Report Predicts Depositary Consolidation After AIFMD

Depositaries may face strong competition and industry consolidation in the wake of the Alternative Investment Fund Managers Directive (AIFMD), according to a Deutsche Bank report.

Under AIFMD, depositaries will be held liable not only for financial instruments they are custodying but also financial instruments custodied by a third party. As depositaries start to underwrite large amounts of risk, only those with a competitive size, market reach and amount of capital will be able remain in the market, says the report.

According to the report, the risk would also lead to an evolving relationship between depositaries, alternative investment funds and prime brokers; depositaries will want to work closely with prime brokers, perhaps those they know and trust. “They may even act as fund administrator in validating cash flow of funds,” it says. The report suggests an integrated approach where a depositary can also act as transfer agent, fund administrator, cash manager and sub-custodian, and provide one of the prime brokers . This would bring down costs and give depositaries that already offer such services a large advantage, further consolidating the industry. Such a model would also reduce administrative burden and increase visibility, thus helping compliance.

The report also urges depositaries to consider their activities in due diligence, cash monitoring and liability. Depositaries must ensure the quality of sub-custodians (such as prime brokers); monitor the movement of the alternative investment fund’s assets; and offset liability, perhaps by acquiring indemnification from prime brokers or by another method yet to be worked out. Finally, the report also suggests that AIFs begin negotiating with depositaries right away, as there are 10,000 European AIFs and only 28 depositaries.