, information is useless if your choices are too limited. This is why policymakers should do their best to increase competition — make it easy to enter the market, but hard to stay there if you do not add value and perform.

Policymakers need to embrace the concept of proportionality in order to achieve this. The required results will not be achieved by complex policies designed for large banks or by complex procedures. Policymakers should instead acknowledge that excessive consumer protection rules will serve as an efficient barrier to entry, which allow established players to keep market share and keep them away from competition on fees and other key factors.

Furthermore, distribution is extremely important for competition. To encourage competition, policymakers should refrain from introducing a retrocession ban for the same reason that

Check out this scenario . . .

Imagine you are the CEO of a large banking group. You have your own fund range, which is well established and has provided healthy profits consistently over a number of years. You are a bit concerned because in the last 10-20 years your fund range has been losing market share, not to the other big banks, but to small- and medium-sized, independent fund houses that have come to the market with innovative and well performing funds. You probably do not like this, but at the same time you realise that an opportunity is emerging. After all, you have invested in a top notch e-banking infrastructure, hundreds of offices and your skilled, well trained staff are ready to serve customers. Surely this must be worth something? So you start your “third-party distribution” business and derive new revenue from your distribution capacity. This means that your own fund range gets exposed to competition, but you sincerely believe this will be good for your clients in the long run, and you are financially compensated for opening up your network, which makes up for your own funds’ falling market share.

But, a retrocession ban is introduced and you are all of a sudden no longer allowed to charge for these services or compensate yourself for the loss you have made by offering competing funds to your clients. What is the likely outcome from this? Probably that you are forced to limit the offering of these competing funds and that you go back to your original operating model where you are mostly promoting your own fund range. Some clients might complain a bit about the reduced supply, but you are not so worried because your competitors are all in the same position and cannot afford to market funds that compete with their own. In a not-too-distant future, the market could look like it used to a decade ago.


it would be unwise to reduce asset managers’ access to the premium pension system (e.g. the open market platform operated by the Swedish Pensions Agency, as proposed in a white paper published in May 2013).5

Policymakers might also consider the removal of structural lock-ups. Good information does not help if you cannot act on it. It should be made easy to switch funds if you are not satisfied with them. A typical example of a barrier to doing this is the Swedish capital gains taxation (CGT). CGT makes investors with accumulated gains more reluctant to switch from one fund to another, as the switch triggers a chargeable taxation event. This lock-up effect could be addressed by providing incentives for investors to transfer funds into investment savings accounts, where tax is levied on the value of assets in the account and the investor may buy and sell without this being a chargeable taxation event.

Johan Wigh Chief Operating Officer East Capital AB

1 Proposal for a Directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the European Parliament and of the Council and Proposal for a Regulation of the European Parliament and of the Council on markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories, dated 20 October 2011.

2 The prevailing model in the UK and the US is somewhat different, where a large share of distribution is done by independent financial advisers (IFAs), which are not part of a banking or insurance group. This difference is important when analysing the effects of a ban. That said, it must be stressed that the points made in this article do not necessarily apply to a market where funds are distributed through IFAs.

3 MoneyMate. MoneyMate is a specialist provider of managed data services to global asset managers and fund administrators.

4 Swedish Competition Authority — Competition on the market for financial services. Report 2013:4, page 187. Last accessed on 3 October 2013.

5 Swedish Regulation Ds 2013:35, which can be accessed at: http://www.regeringen.se/content/1/c6/21/82/97/2e16b21f.pdf.

Securities and Fund Services | International38

FATCA and Non-US Trusts and Trust Structures: Compliance Options Exist Practitioners may not realise how extensively FATCA entity classifications apply to non-US trusts and trust structures, and the resulting impact. There are different options these entities have for FATCA compliance, however.

As the deadlines for FATCA implementation grow closer, more and more foreign entities are facing the hard questions: does this apply to us, and if so, what are we going to do about it? Although the recently released Notice 2013-43 provides a much welcomed six-month delay in FATCA implementation, there is still not much time.1 This is particularly true for institutions that are not the types of large financial institutions that have been collecting and reporting information on their clients in some fashion already. In particular, for non-US trusts and trust structures, including the corporate trustees, fund managers and others who work with these structures, the application of FATCA classifications and how to handle compliance are less straight-forward.

An overview of FATCAThe Foreign Account Tax Compliance Act was signed into law as part of the Hiring Incentives to Restore Employment Act of 2010.2 Regulations implementing FATCA were published by the United States Department of the Treasury (Treasury) on 17 January 2013.3

The principal purpose of FATCA is to “detect, deter, and discourage offshore tax evasion” by US citizens, resident aliens and entities (defined as “US Persons”) 4 through the use of financial institutions outside the US, and to close certain information reporting loopholes that have allowed US persons to avoid disclosure of offshore assets and income.5

To achieve its goal, FATCA requires foreign financial institutions (FFIs) and certain non-financial foreign entities (NFFEs) to identify and document certain US beneficial owners of accounts and US source payments. Under the final Regulations, FFIs that are required to report information to the IRS will be required to enter into an agreement with the Service (FFI Agreement) setting forth the information reporting requirements mandated by the Final

Regulations. Any FFI or NFFE that fails to provide the required information risks having a 30 % withholding tax imposed on payments to it of certain US source income — that is, fixed or determinable, annual or periodic (FDAP) income — and on gross proceeds from any dispositions occurring after 2016 of any property that can produce US source interest or dividends (withholdable payments).

To ease the burdens of FATCA implementation and compliance, the US issued two model intergovernmental agreements (IGAs), the Model 1 IGA and Model 2 IGA, to be implemented between the US and other countries (where each such country is a FATCA Partner). The IGAs represent an alternate means to implement FATCA in a way that is designed to increase reporting compliance by FFIs while addressing difficulties with implementation under FATCA partner local law.

With some exceptions, FFIs will generally be required to collect information and withholding beginning 1 July 2014. Reporting of information generally will begin on 31 March 2015. There is little time for FFIs, including corporate trustee and fiduciary companies and related entities, to begin planning and putting into place procedures for FATCA compliance. Trusts, trustees and asset managers will face unique difficulties in assessing and managing their FATCA implementation requirements, and will require a more bespoke solution to these problems than many other financial institutions.

FATCA and non-US trust structuresIn order to determine its FATCA compliance obligations and the obligations of other FFIs to report and withhold on it an entity in a non-US trust structure must first determine its FATCA classification. To avoid unnecessary reporting and withholding, foreign trusts, private trust companies (PTCs), private investment companies (PICs) and


corporate trustees must determine whether they are FFIs or NFFEs before FATCA implementation begins after 30 June 2014.

Practically speaking, they should make this determination earlier and, if necessary, register online as FFIs with the IRS no later than 25 April 2014, as this is the last day for which registration will guarantee inclusion on the first IRS FFI List by 2 June 2014. The FFI will receive a global intermediary identification number (GIIN), required to demonstrate FATCA registration. Having a GIIN to provide to a withholding agent (e.g. a bank or other financial institution) will help avoid withholding on payments to an FFI and ensure reporting reflects the FATCA-compliant status of each entity.

As discussed below, foreign trusts, corporate trustees, PTCs and PICs are all classified as entities for FATCA purposes. The dividing line between an FFI that has primarily investment income and an NFFE depends on whether the entity is professionally managed. Foreign trusts and PICs that have primarily investment income and are professionally managed will qualify as FFIs; foreign trusts and PICs that have primarily investment income but are not professionally managed will be classified as NFFEs.

FATCA entity classificationBefore assessing the specific due diligence, reporting, withholding or other requirements applicable to a non-US trust structure and the various entities comprising the structure, the entities must first be classified for FATCA purposes as either FFIs or NFFEs. A typical trust structure will require a determination of the application of FATCA at three different levels (see figure 1):

• Level 1: the corporate or individual trustee and/or PTC.

• Level 2: the trust.

• Level 3: any underlying PICs or assets.

The location of the trust, trustee, PTC and PICs, as applicable, as well as the location of any bank accounts, determines whether one or more IGAs are applicable. For example, a trust that is governed by the laws of England and Wales with a Swiss bank account will need to look to the US-UK IGA 6 for guidance in relation to its FATCA compliance requirements as to the trust (i.e. Level 2) and to the US-Swiss IGA 7 for guidance in relation to its FATCA compliance requirements as to the Swiss bank accounts (i.e. Level 3).

FATCA divides legal persons into two categories: individuals and entities. Entities are further divided into FFIs and NFFEs. Trusts, corporate trustees, PTCs and PICs will be classified as FFIs if they have certain characteristics, as described below.

FFIsAn FFI is any non-US entity that holds financial assets for the beneficial ownership of another person and falls within one of five following categories:

1. Depository institutions.

2. Custodial institutions.

3. Investment entities.

4. Insurance companies and their holding companies.

5. Holding companies or treasury centres that are part of a financial group.

The key classification factors of the five FFI categories enumerated in the Regulations are summarised in figure 2 overleaf.8

Figure 1: Typical Trust Structure

Level 1

Level 2

Level 3

Trust

Trustee PTC

PIC 1

E.g. bank account or operating business

E.g. real estate

PIC 2


Entities in a non-US trust structure with a corporate trustee, including trusts, are generally classified as investment entities and therefore as FFIs.

Under the Regulations, an entity is an investment entity if at least 50 % of its gross income during the applicable measuring period (the shorter of the last three calendar years or the duration of the entity’s existence) is attributable to conducting, as a business for or on behalf of customers, one or more of the following activities:

• Trading in instruments, portfolio management, or otherwise investing, administering or managing funds, money or financial assets on behalf of other persons (a Class A investment entity).

• Investing, reinvesting or trading in financial assets if the entity is managed by an FFI that is a depository institution, custodial institution, insurance company or Class A investment entity (a Class B investment entity).

• Functioning or holding itself out as a fund or other investment vehicle (a Class C investment entity).9

The IGAs provide for only one general type of investment entity, largely mirroring the Class A investment entity found in the Regulations.

Application to trustsThe final Regulations provide examples illustrating that the IRS considers trusts that are professionally managed by a trustee or PTC, which is in turn an FFI, to be FFIs. Trusts that are not professionally managed by an FFI will not be FFIs but instead passive NFFEs.

Application to trusteesMost corporate trustees will be classified as investment entities under either the Regulations or an applicable IGA. Corporate trustees primarily manage the funds, money or financial assets of the trusts comprising their mandates. To the

extent a corporate trustee is itself managed by a company classified as an FFI, this could also serve as the basis for the trustee’s classification as an FFI, where management is by an investment entity (under an IGA) or a depository institution, custodial institution, insurance company or Class A investment entity (under the Regulations).

Application to PICsA PIC will also be considered an investment entity FFI if it holds investments in a bank account or shares in an operating business. A PIC should not be considered an investment entity, however, if it holds only tangible assets, such as real estate, art or vehicles, which are not considered investments for FATCA purposes (i.e. not funds, money or other financial assets).

NFFEsIn addition to FATCA reporting, due diligence, and withholding obligations with respect to FFIs, entities in a non-US trust structure may also be affected by classification as an NFFE. An NFFE is, in the broadest sense, any foreign entity that is not an FFI. 10 An NFFE is therefore usually a foreign entity that holds assets for itself and not on behalf of others. The IGAs adopt a substantially similar definition by reference to the Regulations.11

NFFEs are not required to register with the IRS or a FATCA Partner authority, but certain payments made to “passive” NFFEs may be classified as withholdable payments if the NFFE does not certify that it has no substantial US Person owners or provide information about its US Person owners. These rules do not apply to “active” NFFEs.

An entity is an active NFFE if less than 50% of its gross income from the preceding calendar year is passive income or less than 50 % of the weighted average percentage of assets (tested quarterly) are assets that produce or are held for the production of passive income.12 Types of passive income for

Figure 2: Typical Trust Structure

Category of FFI Key classification factor

Depository institution Accepts deposits in the ordinary course of a banking or similar business.

Custodial institution 20% or more of the entity’s gross income is attributable to holding financial assets.

Investment entity Investment funds and investment managers primarily engaged in the business of investing, reinvesting, or trading in financial assets.

Specified insurance company

Insurance company or holding company of a group that includes an insurance company if the insurance company (or holding company) issues or is obligated to make payments on a cash value insurance or annuity contract

Certain holding companies and treasury centres

Holding companies and treasury centres that are (1) part of an EAG that includes a depository institution, custodial institution, insurance company, or investment entity, and (2) a holding company or treasury centre formed in connection with or availed of by an investment fund


determining the test include dividends, interests, royalties and rents, annuities and death benefits from life insurance contracts.13

Active NFFEs, along with certain other entity types, including qualifying publicly traded corporations, are classified as “excepted NFFEs” not subject to the requirement that such entities identify and report any US person beneficial owners.14 If, on the other hand, the NFFE is not an active NFFE (i.e. a passive NFFE), then 30% FATCA withholding will apply to all withholdable payments made to the NFFE payee.15 A passive NFFE can avoid the application of withholding if the NFFE is the beneficial owner of the payment and the NFFE identifies and reports its substantial US owners.16 In the case of a trust, a “substantial US owner” is any specified US person treated as the owner of any portion of the trust under applicable grantor trust rules or that holds, directly or indirectly, more than 10% of the beneficial interests of the trust.17

The treatment of trusts that are FFIsAs mentioned above, the categorisation of a trust and its related entities for FATCA purposes affects the reporting and withholding obligations of those entities under FATCA, as well as whether other FFIs will be required to report and withhold on those entities. This categorisation involves two aspects:

1) Whether the entity has US owners.

2) The entity’s FATCA entity classification.

The latter category involves some flexibility: FFIs may have more than one option for the type of FFI classification for which they can qualify, as long as they fulfil certain requirements.

The ownership of non-US trustsFATCA requires FFIs to report and withhold on certain financial accounts and financial entities owned by US persons. While those reporting and withholding obligations will be discussed below, we first look at how FATCA applies to determine if a trust or other entities or accounts in a trust structure are treated as owned by US persons.

For FATCA purposes, an equity interest in a trust is the equivalent of a financial account.18 Pursuant to the Regulations, a person owning an equity interest in a trust includes any of the following:

1) A person who is the owner of all or any portion of a foreign trust under the grantor trust rules.19

2) Any beneficiary who is, directly or indirectly, entitled to more than 10% from the trust.

3) A beneficiary who receives a discretionary distribution from the trust (if such person receives a distribution in the applicable calendar year).

Not all persons with an equity interest in a trust are necessarily deemed “account holders” for FATCA purposes, however. For example, a person who, although a beneficiary of the trust, may receive only discretionary distributions and does not receive any distributions in the applicable calendar year, and is also not considered an owner of any part of the trust under the grantor trust rules, would not be deemed to be an “account holder” of the trust.

A “US account” is defined as any financial account maintained by an FFI that is held by one or more specified US persons or US foreign-owned entities.20 The person listed or identified as the holder of an account according to the FFI’s records is the account holder,21 subject to certain exceptions, regardless of whether such person is a flow-through entity. If, however, the trust is a grantor trust or a simple trust, a trust grantor or beneficiary may be deemed an account holder. This will generally not be the case for complex trusts.

Categories of exempt or deemed-compliant FFIsWhere an entity in a trust structure is an FFI, and it has been determined that there is an account held by a US person with respect to which the FFI would be required to report, the FFI may still be exempt from certain FATCA obligations under one of several categories of exemptions. The general categories of exempt or deemed-compliant FFIs include the following:

• Deemed-compliant FFIs or non-reporting FFIs that include three sub-categories:

1) Registered deemed-compliant FFIs.

2) Certified deemed-compliant FFIs.

3) Owner-documented FFIs.

• Excluded entities: other categories of entities are exempted from the reporting and registration requirements of FATCA altogether.

Registered deemed-compliant FFIsRegistered deemed-compliant FFIs include certain categories of entities defined in the Regulations and any entity treated as registered deemed-compliant under an applicable IGA (Model 1 FFI).22 While these entities are deemed compliant with FATCA reporting and other requirements, they are still required to register with the IRS if governed by the Regulations or a Model 2 IGA. Registered


deemed-compliant FFIs include qualifying local FFIs and sponsored investment entities.

• Local FFIs. An FFI that is part of a non-US trust structure may qualify as a local FFI exempt from the reporting requirements of FATCA, even if it has some US accounts, if the accounts generally are held by residents of the jurisdiction in which the FFI is incorporated and does business. These are FFIs with a truly local presence and must generally meet a list of requirements to that effect.23

• Sponsored investment entities.24 This is perhaps the most important category of registered deemed-compliant FFIs with respect to non-US trust structures, as this exception permits a higher-level or sponsoring FFI to fulfil the reporting obligations of lower-level or sponsored FFIs. To qualify for this classification, a sponsored FFI (e.g. a trust or a subsidiary of a corporate trustee) must be an investment entity that is not a qualified intermediary, withholding partnership or withholding trust.25 The sponsoring entity (e.g. a fund manager, trustee, corporate director or managing partner) must be authorised to manage the FFI and enter into contracts on its behalf, and must register both as an FFI and as a sponsoring entity, among other requirements.26

Certified deemed-compliant FFIsCertified deemed-compliant FFIs, in contrast to registered deemed-compliant FFIs, are able to certify their status as deemed-compliant, rather than being required to register pursuant to the Regulations or an applicable IGA.27 These FFI types are not generally applicable to non-US trust structures, however, as they include mainly the following:

• Non-registering local banks;

• FFIs with only low-value accounts (i.e., no greater than USD 50,000);

• Sponsored, closely held investment vehicles;

• Limited life debt investment entities.

Owner-documented FFIsA trust or other entity underlying a corporate trustee or PTC may satisfy its FATCA reporting obligations and be classified as a deemed-compliant FFI by qualification as an owner-documented FFI. An FFI may be treated as an owner-documented FFI only with respect to payments received from and accounts held with a designated withholding agent. A designated withholding agent is a US financial institution, participating FFI, or reporting Model 1 FFI that agrees to undertake the additional due diligence and reporting required to treat the FFI as an owner-documented FFI.

The requirements for classification as an owner-documented FFI include that the FFI is an FFI solely because it is an investment entity and that it is not owned by, or in an expanded affiliated group with, any FFI that is a depository institution, custodial institution or specified insurance company. The FFI also must not maintain a financial account for any non-participating FFI.28

Excluded entity typesIn addition to those FFIs that are non-reporting on the basis of their qualification as deemed-compliant FFIs, there are certain entities which, although technically defined as FFIs for FATCA purposes, have been excluded from FFI status.29 These entity types are, however, limited in scope to the following, and would not generally impact a non-US trust structure:

European Fiduciary Services News and Views | Second Edition 2013Securities and Fund Services | International 43

• Excepted non-financial group entities.

• Excepted non-financial start-up companies.

• Excepted non-financial entities in liquidation or bankruptcy.

• Excepted inter-affiliate FFIs.

• Certain tax-exempt foreign organisations described in Section 501(c).

• Certain non-profit organisations.30

FATCA complianceOnce the FATCA classifications of a trust and its related entities are known, their corresponding FATCA compliance requirements can be determined. After outlining the general FATCA compliance requirements, we will examine the different methods potentially available to non-US trust structures to comply with those obligations.

General complianceFFIs are subject to a 30% withholding tax on all withholdable payments they receive unless they become a participating FFI (PFFI) or are otherwise exempt from withholding. Thus, a foreign trust or foreign PIC that is an FFI can avoid FATCA withholding either by becoming a PFFI or a deemed-compliant FFI. A corporate trustee or PTC, as an FFI, must also comply with the reporting and registration requirements of FATCA. As discussed above, a corporate trustee or PTC can undertake to fulfill the reporting obligations of a foreign trust or PIC on its behalf as a sponsoring entity.

A foreign trust or foreign PIC that is an NFFE can avoid withholding either by self-certifying that it has no substantial US owners or by identifying any substantial US owners that it does have.

RegistrationRegistration requirements generally are satisfied by: 1) either entering into an FFI agreement (for an FFI operating under the Regulations or a Model 2 IGA) or following analogous domestic procedures (for a Model 1 FFI); and 2) registering online through the FATCA portal.31 The FFI Agreement has yet to be released and is anticipated in 2013. The substantive reporting requirements contained in the FFI Agreement should match those already set forth in the Regulations.

Certain FATCA obligations begin 1 July 2014, with respect to information collection, reporting and withholding. An FFI, therefore, should be registered by this date, unless otherwise exempt from registration. Further, an FFI should register through the online portal no later than 25 April 2014 to be included on the first IRS FFI List, due to be available

online on 2 June 2014. Failing to register on time could result in non-recognition as a PFFI, thus risking withholding on payments to the FFI. The Registration Portal is due to open on 19 August 2013.

Due diligence and reportingUnder the Regulations, a PFFI is required to report account and account holder information with respect to US accounts or accounts held by recalcitrant account holders. The PFFI also must report payments to recalcitrant account holders and non-participating FFIs. If a PFFI is unable to obtain a waiver (if required by foreign law) to report an account, then the PFFI must close the account.32

Before reporting, an FFI must determine which accounts are reportable. An FFI will need to follow the procedures and examine the information pursuant to the requirements of the Regulations or an applicable IGA to look for “US indicia” that indicate a reportable account.33 The IGAs modify the due diligence requirements somewhat according to the procedures found in Annex I of each Model IGA.

A finding of US indicia associated with an account may be supported or refuted by appropriate documentary evidence, including an appropriate certificate of status, i.e. Form W-9 for US persons or W-8BEN or other Form W-8 as applicable for non-US persons. In the context of trust structures, which generally have relatively few account holders compared to certain FFI types, it may be advisable to obtain a withholding certificate for all account holders, whether a Form W-9 or Form W-8, in any event.

Once US accounts are identified, these are subject to annual reporting by a PFFI. Reporting is done on Form 8966, the FATCA Report. This form is to be filed electronically on 31 March following the end of the calendar year to which the form relates. The first scheduled annual reporting, therefore, is 31 March 2015, with respect to accounts held in 2014. Reporting and due diligence deadlines may be modified by an applicable IGA.

WithholdingAs already discussed, there is a general requirement that a withholding agent withhold 30% on withholdable payments to an FFI. The 30% withholding does not apply if the FFI 1) enters into an FFI agreement with the IRS and becomes a PFFI or 2) the FFI is deemed compliant, including by operation of an applicable IGA. Specific methods for complying with FATCA and preventing the application of withholding requirements, either on payments to a non-US trust structure FFI, or on payments to beneficiaries, are addressed in each of the following compliance options:

Trusts, trustees, and asset managers will face unique difficulties in assessing and managing their FATCA implementation requirements, and will require a more bespoke solution to these problems than many other financial institutions.


Compliance strategiesFFIs have several options to meet their FATCA compliance obligations. Depending on the particular circumstances of a corporate trustee and its affiliated and underlying entities, the trustee may choose to:

1. Have all the trusts or PICs carry out their obligations by becoming PFFIs.

2. Have each underlying entity pursue treatment as an owner-documented FFI (with the consent of the applicable designated withholding agent).

3. Become a sponsoring entity and conduct reporting on behalf of the underlying entities as sponsored FFIs.

4. Report on behalf of trusts as trustee-documented FFIs (where available).

5. Employ a combination of compliance methods.

Participating FFIsHaving all underlying entities pursue PFFI status is not an attractive option for most corporate trustees that have many trusts and PICs among their client mandates. Under this “default” option, each trust must independently enter into an FFI agreement, or comply with the requirements of an applicable Model 1 IGA, and register with the IRS to obtain a GIIN. Practically speaking, the trustee will be responsible for each trust’s compliance obligations separately. The corporate trustee or PTC classified as an FFI must separately register and report. Each PIC classified as an FFI must also separately register and report. This would create a significant compliance burden for the corporate trustee.

Owner-documented FFIsHaving each underlying entity pursue treatment as an owner-documented FFI offers advantages over treating each entity as a PFFI, but still has drawbacks. Generally, an owner-documented FFI will be required to provide each withholding agent or PFFI with which it holds an account with 1) a withholding certificate, 2) an annual owner reporting statement for all owners of the FFI (not just US persons) and 3) documentation for each individual, specified US person, owner-documented FFI, exempt beneficial owner or NFFE that directly or indirectly holds an interest in the payee. While each person with an equity interest must be reported to the withholding agent, the withholding agent would only need to pass along information with respect to US person account holders. This approach requires the consent of the designated withholding agent and may be impractical for

more complicated structures. It may be feasible for specific structures, however, which do not have many underlying entities.

Although owner-documented FFI status represents one path to FATCA compliance for a trust or other underlying entity, this approach generally would seem less preferable than qualification as a sponsored entity (where sponsorship is feasible) or reporting as a trustee-documented trust. An owner-documented FFI must provide still all the documentation to the designated withholding agent and notify such agent of a change in circumstances.

Whether a corporate trustee elects to pursue a strategic implementation of sponsored-entity status or owner-documented FFI reporting, may depend, therefore, on the feasibility of reporting at the level of the corporate trustee. Where information cannot be provided in this manner, or where a trustee may wish to isolate liability with respect to the trust or other entity in question, reporting as an owner-documented FFI may be appropriate.

Sponsored FFIsA sponsored FFI will be deemed compliant, provided that the sponsoring entity fulfils its reporting obligations. These will be substantially the same reporting obligations that a PFFI would have. In other words, the information reporting obligations of the sponsored FFI will be carried out by the sponsoring entity. In the context of a foreign trust or underlying PIC, this probably will entail reporting by the corporate trustee or an affiliated entity. This approach, although requiring registration of each underlying trust and PIC that is an FFI, has the obvious advantage of consolidating the reporting function at the level of the corporate trustee.

The sponsored FFI approach may represent a viable alternative to the owner-documented FFI approach. The sponsored FFI approach will permit a corporate trustee or PTC to aggregate the reporting function at its level with respect to each of the trusts it manages. While reporting still will need to be done with respect to US accounts, this approach should streamline the process significantly by removing the need for each trust to report as an FFI on its own.

Trustee-documented FFIsAs an alternative to the sponsored entity approach, a trust may be classified as a trustee-documented trust under an applicable Model 1 or Model 2 IGA. A trust is a trustee-documented trust if 1) established under the laws of a FATCA partner; and 2) the trustee is a reporting US financial institution, reporting Model 1 FFI, or PFFI and reports all information required to be

The IRS considers trusts that are professionally managed by a trustee or PTC, which is in turn an FFI, to be FFIs. Trusts that are not professionally managed by an FFI will be passive NFFEs.


reported pursuant to the applicable IGA with respect to all US accounts of the trust. Such a trust is treated as a non-reporting FATCA partner financial institution and is classified as a certified deemed-compliant FFI. So no registration of the trust is required.

This clearly is a preferred option, but is limited in application to trusts. Additionally this option is not available in the Regulations or in some IGAs. To the extent available, however, a trustee may wish to consider this approach to trust compliance.

Combined approachIn many cases, a combined approach may be preferable, using either the trustee-documented approach (when available) or sponsored-entity approach in general, but isolating certain problematic structures for compliance purposes by applying the PFFI or owner-documented approach to these structures only. This may be an effective method for isolating risk to the trustee with respect to FATCA compliance for these structures, while generally easing the burden for reporting and compliance across its client mandates as a group.

ConclusionFor non-US trusts and trust structures, complying with FATCA will not be simple. Trustees will need to examine each entity in each structure and first determine how these entities will be classified under FATCA. Then the trustee will need to determine the best method for each entity to comply with FATCA. There is no one-size-fits-all solution: the solution will depend on the particular circumstances of the structure and the trustee, including the specific clients, entities and accounts involved, the jurisdiction, the circumstances and sophistication of the trustee, and so on. Ideally, the solutions employed will reduce the compliance burden for both trustees and clients, whether it is by having a large corporate trustee act as a sponsoring entity for multiple mandates, or a simple trust structure with a smaller trustee operating as an owner-documented FFI, or a combination of approaches. In all cases, non-US trust structures will benefit from a carefully planned, bespoke solution that matches their particular circumstances.

Marnin J Michaels, Gregory C Walsh, Glenn G Fox and Anne H Gibson Baker & McKenzie

1 Notice 2013-43 was published in Internal Revenue Bulletin 2013-31 on 29 July 2013.

2 P.L. 111-147.

3 Internal Revenue Service T.D. 9610, Jan. 28, 2013, available at www.irs.gov/PUP/businesses/corporations/TD9610.pdf, last accessed on 18 July 2013.

4 A “US Person” includes a US citizen, a US resident, a domestic partnership, a domestic corporation, and a domestic trust. A “Non-US Person” is an individual or entity that is not a US Person.

5 Cong. Rec. S10785 (daily ed. Oct. 27, 2009) (statement of Sen. Max Baucus, Chair, S. Comm. on Finance).

6 Bilateral Agreement between the US and the UK to Implement FATCA, dated 12 September 2012, available at http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx, last accessed on 18 July 2013 (“U.K. IGA”).

7 Bilateral Agreement between the US and Switzerland to Implement FATCA, dated 14 February 2013, available at http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx, last accessed on 18 July 2013 (“Swiss IGA”).

8 Treas. Reg. § 1.1471-5(e)(1)-(6).

9 Treas. Reg. § 1.1471-5(e)(4).

10 Treas. Reg. § 1.1471-1(b)(74).

11 Model 1A IGA, Annex I § VI.B(2).

12 Treas. Reg. § 1.1472-1(c)(1)(iv).

13 Treas. Reg. § 1.1472-1(c)(1)(iv)(A).

14 Treas. Reg. § 1.1472-1(c).

15 Treas. Reg. § 1.1472-1(b)(1).

16 Treas. Reg. § 1.1472-1(b)(1)(i)-(iii).

17 Treas. Reg. § 1.1473-1(b)(1)(iii).

18 Treas. Reg. § 1.1471-5(b)(3)(iii)(B); Treas. Reg. § 1.1471-5(b)(1)(iii); Treas. Reg. § 1.1473-1(b)(3).

19 See IRC §§ 671-679 (grantor trust rules).

20 Treas. Reg. § 1.1471-5(a)(2).

21 Treas. Reg. § 1.1471-5(a)(3).

22 Treas. Reg. § 1.1471-5(f)(1).

23 Treas. Reg. § 1.1471-5(f)(1)(i)(A).

24 Treas. Reg. § 1.1471-5(f)(1)(i)(F).

25 Treas. Reg. § 1.1471-5(f)(1)(i)(F)(1).

26 Treas. Reg. § 1.1471-5(f)(1)(i)(F)(3).

27 Treas. Reg. § 1.1471-5(f)(2).

28 Treas. Reg. § 1.1471-5(f)(3)(ii).

29 Treas. Reg. § 1.1471-5(e)(5).

30 Treas. Reg. § 1.1471-5(e)(5).

31 Form 8957, to be used for registration, has been released in draft form by the IRS. Registration to obtain a GIIN is preferred via the online portal, however, and paper registration could result in delayed receipt of the GIIN, which is needed to demonstrate FATCA compliance.

32 Treas. Reg. § 1.1471-4(a)(3).

33 The specific data required to be examined and due diligence procedures for preexisting and new individual and entity accounts are lengthy and are set forth in the Regulations and the Model IGAs. See Treas. Reg. § 1.1471-3 (Identification of payee) and § 1.1471-4(c) (FFI agreement — Due diligence for the identification and documentation of account holders and payees), Model 1A IGA, Annex I and Model 2 IGA, Annex I.

Please note that this article was originally published in the Journal of Taxation, Vol. 119 No. 2 (August 2013).

Michaels is a partner, and Walsh is an associate in Baker & McKenzie Zurich. Fox is a partner in Baker & McKenzie LLP, resident in New York City. Gibson is an adjunct professor at the University of Oklahoma College of Law in Norman. © 2013 Marnin J Michaels, Gregory C Walsh, Glenn G Fox and Anne H Gibson.

Securities and Fund Services | Glossary46

AFR Annual Funding Requirement

AIFMDAlternative Investment Fund Managers Directive

AIF Alternative Investment Fund

AIFM Alternative Investment Fund Manager

AIMAAlternative Investment Management Association

AML Anti Money Laundering

APERStatements of Principle and Code of Practice for Approved Persons — FSA High Level Standard

ARROWAdvanced Risk-Responsive Operating FrameWork

Basel IIIInternational regulatory framework in the banking sector

BCBS Basel Committee on Banking Supervision

BIPRUUK Prudential Sourcebook for Banks, Building Societies and Investment Firms

BRIC Brazil, Russia, India and China

CBU UK Conduct Business Unit

CCP Central Counterparty

CDS Credit Default Swap

CEBS Committee of European Banking Supervisors

CESRCommittee of European Securities Regulators

CF Control Functions

CFT Counter-financial Terrorism

CIS Collective Investment Scheme

COBS Conduct of Business Sourcebook

CRD Capital Requirements Directive

CRE Commercial Real Estate

CSSFCommission de Surveillance du Secteur Financier

DFI Development Finance Institution

Dodd-FrankDodd-Frank Wall Street Reform and Consumer Protection Act

EBA European Banking Authority

EBRDEuropean Bank for Reconstruction and Development

ECB European Central Bank

ECONEU Parliament’s Economic and Monetary Affairs Committee

EEA European Economic Area

EEC European Economic Community

EFAMAEuropean Fund and Asset Management Association

EFSE European Fund for Southeast Europe

EFSF European Financial Stability Facility

EIOPAEuropean Insurance and Occupational Pensions Authority

EIU European Intelligence Unit

EMEA Europe, the Middle East and Africa

EMIR Emerging Markets Infrastructure Regulation

EP European Parliament

ESA European Supervisory Authorities

ESMA European Securities and Markets Authority

ESRB European Systemic Risk Board

ETF Exchange-traded Fund

EU European Union

EVCAEuropean Private Equity and Venture Capital Association

FAIF Fund of Alternative Investment Fund

FATCA Foreign Account Tax Compliance Act

FATF Financial Action Task Force

FCA UK Financial Conduct Authority

FCP Fonds Communs de Placement

FFI Foreign Financial Institution

FIFinansinspektionen — Swedish Financial Supervisory Authority

FINMARFinancial Stability and Market Confidence Sourcebook

FPC Financial Policy Committee

FSA UK Financial Services Authority

FSB Financial Stability Board

FSMA UK Financial Services and Markets Act 2000

FTfm Financial Times Fund Management

G20The Group of Twenty Finance Ministers and Central Bank Governors

GDP Gross Domestic Product

HIRE Hiring Incentives to Restore Employment Act

HMT Her Majesty’s Treasury

Glossary


IBC Independent Banking Commission

ICSD Investor Compensation Scheme Directive

IFA Independent Financial Adviser

IFC International Finance Corporation

IFI International Finance Institutions

IFIA Irish Funds Industry Association

IFRS International Financial Reporting Standards

IMA Investment Management Association

IMF International Monetary Fund

IOSCOInternational Organisation of Securities Commissions

IRS Internal Revenue Service

JFSC Jersey Financial Services Commission

KIID Key Investor Information Document

LHFILag om Handel med Finansiella Instrument — Swedish Financial Trading Act

LVMLag om Vardepappersmarknaden — Swedish Financial Markets Act

MAD Market Abuse Directive

MEP Member of the European Parliament

MiFID Markets in Financial Instruments Directive

NAV Net Asset Value

NewcitsA phrase used to describe hedge fund strategies used within the UCITS III framework

NFFE Non-Financial Foreign Entity

NURS Non-UCITS Retail Scheme

OECDOrganisation for Economic Co-operation and Development

ORA Ongoing Regulatory Activity

OTC Over-the-counter (derivatives)

PBU UK Prudential Business Unit

PCF Pre-Approved Control Functions

PIF Professional Collective Investment Scheme

PFFI Participating Foreign Financial Entity

PRA UK Prudential Regulation Authority

PRIPs Packaged Retail Investment Products

PRO Prudential Risk Outlook

QCF Qualifications and Credit Framework

QI Qualifying Intermediary

QIF Qualifying Investor Fund

QIS Qualified Investor Scheme

RCRO Retail Conduct Risk Outlook

RDR Retail Distribution Review

RIS Regulatory Information Service

SAR Special Administration Regime

SEC Securities and Exchange Commission

SEPA Single European Payments Area

SICAV Société d’Investissement à Capital Variable

SICARSociétés d’Investissement en Capital à Risque

SIF Significant Influence Function

SIF Specialised Investment Funds

SIFA Swedish Investment Funds Association

SLD Securities Law Directive

SME Small and Medium Sized Enterprises

SOPARFI Sociétés de Participation Financière

SUP Supervision — FSA Regulatory Process

SYSCSenior Management Systems and Controls — FSA High Level Standard

TIEA Tax Information Exchange Agreement

TSC UK Treasury Select Committee

UCIsUndertakings for Collective Investment (Part II Funds)

UCISUnauthorised Collective Investment Scheme

UCITSUndertakings for Collective Investment in Transferable Securities

USFI US Financial Institution

VaR Value at Risk

Securities and Fund Services | Contacts48

EUROPE

David Morrison Head of Fiduciary Services, EMEA [email protected] +44 (0) 20 7500 8021

Amanda Hale Head of EMEA Fiduciary Technical [email protected] +44 (0) 20 7508 0178

IRELAND

Shane Baily Head of Fiduciary Services, Ireland [email protected] +353 1 622 6297

Ian Callaghan Head of Trustee Client Management and Fiduciary Monitoring [email protected] +353 1 622 1015

Rafal Moryson Fiduciary Monitoring Officer [email protected] +353 1 622 1010

JERSEY

Ann-Marie Roddie Fiduciary Manager [email protected] +44 (0) 1534 608 201

LUxEMBOURG

Patrick Watelet Head of Fiduciary Services, Luxembourg [email protected] +352 451 414 231

Pascale Kohl Fiduciary Relationship Manager [email protected] +352 451 414 279

Francis Pedrini Fiduciary Relationship Manager [email protected] +352 451 414 228

Davide Tassi Fiduciary Relationship Manager [email protected] +352 451 414 630

Ulrich Witt Fiduciary Relationship Manager [email protected] +352 451 414 520

THE NETHERLANDS

Jan-Olov Nord Head of Dutch Fiduciary Services [email protected] +31 20 651 4313

Jenny Weima Dutch Fiduciary Services [email protected] +31 20 651 4233

SWEDEN

Johan Ålenius Head of Swedish Fiduciary Services [email protected] +46 8 723 3529

UNITED KINGDOM

Therese Lundie Fiduciary Business and Relationship Manager [email protected] +44 (0) 131 524 2825

Iain Lyall Head of Relationship Management [email protected] +44 (0) 20 7500 8356

Francine Bailey Senior Fiduciary Relationship Manager [email protected] +44 (0) 20 7500 8580

Andrew Newson Senior Fiduciary Relationship Manager [email protected] +44 (0) 20 7500 8410

Selina Gayle Fiduciary Technical Analyst, UK [email protected] +44 (0) 20 7500 9741

ContactsIf you would like to comment on any of the articles covered in this edition of European Fiduciary Services News and Views, share ideas for future content or write an article in the next issue, please contact Amanda Hale or Selina Gayle at [email protected].


citi.com/securitiesandfundservices

© 2013 Citibank, N.A. All rights reserved. Citi and Arc Design, CitiConnect and CitiDirect are trademarks and service marks of Citigroup Inc. or its affiliates, used and registered throughout the world. The information and materials contained in these pages, and the terms, conditions, and descriptions that appear, are subject to change. The information contained in these pages is not intended as legal or tax advice and we advise our readers to contact their own advisers. Not all products and services are available in all geographic areas. Your eligibility for particular products and services is subject to final determination by Citi and/or its affiliates. Any unauthorised use, duplication or disclosure is prohibited by law and may result in prosecution. Citibank, N.A. is incorporated with limited liability under the National Bank Act of the U.S.A. and has its head office at 399 Park Avenue, New York, NY 10043, U.S.A. Citibank, N.A. London branch is registered in the UK at Citigroup Centre, Canada Square, Canary Wharf, London E14 5LB, under No.BR001018, and is authorised and regulated by the Financial Services Authority. VAT No. GB 429 6256 29. Ultimately owned by Citi Inc., New York, U.S.A.

GRA24552 10/13

Documents

European Fiduciary Services NEWS & VIEWS - Citibank · European Fiduciary Services NEWS & VIEWS 06 European Financial Transaction Tax: What it Means for Investors ... Partner, Asset