AFME makes push for standardised network due diligence

Standardisation of due diligence processes is gaining traction across a variety of sectors in the financial services industry including network management. 

By Charles Gubert

The Association for Financial Markets in Europe (AFME) is pushing for the creation of a standardised due diligence template for network managers. The initiative is being backed by a number of industry participants including Thomas Murray Data Services, which conducts due diligence on behalf of global custodians on sub-custodians, and has its own due diligence methodology. AFME is also reportedly developing similar toolkits for depositary institutions and prime brokers. The move towards standardisation is broadly welcomed. An impromptu survey of delegates at NEMA in Dubrovnik in June 2016 found just under 90% of audience members welcomed AFME’s standardisation template.

Alan Cameron, head of relationship management at BNP Paribas Securities Services, said he fully supported AFME’s initiative. “Those sending due diligence questionnaires will get quicker, fuller and more accurate responses. Those responding will get clearer, better organised questions which allows them to provide answers that explain their markets and capabilities better to clients. By having one document to focus on, we expect the quality to improve,” said Cameron.

Due diligence by network managers is yet to be streamlined. Numerous “tick the box” questions are fairly generic, and could in theory be answered in a simple questionnaire. This would simplify the request-for-proposal (RFP) process if properly adopted. “Some of our branches spend a significant number of hours – from hundreds to thousands each year – dealing with individual network manager DDQs and on-site due diligence,” said Ryan Cuthbertson, head of product, direct custody and clearing at HSBC Securities Services.

Another benefit of a standardised DDQ is that it would reduce duplication, a point made by Clive Triance, global head of sales and business development, banks and broker dealers, at HSBC Securities Services in Hong Kong. “Removing duplication would be a huge benefit for the industry and us as a provider. The DDQ needs to ensure it captures sufficient vanilla data points, which are duplicative and not unique selling points but rather industry standard questions and issues. This may include areas such as segregation of duties, IT platform security and standard corporate action processes,” said Triance.

Financial institutions are facing cost-pressures. Basel III capital requirements are having adverse consequences across entire business streams at banks and global custodians and their network managers are not immune to this. Many network managers are now covering more markets with dramatically scaled down budgets and personnel. The AFME questionnaire – as and when it comes into fruition – would certainly save them time, costs and resources. “Network managers are overworked. Having a standardised DDQ would free up a lot of their time and enable them to focus on other areas of the business and innovations, for example,” said Triance.

The regulatory scrutiny facing global custodians and depositary institutions under the Alternative Investment Fund Managers Directive (AIFMD) and UCITS V is greater than ever. This just reinforces the importance for network managers to look at key areas rather than just tick the box questions. “Banks now have to show compliance with regulation not just when they appoint agents, but throughout the life-cycle of their relationship,” said Cameron.

UCITS V was introduced into law in March 2016 and states that depositary institutions in charge of safekeeping UCITS’ assets will be held completely liable if those assets go missing or are stolen at their global custody or sub-custody partners. The cost of strict liability – depending on the sums involved – could be sizeable. AIFMD is marginally more flexible – purely because AIFM strategies can be quite bespoke and riskier than UCITS.

While AIFM depositaries can indemnify themselves or discharge liability to their sub-custodians, this can only be done in exceptional circumstances or black swan market events which the depositary could not have reasonably foreseen. Lawyers have regularly said strict liability for AIFM depositaries is not a carte blanche to avail themselves of responsibility, and warn that depositaries could be made to make clients right if assets go missing in custody/sub-custody in the majority of circumstances.

This means network managers cannot leave any stone unturned in their due diligence process. Therein lies the risk of a standardised toolkit. A number of markets, particularly emerging or frontier jurisdictions, are simply so niche that standardisation is not appropriate or applicable. This is a criticism commonly levelled against proponents of standardisation elsewhere. One outcome could be that network managers complement the AFME toolkit with their own tailor-made questions for certain markets, a point made by Cameron.

Cuthbertson acknowledged a standardised DDQ was not a one size fits all. “The DDQ needs to be highly detailed and recognise markets are bespoke. A major risk would be if network managers started adding 15 to 20 proprietary questions to the AFME template, which would simply defeat the purpose of a standardised toolkit. We would simply revert to existing practices if that occurred. The toolkit should allow network managers to focus and conduct more in-depth analysis on individual risks in these niche markets, as well as the unique selling propositions of their agent bank partners.  It would also allow network managers to focus more on pricing and differences across markets,” he said.