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.