This INDOS Financial article was first published by HFM Week and can also be read here (subscription required).

A UK withdrawal from the European Union (EU) following the 23 June 2016 Brexit Referendum could impact the requirement for UK Alternative Investment Fund Managers (AIFMs) to appoint a depositary under the Alternative Investment Fund Managers Directive (AIFMD).

Since its introduction in July 2014, AIFMD has required full scope UK AIFMs managing EU Alternative Investment Funds (AIFs), or marketing non-EU AIFs in Europe, to appoint a depositary to perform a fiduciary oversight, safe keeping, asset verification and cash flow monitoring role over the AIFs operations.

Two years on, market feedback on the value of the depositary function has been mixed. Whilst a growing number of managers, investors, consultants and fund directors are recognising the value that can be added by additional oversight provided by a well implemented and thorough depositary service, others feel the function has been more of a compliance ticking exercise. For many fund administrators, providing depositary services was considered a natural add-on to existing services, but they are all coming under pressure to demonstrate how the depositary is acting objectively and independently of the core administration business. We are starting to see some firms re-assessing their depositary strategy and one fund administration has exited the depositary business altogether.

For as long as the UK remains in the EU and subject to existing EU rules, there is unlikely to be any change to the current depositary requirements except potentially around asset segregation and the need for managers to migrate from a depositary-lite to full depositary model in order to access the EU marketing passport (should this be extended to non-EU countries).

Post-Brexit, the depositary requirements will depend on the relationship which the UK has with the EU,  as well as the policy position taken by HM Treasury and the FCA.

On the one hand, if the UK opts for the Norway/ European Economic Area (“EEA”) model, the UK would stay in the single market for goods and services subject to on-going compliance with EU legislation including AIFMD.  The depositary requirements would likely remain broadly the same as today.

On the other hand, if the UK is no longer part of the EEA, UK AIFMs would become so-called ‘third ‘country’ non-EU AIFMs where there are no depositary requirements except if an AIF is being marketed in Germany and Denmark – two countries which have ‘gold-plated’ Article 42 of the AIFMD.

Today, many UK managers are only registered to market via private placement in the UK and therefore required to comply with the so-called depositary-lite regime, a requirement which could fall away if the UK ceases to be part of the EU or EEA.

If the AIFMD marketing passport were to be extended to the UK once outside the EU, the UK would probably, as a minimum, follow the route being taken by Jersey, Guernsey and Switzerland in terms of a parallel, optional AIFMD opt-in regime if UK managers wanted to access markets in the EU more broadly. AIFMD also envisages in due course all national private placement rules in the EU would be switched off (although this is likely to be 2020 at the earliest) and so all non-EU managers would have to fully comply with the AIFMD, including the full depositary, in order to access EU markets.

In our view the UK is likely retain the bulk of the existing AIFMD legislation. This would enable the UK (like any other non-EU domicile) to demonstrate equivalence with EU rules for UK AIFMs to be able to access EU markets, and particularly through the AIFMD marketing passport.

Removal of the requirement to appoint a depositary would likely be viewed as a backward step at a time when the UK will be seeking to retain its status as a leading domicile for hedge fund and private equity management businesses through a strong regulatory framework that protects the interests of investors. Coupled with the fact the FCA views the depositary as a cornerstone of good fund governance we are confident that amendments would be made to legislation to ensure depositaries remain a core regulatory compliance requirement for UK managers.