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12 Jul 2018

Depositary Safe-Keeping Rules | Proposals for Amendment

On May 29th 2018, the European Commission published two draft delegated regulations which contain proposals to amend certain rules relating to the safe-keeping duties of depositaries under the alternative investment fund managers directive, Directive 2011/61 EU (the “AIFMD”) and the undertakings for collective investment in transferable securities directive (the “UCITS” Directive).

Experience gained since July 22nd 2013 has shown that further clarification is needed on the requirements laid down in Article 21 (11)(d)(iii) of the AIFMD. Since securities and insolvency laws are not harmonised at EU level, it is imperative to have common rules to ensure protection of assets safe-kept by depositaries or custodians for their clients.

The draft regulations propose to amend Delegated Regulation (EU) 231/2013 (AIFMD Level 2) and Delegated Regulation (EU) 2016/438 (UCITS V Level 2) in accordance with ESMA’s opinion of July 2017. We refer to our earlier newsletter dated October 2017.

Reconciliation – Article 89(1)(c) of the AIFMD Level 2 and Article 13(1)(c) of UCITS V Level 2

These articles are to be amended in order to foresee that reconciliations are conducted as often as necessary (rather than on a regular basis) between the depositary’s internal accounts and records and those of any third party to whom custody functions are delegated. The trading frequency of the relevant client, any trade which would occur outside the normal trading activity and also trades carried out by other clients whose assets are kept in the same omnibus account should be taken into account in determining the frequency.

Record-keeping – Article 89(2) of the AIFMD Level 2 and Article 13(2) of UCITS V Level 2

The drafts clarify that when custody functions are delegated, the depositary remains subject to the requirement to maintain a segregated account in the name of the UCITS or AIF or of the AIFM/UCITS management company acting on behalf of the UCITS/AIF, where the financial assets are recorded. The depositary shall also ensure that the delegate maintains accurate records and accounts.

Contract between the depositary and an appointed third-party - a new paragraph 2a is inserted in Article 98 of the AIFMD Level 2 and in Article 15 of UCITS V Level 2

This new paragraph sets out the minimum provisions to be included in the contract between the depositary and its delegate. Such contract should guarantee the depositary’s right to sufficient information, inspection, and access to the records and accounts of the third party held in custody to enable the depositary fulfil its oversight and due diligence obligations and in particular to allow the depositary to verify all entities within the custody chain and verify that the quantity of the financial instruments opened in the depositary’s books in the name of the fund or its management company, matches the quantity of the identified financial instruments held in custody by the third party for that fund as recorded in the financial instruments account opened in the third party’s books.

In case of further sub-delegation of the custody function, the contract must detail the equivalent rights and obligations agreed on between the delegate and the sub-delegate.

Segregation requirements at the level of the delegate – Paragraph 1 of Article 99 of the AIFMD Level 2 and Article 16 of UCITS Level 2

The depositary shall ensure that the third party to whom safe-keeping functions are delegated correctly records all identified financial instruments in the financial instruments account opened in the third party’s books in order to be separated from the delegate’s own assets, from the depositary’s own assets and from the assets belonging to other clients of the delegate. This means that a third party may hold assets of UCITS clients, AIF clients and other clients of one depositary all together in one omnibus account.

In addition, the depositary in its oversight functions must be supplied, by the delegate, with a statement detailing the assets of the depositary’s clients whenever a change relating to those assets occurs.

AIF’s assets held in third countries- a new paragraph 2a is inserted in Article 99 of the AIFMD Level 2

The depositary must ensure a) to receive legal advice confirming that the segregation of assets is recognised generally and by the applicable insolvency laws of the third country and b) that the third party complies with the segregation requirement he is himself subject to.

The third party located in a third country should immediately inform the depositary of any change in insolvency laws and in its effective application.