INDOS Financial Limited has been admitted as an Affiliate Member of the Depositary and Trustee Association (DATA http://www.datasoc.co.uk/)

For more information about DATA and the Affiliate Membership please visit http://www.datasoc.co.uk/about/what-data-does.html

INDOS Financial’s Bill Prew was recently interviewed by leading alternatives industry consultant Albourne (www.albourne.com) about how the AIFMD depositary is beneficial to investors and, when implemented well, should enhance investor protection. The video is only available to Albourne clients but we have shared an outline below. 

The EU Alternative Investment Fund Managers Directive has generated a lot of contentious debate since it was first announced as part of Europe’s response to the financial crisis and high- profile frauds in the funds industry.

The Directive finally came into effect in July last year following a one year transitional period. Now the dust is starting to settle, it is becoming clear that some aspects of the Directive, and in particular the new depositary requirements, are in fact a positive for investors, and when implemented properly will provide a genuine independent additional layer of controls and enhance investor protection.

The depositary is an independent service provider that is appointed by the fund and has a fiduciary duty to act in the best interests of investors. The depositary’s duties fall into three main categories:

• safe keeping of the fund’s assets and ensuring the existence of, and title to, those assets;
• monitoring of the fund’s cash and cash flows; and
• a range of oversight duties including oversight over the calculation of the net asset value of the fund and compliance with leverage and investment restrictions.

The depositary’s duties go beyond those performed by the fund administrator today. For example, the depositary is responsible for oversight over compliance with investment restrictions, something which falls outside the remit of the fund administrator. The depositary should also perform a comprehensive independent review over each dealing NAV.

Initial fears about the cost of the depositary to the fund have proven to be unfounded. Fees (charged to the fund) are more likely to be in the range of 2 to 5 basis points depending on the domicile and complexity of the fund. Given the enhanced protections, the depositary is therefore a relatively inexpensive additional cost.

Investors should build questions around the Depositary function into their due diligence to ensure they are receiving the value and protections they should expect. The principal questions to ask are:

• What was the manager’s process for selecting a depositary, i.e. which firms did they consider, what type of due diligence did they and the fund board undertake over the selected provider?
• What are the core contractual terms (for example, what standard of liability does the depositary accept, does the depositary seek to carve out responsibility for certain duties, does it seek to cap liability, what indemnities does it require from the fund or the manager?)
• What transparency and reporting does the depositary provide?
• How are issues escalated and to whom?
• As is often the case, where a depositary is an affiliate of the fund’s administrator, how is the manager comfortable the depositary will act independently in the interests of the fund if issues are identified with the fund administration function?

Some managers have viewed the appointment of a depositary as a “tick the box” exercise and simply opted to appoint an affiliate of their fund administrator since it is the path of least resistance. By contrast, other managers have recognised the value the depositary function brings to their investors and are using this as a business differentiator vs. their peers. They have a well thought out depositary strategy and have given proper thought to issues such as conflict management and issue escalation.

Increasingly we are seeing managers and fund boards questioning the value the fund is receiving from their depositary. Many firms are opting to appoint a wholly independent, regulated third-party that is free of all potential conflicts and acts solely in the best interests of investors.

It is in the best interests of investors and the industry as a whole that appropriate focus is given to the role of the depositary to ensure the appointment is not simply a tick the box exercise. We all have a vested interest to ensure there is no repeat of the frauds seen in the industry and the depositary should play an important part in reducing this risk.

INDOS Financial CEO Bill Prew will be speaking at the HFM Week “Launching and growing a hedge fund in 2015” event in London on Friday 15th May 2015.

For more details and to register for the event, click here.