The regulatory hiatus following the implementation of the Alternative Investment Fund Managers Directive (AIFMD) and before the introduction of the Markets in Financial Instruments Directive II (MiFID II) should give managers an opportunity to review their AIFMD service provider relationships, and if necessary, change them.
The majority of fund managers affected by AIFMD have successfully navigated the process, which included appointing a depositary or depositary-lite, implementing the appropriate risk management procedures and filing Annex IV regulatory reports. MiFID II will come into effect on January 3, 2017 and managers have been advised to review the depositary arrangements they have in place during this brief “regulatory lull” period.
“A number of managers are evaluating the state of play with some of their depositaries, particularly those offered by fund administrators. Some managers have been disappointed with the level of service and transparency offered by their depositaries, and have either already changed depositary after a little more than a year or are actively considering a change. Unbundling depositary from fund administration is being considered as some firms are sceptical about the independence between the depositary and the administrator” said Bill Prew, founder and CEO of INDOS Financial, an independent AIFMD depositary in London.
Some institutional investors have expressed concern that smaller fund administrators offering depositary services – which among other roles is meant to ensure the administrator itself is doing its job correctly – could lead to conflicts, or a failure to self-report. Those administrators, however, point out there are strict Chinese walls between the businesses, each reporting to different management teams and boards.
Furthermore, banks offering multiple service lines highlight that they can give discounted depositary rates to fund managers through cross-subsidization. Banks offering full scope depositary services highlight it is simpler to port from their depositary-lites to full-depositary rather than changing service providers entirely. They also emphasize that they are better capitalized than some of their standalone competitors, something that is particularly attractive should they be forced to make right any liability claims.
Prew highlighted the majority of managers electing to change depositary were doing so for independence reasons. “Managers recognize that an independent depositary can provide an additional layer of oversight and control. The benefits of an independent model are also starting to be recognized by operational due diligence teams at institutional investors or investment consultants who are familiarizing themselves more with depositary selection and the criteria behind it. These allocators will undoubtedly become more vocal about their managers’ depositary choices. The current interim between AIFMD implementation and MiFID II is an ideal time for managers to reassess their AIFMD service providers,” commented Prew.
Depositary-lites, which were assumed to be a temporary reprieve for EU managers of non-EU funds, or non-EU managers of non-EU funds marketing into certain member states, have also been given an extended lifeline. The European Securities and Markets Authority (ESMA) announced in July 2015 that it was recommending the extension of the pan-EU marketing passport to Guernsey, Jersey and Switzerland only as it felt these jurisdictions met EU regulatory equivalence. However, this is still subject to approval by the European Commission.
Firms operating out of those countries and looking to market into the EU, will need to upgrade to a full-scope depositary, which unlike a depositary-lite is subject to strict liability for loss of financial instruments at the sub-custodian level.
ESMA added it would review equivalence across other major jurisdictions including the US, Hong Kong, Singapore and the Cayman Islands on an individual basis. This will take time and it is unlikely to be completed before 2018 when national private placement regimes (NPPR) were supposed to expire. As such, firms based or domiciled in these jurisdictions can continue to rely on national private placement and retain or appoint a depositary-lite. Prew said he could not envisage NPPR or the depositary-lite business model expiring before 2020 given the likely pace of ESMA approvals.
The majority of fund managers affected by AIFMD have successfully navigated the process, which included appointing a depositary or depositary-lite, implementing the appropriate risk management procedures and filing Annex IV regulatory reports. MiFID II will come into effect on January 3, 2017 and managers have been advised to review the depositary arrangements they have in place during this brief “regulatory lull” period.
“A number of managers are evaluating the state of play with some of their depositaries, particularly those offered by fund administrators. Some managers have been disappointed with the level of service and transparency offered by their depositaries, and have either already changed depositary after a little more than a year or are actively considering a change. Unbundling depositary from fund administration is being considered as some firms are sceptical about the independence between the depositary and the administrator” said Bill Prew, founder and CEO of INDOS Financial, an independent AIFMD depositary in London.
Some institutional investors have expressed concern that smaller fund administrators offering depositary services – which among other roles is meant to ensure the administrator itself is doing its job correctly – could lead to conflicts, or a failure to self-report. Those administrators, however, point out there are strict Chinese walls between the businesses, each reporting to different management teams and boards.
Furthermore, banks offering multiple service lines highlight that they can give discounted depositary rates to fund managers through cross-subsidization. Banks offering full scope depositary services highlight it is simpler to port from their depositary-lites to full-depositary rather than changing service providers entirely. They also emphasize that they are better capitalized than some of their standalone competitors, something that is particularly attractive should they be forced to make right any liability claims.
Prew highlighted the majority of managers electing to change depositary were doing so for independence reasons. “Managers recognize that an independent depositary can provide an additional layer of oversight and control. The benefits of an independent model are also starting to be recognized by operational due diligence teams at institutional investors or investment consultants who are familiarizing themselves more with depositary selection and the criteria behind it. These allocators will undoubtedly become more vocal about their managers’ depositary choices. The current interim between AIFMD implementation and MiFID II is an ideal time for managers to reassess their AIFMD service providers,” commented Prew.
Depositary-lites, which were assumed to be a temporary reprieve for EU managers of non-EU funds, or non-EU managers of non-EU funds marketing into certain member states, have also been given an extended lifeline. The European Securities and Markets Authority (ESMA) announced in July 2015 that it was recommending the extension of the pan-EU marketing passport to Guernsey, Jersey and Switzerland only as it felt these jurisdictions met EU regulatory equivalence. However, this is still subject to approval by the European Commission.
Firms operating out of those countries and looking to market into the EU, will need to upgrade to a full-scope depositary, which unlike a depositary-lite is subject to strict liability for loss of financial instruments at the sub-custodian level.
ESMA added it would review equivalence across other major jurisdictions including the US, Hong Kong, Singapore and the Cayman Islands on an individual basis. This will take time and it is unlikely to be completed before 2018 when national private placement regimes (NPPR) were supposed to expire. As such, firms based or domiciled in these jurisdictions can continue to rely on national private placement and retain or appoint a depositary-lite. Prew said he could not envisage NPPR or the depositary-lite business model expiring before 2020 given the likely pace of ESMA approvals.