The prohibition on depositaries discharging liability for loss of financial instruments to sub-custodians under UCITS V could potentially be extended to non-UCITS retail fund managers in certain jurisdictions regulated under the Alternative Investment Fund Managers Directive (AIFMD).
AIFMD is broad and applies to any manager that is not a UCITS. This includes hedge funds, private equity and even a handful of securitization vehicles and family office structures. AIFMD permits depositary banks servicing full-scope AIFMs to discharge liability against losses of financial instruments at sub-custodians if an external event occurs that is beyond the control of the depositary. UCITS V clamps down on this and explicitly prohibits depositaries discharging liability to sub-custodians including market infrastructures.
One European regulator said that UCITS V depositary rules could be extended to some non-UCITS AIFMs albeit not for a long time. However, the regulator, speaking anonymously, said revisions to AIFMD were not being considered at present, nor were there any plans to introduce a second iteration of AIFMD. Another regulator said the issue of extending depositary liability to AIFMs was something for policymakers to decide.
"The discharge of liability is permitted under AIFMD in order to accommodate institutional investors with a greater risk appetite compared to retail investors. The discharge is, however, conditional on there being an objective reason to do so and this could limit its use where, for example, AIFMD compliant funds are sold to retail investors," said Paul Ellis, head of regulatory product solutions at HSBC Securities Services.
At present, depositaries to AIFMs rarely charge more than three basis points to provide safekeeping of assets, monitoring of cash flows and oversight of the fund’s compliance and adherence to its investment mandate. Were UCITS V’s depositary rules to be applied to AIFMs, which invest in higher risk investments and markets than traditional UCITS funds, it is likely depositary costs would increase markedly. Some UCITS fund managers are already reporting depositaries increasing their fees as UCITS V approaches imminently.
“AIFMs sold to institutional investors usually have a higher risk appetite than UCITS being marketed to retail. There is logic to allowing depositaries to AIFMs to discharge liability as it gives those firms a broader investment mandate and fewer investment restrictions,” commented Ellis.
The introduction of UCITS VI could potentially bring about the creation of a pan-EU depositary passport whereby a manager could utilize a depositary based in any EU member state irrespective of where the fund is domiciled. This could provide significant opportunities for countries attempting to grow their funds industry such as Malta. The creation of a pan-EU depositary passport would imply there would be harmonized rules governing depositaries.
“In terms of a client perspective, we are seeing much more focus on depositaries during the operational due diligence process. Managers are focusing on the security of the depositary, who is backing the depositary up and areas around asset safety,” said Ronnie Griffin, global head of trustee and fiduciary services at HSBC Securities Services.
Much uncertainty remains over AIFMD. In July 2015, the European Securities and Markets Authority (ESMA) said it saw no reason as to why Jersey, Guernsey or Switzerland should not be able to take advantage of the pan-EU AIFMD marketing passport. ESMA added it needed more time to review jurisdictions including the US, Hong Kong and Singapore.
It is expected other jurisdictions will be analysed by ESMA on a country-by-country basis in what could be a time-consuming process. Managers are still none the wiser about how long the National Private Placement Regimes (NPPR) will remain in place in EU member states, which would imply depositary-lites could be around for some time yet.