On 29 May 2018, the European Commission published a draft Delegated Regulation amending several of the AIFMD Delegated Regulations relating to the safe-keeping duties of depositaries and their delegates. Equivalent amendments are proposed to the UCITS regulations.
Publication of the draft Delegated Regulation follows ESMA’s opinion on asset segregation, in which ESMA asked the Commission to clarify certain obligations of depositaries where they delegate safe-keeping functions to third parties. The consultation paper was covered in previous INDOS updates:
http://www.indosgroup.com/2017/08/esma-opinion-on-asset-segregation-and-application-of-depositary-delegation-rules-to-csds/
The AIFMD Delegated Regulation sets out the depositaries’ duties with regard to the safe-keeping of alternative investment fund (AIF) clients’ assets. Article 21(11)(d)(iii) of the AIFMD requires that where a depositary delegates safe-keeping functions to third parties (i.e. custodians or prime brokers acting as custodians), the assets also need to be segregated at the delegate.
Article 99 of the Delegated Regulation sets out the obligations but the European Commission notes that experience gained since 22 July 2013 (the AIFMD implementation date) has shown that further clarification is needed on the requirements laid down in Article 21(11)(d)(iii). The Commission also notes securities and insolvency laws are not harmonised at the EU level but considers it important to have common rules to ensure the protection of assets safe-kept by depositaries or custodians for their clients. The proposals therefore seek to ensure the clear identification of assets belonging to a particular AIF, and to the protection of these assets in the case of insolvency of the depositary or the custodian.
The Commission also notes that diverging applications by European regulators and market participants of depositaries’ obligations as regards safe-keeping of AIF clients’ assets. As a result, it is proposing amendments to Articles 89(1)(c), 89(2), 98 and 99 of the Delegated Regulation to clarify the requirements in this area.
To allow depositaries time to adapt to the new requirements, the application of the Delegated Regulation will be deferred for six months after publication in the Official Journal of the EU.
In summary, the amendments are as follows:
- Article 89(1)(c) is amended to provide for the factors that should determine the frequency of reconciliation between the depositary’s financial securities accounts and internal records and those of the third parties to which safe-keeping functions have been delegated. The trading frequency of the depositary’s AIF client and also the trades carried out by other clients, whose assets are held in the same omnibus account, must be taken into account.
- Article 89(2) is amended to require that the depositary maintains a record in its financial instruments account opened in the name of an AIF client or in the name of the AIFM acting on behalf of the AIF showing that the assets kept in custody by a third party belong to a particular AIF client. The depository must at all times have a complete overview of the assets of its AIF clients where the custody of assets has been delegated to a third party.
- Article 98 is enhanced to prescribe the minimum details that should feature in the contract between a depositary and a third party on delegation of custody of assets of the depositary’s AIF clients. The depositary must be able to identify all the entities in the custody chain and secure access to all the relevant information in the third party’s possession to be able to verify the quantity of the identified financial instruments kept in custody by the third party. Should the third party need to delegate the custody function to another third party, the proposed provision requires the delegating third party to contractually secure equivalent rights from that another third party, as itself granted to the depositary.
- Article 99 is amended to clarify the asset segregation requirements for the third parties (custodians) to which the custody of AIFs assets has been entrusted. A custodian can hold assets of UCITS and AIFs clients and other clients of one depositary in the same omnibus account, provided its own assets, proprietary assets of the depositary and assets belonging to other clients of the third party are held in segregated financial instruments accounts. To ensure increased asset protection and facilitate the depositary’s duty of the oversight of the entrusted assets, custodians must issue depositories with a statement whenever a change relating to the safe-kept assets occurs. Factors to determine the frequency of reconciliation mirrors those set out in the amendment to Article 89(1)(c) of the Delegated Regulation.
- Article 99 is also amended to introduce new obligations for depositaries which delegate the custody of assets to third parties located outside the EU. Legal advice from independent parties on the insolvency laws of the third country is required. The depositaries should also ensure that the third party complies with their national laws securing the benefits of asset segregation and that the third party communicates any changes to the insolvency laws which are a part of the legal system in which they are operating.
INDOS will be considering the implications of these changes as they relate to its EU AIF depositary business and sub-custodial relationships.
