Transcript New industry requirements for depositaries

16 February 2015
Continuing Professional
Development Course for
Directors of Investment
Companies and Investment
Funds:
Custody/Depositary and Prime
Brokerage
Peter Astleford, Dechert LLP
© 2015 Dechert LLP
Custody: High Level Legal/Commercial
Considerations
 Single provider or multi-custodian model?
 Market coverage under branch and sub-custody network.
 Creditworthiness/reputation (credit rating or availability of a
guarantee).
 Responsibility taken for sub-custody network.
 Costs (Direct and Indirect).
 Service offering.
 What assets are “custodiable”?
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
2
Prime Brokerage Services
 A package of services including stock and cash
financing.
 “Custody” services offered as an “add on” to
maximise the prime broker’s access to the fund’s
collateral.
 The custody service may be real (i.e. under a trust
arrangement or similar) or based upon a simple
contractual promise (bankruptcy risk)
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
3
Prime Brokerage Services (cont.)
 Services provided “at will”.
 Financing re-payable on demand.
 Margin terms can generally be changed on short
notice.
 Rehypothecation (loss of proprietary right of
ownership).
 Rehypothecation cap (and impact on pricing).
 Availability of bankruptcy remote custody solutions.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
4
Prime Brokerage Services (cont.)
 Client money protection.
 Reporting.
 Availability of other services (e.g. research, cap
intro).
 For a multi-prime broker model:
– appoint providers with complementary strengths.
– may provide extra insolvency protection.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
5
Depositary Arrangements: What does
AIFMD require?
 EU AIFMs must appoint a single depositary for
EU AIFs.
 EU AIFMs must appoint one or more entities to
carry out “depositary lite” for non-EU AIFs
marketed in the EEA (oversight services only).
 Non-EU AIFMs and EU AIFMs not marketing in
the EEA need not have any depositary
services at present.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
6
Depositary Arrangements: What does
AIFMD require? (cont.)
 Post 2015, if passport extended to non-EU
AIFs, AIFMs of non-EU AIFs will need to
appoint a single full depositary if marketed in
the EEA on the basis of a passport.
 Post 2018, if private placement abolished,
AIFMs of non-EU AIFs may need to appoint a
full depositary if marketed at all in the EEA.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
7
Depositary Arrangements: What does
AIFMD require? (cont.)
Depositary/Prime Broker Structures
Offshore AIFM/Onshore AIFM
with no EEA marketing
Out of Scope
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
8
Depositary liability under AIFMD
 Once the fund proves “loss”, a full depositary is liable unless it can
prove external event beyond its reasonable control.
 Even then, the depositary must prove that the consequences of
the external event “would have been unavoidable despite all
reasonable efforts to the contrary”.
 So a depositary may be liable for loss following sub-custodian’s
insolvency, fraud or error or even a foreseeable nationalisation.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
9
Discharge of depositary liability under
AIFMD
 A depositary can discharge itself of (i.e. avoid) liability
for loss of assets by:
– having a sub-custodian agree to accept liability
directly to the fund; and
– having the fund agree to this discharge of liability.
 There must be an “objective reason” for the discharge
(usually agreed under the contract).
 The depositary still has a regulatory obligation to
perform oversight and control (contractual position to
be negotiated).
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
10
Discharge of depositary liability under
AIFMD (cont.)
 Apportionment of risk will then be a commercial
negotiation between the prime broker and the
depositary.
 Contractual discharge vs indemnity (no
restrictions).
 Impact on fund launch timetable.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
11
UCITS V requirements
 UCITS V (scheduled for implementation by 18 March 2016) aligns
UCITS depositary rules with AIFMD.
 The liability standard will be the same as under AIFMD, but there
is no contractual discharge of liability permitted.
 Commission’s view: UCITS investors would not understand the
consequences of such a discharge.
 So there is no means at all for UCITS depositaries to achieve
contractual avoidance of liability, even where they must appoint a
local custodian...
unless they refuse to service a particular market or country.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
12
Implications of the Depositary Liability
Regime under AIFMD and UCITS V
 Concentration risk.
 Increased costs and a new pricing framework for
depositaries.
 Greater due diligence on the sub-custody network.
 Benefits for custodians using group companies leading
to further concentration risk.
 Development of new operating models.
 Risk premia/blackout for emerging/frontier markets?
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
13
AIFMD and Asset Segregation at SubCustody Level
Depositary
Sub-Custodian
Box 1
SubCustodian’s
own assets
Assets of the
depositary’s
AIF clients
Assets of the
depositary’s
non-AIF clients
Assets of the
clients of
other
depositaries
Depositary’s
own assets
 ESMA’s consultation on Box 1 closed on 30th January 2015.
 The results are expected in Q2 2015
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
14
Key points for directors to consider on
and during their appointment
1. What are the imposed custody/depositary regulatory
rules applicable to that fund?
2. What do the directors consider a safe way for assets to
be held?
3. What particular risks does the fund’s investment policy
give rise to in terms of safe custody?
4. Safety/reputation/capitalisation/insurance
arrangements of the depositary/prime broker/subcustodian network.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
15
Key points for Directors to consider on
and during their appointment (cont.)
5. Robustness and integrity of the legal documentation
including impact of transfer of title/rehypothecation, client
money protection, legal charges etc.
6. Disclosure of the arrangements to investors.
7. Initial ongoing due diligence (get warranties?) and periodic
re-appraisal of 1-6.
8. Above all, don’t ignore common sense and the smell test.
There will be inevitable reliance upon others for the multiplicity of
parties and legal regimes that will probably apply.
16 February 2015
Continuing Professional Development Course for Directors of Investment Companies and Investment Funds
16
For further information, visit our
website at dechert.com.
Any questions?
Dechert practices as a limited liability partnership
or limited liability company other than in Dublin and
Hong Kong.
21300469.doc