The Alternative Investment Fund Managers Directive (“AIFMD”) has been widely regarded by European regulators and industry players alike, as a very powerful and proficient tool, responsible for the establishment of a coherent and integrated legislative framework amongst Member States in the European Union.


As with every legislative instrument, time has come for further fine tuning and clarification. Accordingly, on the 16th of April 2019, the European Parliament voted a new set of regulations with the aim being to tackle some of the issues identified within ESMA’s report on the 20 of July 2017. More specifically, the measures introduced cover four categories and aim to strengthen the Depositaries’ position in case where a Depositary elects to delegate its safe keeping functions,

The Alternative Investment Fund Managers
Directive (“AIFMD”) has been widely regarded by European regulators and
industry players alike, as a very powerful and proficient tool, responsible for
the establishment of a coherent and integrated legislative framework amongst
Member States in the European Union.

As with every legislative instrument, time
has come for further fine tuning and clarification. Accordingly, on the 16th of April
2019, the European Parliament voted a new set of regulations with the aim being
to tackle some of the issues identified within ESMA’s report on the 20 of July
2017.

More specifically, the measures introduced
cover four categories and aim to strengthen the Depositaries’ position in case
where a Depositary elects to delegate its safe keeping functions.

The new set of rules is contained within
the following legislative instruments:

1.
Commission Delegated Regulation (EU) 2018/1618 which amends the
safekeeping provisions of Delegated Regulation (EU) 231/2013; and

2.
Commission Delegated Regulation (EU) 2018/1619 which amends the
safekeeping provisions Delegated Regulation (EU) 2016/438.

(collectively
referred to as the “Regulations”)

The deadline for complying with the above
has been fixed for the 1st of April 2020 whereby, all
Depositaries of AIFs and UCITS need to comply with the legislative requirements
contained in the said Regulations.

“The reasons behind this initiative”

Both Regulations came as a direct response
to the problem of differing and in some cases contradictory national securities
and insolvency laws which currently exist at European Union level. This
diversity amongst Member States in the European Union creates a divergence in
the level of protection for financial instruments held in custody for AIFs and
UCITS and poses significant hazards in the fund industry sector.

As it becomes clear from the Regulations,
coherent rules are being introduced with the underlying purpose being the
provision to Depositaries of the necessary tools and statutory power to
supervise third party delegates more efficiently and effectively.

As many will agree, by strengthening the
position of the Depositaries vis-à-vis third-party delegates, better investor
protection is achieved, and further targeted safeguards are being introduced
for the better safekeeping of assets.

“The changes introduced”

Reconciliations

Reconciliations’ must be conducted as
frequently as necessary between the Depositary’s internal accounts and records
and those of any third party to whom safekeeping has been delegated.

The frequency of the reconciliations shall
be determined on the basis of the following:

a)the normal trading activity of the AIF/UCIT;

b) any trade occurring outside the normal trading activity; and

c) any trade occurring on behalf of any other client whose assets are held by the third party in the same financial instruments account as the assets of
the AIF/UCIT.

As the Regulations specify this measure has been introduced in order to minimize the lack of loss of assets held in omnibus financial accounts provided by third parties to whom the custody
function has been delegated.

The Contract of Delegation

The delegation relationship should be
documented by a written contract. The contract should allow the Depositary to
take all necessary steps ensuring that the assets kept in custody are properly
safeguarded and that the third party complies at all times with its contractual
terms.

In addition, the Depositary must have the
right to request and obtain information in relation to accounts and information
in relation to the assets held under custody to enable the Depositary to fulfil
its oversight and due diligence obligations and in particular allow the
Depositary to:

a)
identify all entities within the custody the custody chain;

b) verify that the
quantity of the identified financial instruments recorded in the financial
accounts of the Depositary of the fund matches the quantity of the financial
instruments held in custody by the third party;

c) verify that the quantity of the identified financial instruments
recorded and held in a financial instruments account opened at the issuer’s
Central Securities Depositary (CSD), matches the quantity of the identified
financial instruments recorded in the financial instruments’ accounts opened in
the Depositary books; and

d) details of equivalent
rights and obligations should the third party further delegate the custody
functions to another party.

Asset Segregation

Where safekeeping functions have been
delegated wholly or partly to a third party the Depositary shall ensure that
the third party (in brief):

a) correctly records all identified financial instruments in the financial
instruments account which is opened in the third party’s books;

b) keep all necessary
records and financial instruments accounts;

c) maintains records and financial securities accounts in a way that ensures their accuracy;

d) provides the
Depositary with a statement on a regular basis;

e) conducts reconciliations, as often as necessary, between its financial instruments’ accounts and internal records;

f) introduces adequate organisational arrangements to minimize the risk of
loss or diminution of financial instruments; and

g) holds the fund cash in an accountor accounts with a central bank of a third country or a credit institution authorised in a third country provided that the prudential, supervisory and
regulatory requirements apply based on the equivalence principle.

Third Country Delegate

In case where the safekeeping is delegated
to non-EU third parties, Depositaries must seek and obtain a legal opinion from
an independent natural or legal person confirming that the applicable
insolvency law recognises the segregation of the assets of the Depositary’s
clients from the third party’s own assets, from the assets of the third party’s
other clients and from the assets held by the third party for the Depositary
own account and that the assets of the Depositary clients do not form part of
the third party’s property in case of insolvency and thus such assets will not
be distributed in case of insolvency proceedings for the benefit of
creditors.

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