This INDOS Financial article was first published in AlphaQ and can also be read here.
Almost 18 months has passed since the Alternative Investment Fund Managers Directive (AIFMD) came into effect and introduced a requirement for many alternative investment funds to appoint a depositary for the first time. The depositary is responsible for the safe keeping of financial instruments, record keeping and verification of ownership of other assets not held in custody, monitoring of cash flows, and a series of oversight duties. The latter includes oversight of the valuation of the fund, and its compliance with investment restrictions set out in the offering document. As such, the depositary performs an important fiduciary role and protects the interests of investors.
INDOS Financial (INDOS) provides depositary services to over 45 funds representing in excess of $6bn of assets. INDOS always act independently of the administrators to these funds and therefore performs an entirely objective review of the calculation of the net asset value and other related services. In the past 18 months, we have gained first-hand experience as to how the depositary can add value to the fund manager, the board of the fund and ultimately investors in the fund. We have set out below a list of 15 types of issues that have been identified and addressed to date:
1. Investment restriction breaches.
2. AIFMD leverage breaches.
3. Mis-priced investment securities.
4. Expenses not being accrued accurately, or outside the fund’s range of permitted expenses.
5. Borrowing restriction breaches.
6. Incorrect P&L allocation between share classes.
7. Duplicate trades processed and recorded in the NAV.
8. Position reconciliation errors.
9. Aged or material cash reconciliation items requiring further explanation.
10. Unclear title of ownership of assets.
11. Erroneous, unsupported balances in trial balances.
12. Anti-money laundering control weaknesses (around investor screening).
13. Shareholder transactions not processed correctly.
14. Cash wires being paid out of the wrong fund’s bank account.
15. Compliance gaps around the AIFMD rules.
These are a broad range of issues. Whilst none have resulted in material NAV errors or restatements, and by no means impact every firm or fund, managers and the fund boards take comfort from the fact that the issues are identified on a timely basis. It enables them to address control weaknesses in the system, whether they are at the administrator or within the manager’s own operations.
General sentiment among managers appears to be that depositaries have added little value and that there is barely any interaction with the depositary meaning few queries are raised and even fewer issues identified and reported. In response, a number of large managers have already switched their depositary to INDOS to address these shortcomings.
Irrespective of whether the depositary is affiliated to the administrator or independent, it is inconceivable that some issues similar to those listed above are not being identified or at least queried in every depositary relationship. The depositary ought to be adding real value to managers and fund boards and ultimately investors that pay for the service.
With a lull in new regulations coming into force and potential delays to implementation of MiFID 2, managers have an opportunity to review supplier relationships to ensure they are fit for purpose. We hope that by publishing this list, managers will be able to benchmark the service and value they are receiving from their depositary providers as well as assess if there are similar control weaknesses in their own operations.
