Ucits victory soured by Madoff scandal

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Ucits victory soured by Madoff scandal
By Pauline Skypala
Published: January 18 2009 21:37 | Last updated: January 18 2009 21:37
Much to the chagrin of the European fund industry, the voting through of the Ucits IV package by the European Parliament last week was completely overshadowed by the fallout from the Madoff affair.

After a hard-fought campaign to get accepted the changes the industry wanted to make cross-border fund management more cost efficient, the champagne corks should be popping. Instead, the political infighting that characterised the Ucits IV debate continues as the Ucits brand suffers by association with the Madoff scandal.


The Ucits funds exposed to losses from the alleged fraud are based in Luxembourg and Ireland. Questions are being asked about the standards of regulation in these fund centres following the revelation that custodians for the funds subcontracted the safekeeping of assets to Mr Madoff’s market-making and investment management business Bernard L Madoff Securities.

Regulators have said regulations decree that custodians remain responsible for knowing “in which manner the assets are invested and where and how these assets are available”, to quote CSSF the Luxembourg regulator, even when they have been entrusted partly or fully to a third party.

Fund documents indicate a different view is taken by the custodian banks. Investors in Luxalpha, one of the funds that invested with Madoff, signed documents saying assets would be “safekept” by a US broker, adding that investors would bear most of the risk of that broker’s default.

The use of sub-custodians is widespread across the fund industry so the question of liability is an important one.

Christine Lagarde, French finance minister, last week suggested rules on this varied from one member state to another. The suggestion was that French rules guaranteed custodian banks would accept liability for assets where safekeeping was subcontracted to a third party.

This is contrary to standard industry documentation, according to lawyers. One suggests most custody banks would be “horrified” by such an interpretation.

Luxembourg, which was implicitly if not explicitly under attack from the French, said the French government had made its claims “without properly informing itself”. CSSF, the Luxembourg regulator, says the Ucits rules have been faithfully transposed into Luxembourg law, and it has the same requirements as France.

The spat is a continuation of the battle fought over the so-called management company passport, which will allow a fund manager based in one EU country to run funds in other EU countries without setting up separate administrative functions.

It is ironic that Luxembourg, which along with Dublin opposed the inclusion of the passport in Ucits IV on the grounds it would undermine investor protection, is now under fire on just that issue.

The possibility of damage to the Ucits brand the two jurisdictions cited as a potential danger of the passport is now a reality due to back office issues it seems few regulators have taken notice of.

Adding fuel to the fire is the detail in the passport that says while funds set up in, say, Luxembourg, can have an external manager, they must have a local custodian. Thus Luxembourg funds will have custodians governed by Luxembourg law, as at present.

Ucits has been a global success story, but if the strength of the investor protection the funds provide is called into question it will not be good for business.

This is alarming for Efama, the European Fund and Asset Management Association. Peter de Proft, director general, says it would be damaging if people thought the money they invested in Ucits funds was not ringfenced. The best outcome would be if those with the responsibility accept it and make good investors’ losses, he adds.

Efama has called on the Council of European Securities Regulators to ensure rules regarding the duties of depositary banks are applied consistently. Ecofin, the EU’s Economic and Financial Affairs Council, will discuss the liabilities of fund depositaries when it meets tomorrow. Charles Muller, deputy director general of the Association of the Luxembourg Fund Industry, believes the Ucits brand will emerge intact if investigators conclude the law is clear and organisations that have not respected the law must make reparations. Problems will only arise if the conclusion is instead that the existing legislation is not good enough, he says.

The best outcome all round would be if the custodian banks agree a deal with the investors concerned that does not set a precedent. The regulators, legislators and industry could then sort out what are the legal liabilities of custodian banks.

If the matter goes to court litigation could drag on for years, potentially damaging the Ucits brand irreparably. Ucits IV will be an irrelevance if this issue is not resolved fast.

pauline.skypala@ft.com

Copyright The Financial Times Limited 2009