3 czerwca 2021 Investment Funds

Depositaries

 

Applicability

An AIFM that is fully authorised under AIFMD is required to appoint a single independent depositary in respect of each AIF it manages.

NB: Member States are currently permitted (but not required) to allow EU AIFMs to market non-EU AIFs, and non-EU AIFMs to market both EU and non-EU AIFs, in their territories on the basis of a national private placement regime (NPPR). The depositary requirements of AIFMD apply differently to AIFs marketed under NPPR. An authorised EU AIFM marketing a non-EU AIF to professional investors on the basis of a private placement exemption will not be subject to many of the depositary requirements and a non-EU AIFM marketing EU AIFs or non-EU AIFs to professional investors on a private placement basis will not be subject to any of the depositary requirements (unless Member States impose stricter private placement rules in their territories, notably the case for Germany and Denmark). However, AIFMD contains provisions which, if activated in the future, would require all AIFs to be marketed to professional investors in the EU on the basis of the AIFMD passport and not on the basis of NPPR, thus requiring full compliance with the AIFMD depositary rules for all AIFs marketed in the EU.  Please see the Marketing and Third Country Provisions page for more information in relation to marketing AIFs in accordance with a passport and under NPPR.

Appointment and functions
(Article 21(2), and (7) to (9) of AIFMD)

The appointment of the depositary must be evidenced in writing. The depositary must be appointed to carry out certain functions, including:

  • Safe keeping the assets of the AIF, namely:
  • in respect of any financial instruments which belong to the AIF, holding such instruments in custody; (see below for more detail);
  • in respect of all other assets of the AIF, verifying that the AIF (or AIFM acting on behalf of the AIF) holds an ownership interest in those assets, based on internal and external evidence of ownership (see below for more detail);
  • monitoring the AIF’s cash flows (see below for more detail);
  • performing oversight as follows:
  • ensure that the sale, issue, re-purchase, redemption and cancellation of units or shares of the AIF are carried out in accordance with the applicable national law and the AIF rules;
  • ensure that the value of the units or shares of the AIF is calculated in accordance with the applicable national law, the AIF rules and the valuation principles prescribed by AIFM;
  • carry out the instructions of the AIFM, unless they conflict with the applicable national law or the AIF rules;
  • ensure that in transactions involving the AIF’s assets any consideration is remitted to the AIF within the usual time limits;
  • ensure that an AIF’s income is applied in accordance with the applicable national law and the AIF rules;
  • maintaining accurate records in relation to the above functions.

Eligibility to act as Depositary
(Article 21(3) to (6) of AIFMD)

Typically the depositary must be an EU credit institution or the branch of an EU credit institution, investment firm or other entity which, on 21 July 2011, was eligible to act as a depositary under the UCITS Directive. However, for closed-ended funds which do not generally invest in assets that must be held in custody (see here for further details) AIFMD permits Member States to cater for a lighter regime whereby another entity which carries out depositary services as part of its professional activities may carry out the depositary functions. Luxembourg has for this purpose created the “professional depositary of assets other than financial instruments”.

The AIFM itself is not allowed to act as the depositary. Prime brokers acting as a counterparty to an AIF may act as a depositary for an AIF, subject to functional and hierarchical separation of their depositary and prime brokerage roles, and appropriate management of conflicts of interest. In addition, for EU AIFs, the depositary must be located in the same jurisdiction as the AIF.

Luxembourg depositaries are subject to rather detailed rules, as laid down in a specific CSSF Circular (Circular CSSF 16/644), including the need to apply for a specific permission to act as AIFMD depositary.

Basis of Liability
(Article 21(12) to (15) of AIFMD, Article 100 to 102 of the Level 2 Regulations and Part III Chapter 5 of the CSSF circular 18-697)

The depositary is subject to near strict liability in relation to the loss of financial instruments held in custody by the depositary or a delegate. In the case of loss of such financial instruments, the depositary is obliged to return identical financial instruments or the corresponding amount to the AIF (or the AIFM acting on behalf of the AIF) without undue delay, even if the instruments were held in custody by a sub-custodian.

However, the depositary will not be liable if it can prove that the loss of financial instruments has arisen as a result of “an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary” (e.g. a natural event beyond human control or influence, a change in the law, or war, riots or another major upheaval). However this exemption is subject to strict rules which in practice make it less extensive than it may first appear – in particular, the insolvency of a sub-custodian is not covered. Click here for more detail in relation to circumstances in which the depositary may not be liable for loss of financial instruments.

Furthermore, where the assets are held by a sub-custodian, the depositary may be able to contract out of liability for loss of those assets if it has complied with all prescribed obligations in AIFMD in relation to the delegation and there is an "objective reason" for discharging itself of liability (e.g. where the law of a third country requires that certain financial instruments be held in custody by a local entity so the depositary had no option but to appoint a third party delegate). Click here for more detail on the applicable requirements.

In the case of “other losses” which the AIF or its investors may suffer, liability only flows if there is a “negligent or intentional” failure on the part of the depositary to comply with its obligations under AIFMD.

Delegation
(Article 21(11) of AIFMD, Article 98 and 99 of the Level 2 Regulation, Part II Chapter 2 and sub-chapter 2.4 of the CSSF circular 18-697)

General requirements for delegation of safekeeping functions

Under AIFMD, the depositary may delegate its safekeeping functions provided that the functions are not delegated to circumvent AIFMD, the depositary has an objective reason for the delegation, and the depositary exercises all due skill, care and diligence in the selection, appointment and ongoing monitoring of the sub-custodian.

Additionally, the sub-custodian must:

  • have structures and expertise adequate and proportionate to the nature, scale and complexity of the assets of the AIF (or of the AIFM acting on behalf of the AIF);
  • in respect of the custody of financial instruments, be subject to effective prudential regulation and supervision in its local jurisdiction and periodic external audits;
  • provide throughout the custody chain for segregation between the depositary’s own financial instruments, financial instruments belonging to the AIF and financial instruments belonging to other clients; and
  • not make use of the AIF’s assets without the express consent of the AIF (or the AIFM acting on behalf of the AIF).

The sub-custodian must act honestly, fairly, independently and in the interests of the AIF and the investors of the AIF when carrying out its duties, and must comply with certain general obligations as set out in AIFMD.

Due diligence and asset segregation obligations

When a depositary delegates the custody function to a sub-custodian, it must comply with detailed rules which are set out in the Level 2 Regulation. In summary, under Article 98 of the Level 2 Regulation, the depositary must:

  • implement an appropriate documented due diligence procedure for the selection and ongoing monitoring of the sub-custodian, which must be reviewed at least once a year, and made available upon request to competent authorities;
  • exercise all due skill, care and diligence to ensure that entrusting financial instruments to the sub-custodian provides an adequate standard of protection, taking into account the matters specified in the Level 2 Regulation;
  • appoint the sub-custodian under a contract which contains certain provisions specified in the Level 2 Regulation with respect to the depositary’s right to information, inspection and access to records and accounts of the sub-custodian, and details of any equivalent rights that the sub-custodian has with respect to any third party to which it has sub-delegated its functions;
  • devise contingency plans for each market in which it appoints a sub-custodian;
  • exercise all due skill, care and diligence in the periodic review and on-going monitoring of the sub-custodian to ensure that the sub-custodian continues to comply with the requirements for delegation, taking into account the matters specified in the Level 2 Regulation; and
  • take measures, including termination of the contract, which are in the best interest of the AIF and its investors where the sub-custodian no longer complies with the requirements.

In addition, as set out in detail in Article 99 of the Level 2 Regulation, the depositary must:

  • ensure that the sub-custodian acts in accordance with the asset segregation requirements laid down in the Level 2 Regulation;
  • where the sub-custodian is a bank, ensure that any cash of the AIF held with the sub-custodian is booked in cash accounts opened in the name of the AIF, in the name of the AIFM acting on behalf of the AIF, or in the name of the depositary acting on behalf of the AIF;
  • ensure that the financial instruments are protected from the insolvency of the sub-custodian.

The requirements of Articles 98 and 99 of the Level 2 Regulation generally apply on the same basis with respect to any further sub-delegation by the sub-custodian of its safe-keeping functions.

The depositary agreement
(Article 21(2) of AIFMD, Article 83 of the Level 2 Regulation and the CSSF Circular 18-697)

Unless otherwise required by national law, an AIFM will not need to enter into a specific written agreement for each AIF. It is therefore possible for the AIFM and the depositary to enter into a framework agreement that applies to a number of AIFs managed by the AIFM.

In practice, however, we see that there is always a separate agreement for each AIF.

Article 83 of the Level 2 Regulations specifies the matters which must be addressed in the written agreement between the depositary and the AIFM and/or AIF. These matters are extensive, and include the following:

  • a description of the depositary’s services and the procedures for each type of asset of the AIF that is entrusted to the depositary;
  • a description of the way in which safekeeping and oversight is to be performed in accordance with the types of asset and the geographical regions in which the AIF plans to invest;
  • a statement that the depositary’s liability will not be affected by any delegation of its custody functions unless it has discharged itself of its liability in accordance with AIFMD requirements;
  • the period of validity and the conditions for amendment and termination of the contract;
  • the confidentiality obligations applicable to the parties;
  • the means and procedures for transmission of information between the depositary and the AIFM or AIF;
  • information on whether the depositary or a sub-custodian may re-use AIF assets and on the conditions of such re-use;
  • the procedures for amending the AIF rules, instruments of incorporation and offering documents, detailing any requirements to notify the depositary or obtain its consent;
  • a provision specifying which information must be exchanged between the AIF, the AIFM, any third party acting on behalf of the AIF or AIFM, and the depositary in relation to the sale, subscription, redemption, issue, cancellation and repurchase of units or shares of the AIF and in relation to the performance of the depositary’s oversight and control function;
  • a commitment by each party to provide, on a regular basis, details of any third party appointed and, upon request, information on the criteria used to select the third party and the steps envisaged to monitor the activities of the third party;
  • information on the responsibilities of the parties relating to the prevention of money laundering and terrorist financing;
  • information on all cash accounts opened in the name of the AIF or in the name of the AIFM acting on behalf of the AIF, and the procedures to inform the depositary when any new account is opened;
  • details on the depositary’s escalation procedures;
  • a commitment by the depositary to notify the AIFM when it becomes aware that the segregation of assets is not sufficient to protect a sub-custodian from insolvency;
  • the procedures to ensure that the depositary can enquire into the conduct of the AIFM and/or the AIF and assess the quality of information transmitted (including by accessing the books of the AIFM and/or AIF in on-site visits); and
  • the procedures to ensure that the AIFM and/or AIF can review the depositary’s performance of its contractual obligations.

Depositary obligations relating to cash-flow monitoring
(Article 21(7) of AIFMD and Articles 85 and 86 of the Level 2 Regulations)

As part of its obligations relating to cash-flow monitoring, the depositary must ensure that payments made by or on behalf of investors and those received for the benefit of investors are booked in segregated accounts opened in the name of the AIF (or AIFM or depositary acting on behalf of the AIF) at a central bank, an EU authorised bank or a non-EU authorised bank. It falls on the AIFM to ensure that the depositary is provided with all relevant information it needs to comply with this obligation. To ensure that the depositary has access to information regarding the AIF’s cash accounts and an overview of all the AIF’s cash flows, the depositary must:

  • be informed, upon its appointment, of all existing cash accounts opened in the name of the AIF, or in the name of the AIFM acting on behalf of the AIF;
  • be informed at the opening of any new cash account by the AIF or by the AIFM acting on behalf of the AIF; and
  • be provided with all information related to the cash accounts opened at a third party entity, directly by those third parties.

The depositary’s cash-flow monitoring obligations also require it to:

  • implement effective procedures to reconcile all cash-flow movements and perform such reconciliations on a daily basis or, in the case of infrequent cash movements, when such cash-flow movements occur;
  • implement appropriate procedures to identify at the close of each business day significant cash flows, and in particular those which could be inconsistent with the AIF’s operations;
  • review periodically the adequacy of those procedures, including through a full review of the reconciliation process at least once a year, and ensure that the cash accounts opened in the name of the AIF, or in the name of the AIFM or depositary acting on behalf of the AIF, are included in the reconciliation process;
  • monitor the outcomes of the reconciliations and actions taken as a result of any discrepancies identified by the reconciliation procedures, and notify the AIFM if an irregularity has not been rectified without undue delay, as well as the competent authorities if the situation cannot be clarified and/or corrected; and
  • check the consistency of its own records of cash positions with those of the AIFM (which the AIFM must provide to the depositary for this purpose).

Depositary obligations relating to custody of financial instruments
(Article 21(8)(a) of AIFMD, Articles 88 and 89 of the Level 2 Regulations)

The depositary must hold in custody:

  • all financial instruments belonging to the AIF (or the AIFM acting on behalf of the AIF) (i.e. transferable securities, money market instruments and – in certain cases - units in collective investment undertakings) that are capable of being registered or held in an account directly or indirectly in the name of the depositary. These must be held in segregated accounts opened in the depositary’s books in the name of the AIF or the AIFM acting on behalf of the AIF; and
  • all financial instruments belonging to the AIF (or the AIFM acting on behalf of the AIF) that can be physically delivered to the depositary.

The depositary’s custody obligation does not, however, extend to financial instruments which, in accordance with applicable national law, are only directly registered in the name of the AIF with the issuer itself or its agent, such as a registrar or a transfer agent.

The scope of the depositary’s custody duty covers the following:

  • proper registration of those financial instruments that are capable of registration in an account;
  • maintaining records and segregated accounts relating to financial instruments and cash in an accurate manner;
  • conducting reconciliations between the depositary’s internal accounts and records and those of any sub-custodian as often as necessary, with the frequency of such reconciliations to be determined taking into account the AIF’s normal trading activity, trades which occur outside the AIF’s normal trading activity and trades made on behalf of other clients whose assets are held by the sub-custodian in the same account as the AIF’s assets;
  • exercising due care in relation to the financial instruments held in custody in order to ensure a high standard of investor protection;
  • assessing and monitoring all relevant custody risks throughout the custody chain, and informing the AIFM of any material risk identified;
  • introducing adequate organisational arrangements to minimise the risk of loss or diminution of the financial instruments, or of rights in connection with those financial instruments as a result of fraud, poor administration, inadequate registering or negligence; and
  • verifying the AIF’s ownership right, or the ownership right of the AIFM acting on behalf of the AIF, over the assets.

Where a depositary has delegated custody functions to a sub-custodian, the depositary will nonetheless be required to ensure proper registration of the relevant financial instruments, maintain accurate records and segregated accounts, to conduct reconciliations as often as necessary between its internal accounts and records and those of the sub-custodian, to exercise due care so that the exercise of the custody function ensures a high standard of investor protection, to assess and monitor all relevant custody risks, and to inform the AIFM of any material risk. The depositary will also need to ensure that the sub-custodian duly performs the custody functions listed above (with the exception of registration of financial instruments), and complies with the segregation obligations in the Level 2 Regulations. See above for further information in relation to requirements that apply to a depositary which delegates safekeeping functions to a sub-custodian.

The depositary’s duties above apply on a look-through basis to underlying assets held by financial and/or legal structures controlled directly or indirectly by the AIF (or the AIFM acting on behalf of the AIF), although they do not apply to fund-of-funds structures or master-feeder structures where the underlying funds have a depositary which keeps the assets of these funds in custody.

Depositary obligations relating to ownership verification
(Article 21(8)(b) of AIFMD and Article 90 of the Level 2 Regulations)

In respect of assets which do not constitute financial instruments that can be held in custody, the depositary must verify the ownership of the AIF (or the AIFM acting on behalf of the AIF) of such assets and maintain a record of those assets for which it is satisfied of such ownership. This ownership assessment must be based on information or documents provided by the AIF or the AIFM and, where available, on external evidence. The depositary must also ensure that it keeps its records relating to this assessment up to date.

The AIFM is under a separate obligation to provide the depositary, and to ensure relevant third parties provide the depositary, with all relevant information the depositary needs to comply with its ownership verification obligations.

The arrangements relating to ownership verification and related record-keeping must be such that:

  • the depositary can access without undue delay all relevant information it needs in order to perform its ownership verification and record-keeping duties;
  • the depositary possesses sufficient and reliable information for it to be satisfied of the AIF’s ownership, or of the ownership of the AIFM acting on behalf of the AIF, in respect of the assets; and
  • the depositary maintains a record of those assets for which it is satisfied that the AIF (or the AIFM acting on behalf of the AIF) holds the ownership. For this purpose, the depositary must register the relevant assets in its records in the name of the AIF, and must be able to provide, at any time, a comprehensive and up-to-date inventory of the AIF’s assets. Accordingly, the depositary must ensure that it (or a sub-custodian) is informed of any assignment, transfer, exchange or delivery of registered assets, and that relevant third parties provide the depositary with documentary evidence every time a transaction in assets occurs, and at least once a year.

The depositary must also ensure the AIFM implements appropriate procedures to verify that the assets acquired by the AIF it manages are appropriately registered in the name of the AIF or in the name of the AIFM acting on behalf of the AIF, and to check the consistency between the positions in the AIFM’s records and the assets for which the depositary is satisfied that the AIF (or the AIFM acting on behalf of the AIF) holds the ownership. The AIFM must ensure that all instructions and relevant information relating to the AIF’s assets are sent to the depositary, so that the depositary is able to perform its own verification or reconciliation procedure.

The depositary must implement an escalation procedure for situations where an anomaly is detected, including notification of the AIFM and of the competent authorities if the situation cannot be clarified and/or corrected.

The depositary’s duties above apply on a look-through basis to underlying assets held by financial and/or legal structures controlled directly or indirectly by the AIF (or the AIFM acting on behalf of the AIF), although they do not apply to fund-of-funds structures or master-feeder structures where the underlying funds have a depositary which provides ownership verification and record-keeping functions for these funds’ assets.

Prime brokers as depositaries and sub-custodians
(Article 21(4)(b) of AIFMD and Article 91 of the Level 2 Regulations)

A prime broker acting as a counterparty to an AIF may be appointed as the depositary for the AIF provided that it has functionally and hierarchically separated the performance of its depositary functions from its tasks as prime broker, and that potential conflicts of interest are properly identified, managed and disclosed to the investors of the AIF.

In addition, depositaries of AIFs can delegate custody tasks to one or more prime brokers provided that they meet the conditions above and below.

Where a prime broker has been appointed as sub-custodian, it must provide to the depositary of the AIF, no later than the close of the next business day to which it relates, a statement in a durable medium which contains the following information:

  • at the end of each business day, the total value of assets held by the prime broker for the AIF as sub-custodian:
  • the value of other assets (i.e. not financial instruments) held as collateral by the prime broker in respect of secured transactions entered into under a prime brokerage agreement;
  • the value of the assets where the prime broker has exercised a right of use in respect of the AIF’s assets;
  • a list of all the institutions at which the prime broker holds or may hold cash of the AIF in an account opened in the name of the AIF or in the name of the AIFM; and
  • details of any other matters necessary to ensure that the depositary of the AIF has up-to-date and accurate information about the value of assets the safekeeping of which has been delegated to the prime broker.
Luxembourg specifics

A list of the prime brokers or collateral agents has to be part of the information on depositary functions to be kept updated and to be provided to the CSSF on a periodic, ad hoc or annual basis.

Discharge of depositary's liability – events beyond the depositary's reasonable control
(Article 21(12) of AIFMD, Article 100 and 101 of the Level 2 Regulations)

A loss of a financial instrument held in custody by a depositary (or a sub-custodian) is deemed to have taken place when any of the following conditions is met:

  • a stated right of ownership of the AIF is demonstrated not to be valid because it either ceased to exist or never existed;
  • the AIF has been definitively deprived of its right of ownership over the financial instrument, unless the instrument is substituted by or converted into another financial instrument(s); or
  • the AIF is definitively unable to directly or indirectly dispose of the financial instrument.

In general, the depositary is strictly liable with respect to any loss of the AIF’s financial instruments. However, in the case where the loss of financial instruments resulted from an external event beyond the depositary’s reasonable control, the consequences of which were unavoidable despite all reasonable efforts to the contrary, the depositary may be able to discharge its liability for the loss provided the depositary can prove that all the following conditions are met:

a) the event which led to the loss is not the result of any act or omission of the depositary or a sub-custodian, and the depositary could not have reasonably prevented the occurrence of that event despite adopting all precautions incumbent on a diligent depositary as reflected in common industry practice.

Such events include:

  • natural events beyond human control or influence;
  • the adoption of any law, decree, regulation, decision or order by any government or governmental body, including any court or tribunal, which impacts the financial instruments held in custody;
  • war, riots or other major upheavals,

but exclude cases such as accounting errors, operational failures, fraud and failure to apply the segregation requirements at the level of the depositary or a sub-custodian.

b) despite rigorous and comprehensive due diligence, the depositary could not have prevented the loss.

Such rigorous and comprehensive due diligence includes:

  • establishing, implementing, applying and maintaining structures and procedures and insuring expertise that are adequate and proportionate to the nature and complexity of the assets of the AIF in order to identify in a timely manner and monitor on an ongoing basis external events which may result in loss of a financial instrument held in custody;
  • assessing on an ongoing basis whether any of the events identified under the first indent presents a significant risk of loss of a financial instrument held in custody;
  • informing the AIFM of the significant risks identified and taking appropriate actions, if any, to prevent or mitigate the loss of financial instruments held in custody, where actual or potential external events have been identified which are believed to present a significant risk of loss of a financial instrument held in custody.

In the case where the depositary has delegated the safekeeping of an AIF’s assets to a sub-custodian, and the depositary has contracted out of its liability and transferred it to the sub-custodian, the sub-custodian may discharge its strict liability provided it can fulfil the conditions listed in paragraphs (a) and (b) above.

Discharge of depositary's liability – transfer of liability to a sub-custodian
(Article 21(13) and 21(14) of AIFMD and Article 102 of the Level 2 Regulations)

When a depositary delegates the custody of an AIF’s assets to a sub-custodian, the depositary remains strictly liable for any loss of financial instruments. However, the depositary may discharge itself of liability if it can prove that:

a) the delegation complies with AIFMD;

b) a written contract between the depositary and the sub-custodian expressly transfers the liability of the depositary to the sub-custodian and makes it possible for the AIF or the AIFM acting on behalf of the AIF to make a claim against the sub-custodian in respect of the loss of financial instruments or for the depositary to make such a claim on their behalf; and

c) a written contract between the depositary and the AIF or the AIFM acting on behalf of the AIF expressly allows a discharge of the depositary’s liability and establishes the objective reason to contract such a discharge.

Such an “objective reason” must be established each time the depositary intends to discharge itself of liability, and must be:

  • limited to precise and concrete circumstances characterising a given activity; and
  • consistent with the depositary's policies and decisions.

In addition, in situations where the depositary has no other option but to delegate its custody duties to a sub-custodian, the depositary will be deemed to have objective reasons for contracting the discharge of its liability. In particular, this is the case where:

  • the law of a third country requires that certain financial instruments be held in custody by a local entity and local entities exist that satisfy the delegation criteria laid down in AIFMD (see below); or
  • the AIFM insists on maintaining an investment in a particular jurisdiction despite warnings by the depositary as to the increased risk this presents.

Where the law of a third country requires that certain financial instruments are held in custody by a local entity and there are no local entities that satisfy the delegation requirements laid down in AIFMD with respect to effective prudential regulation, supervision and external periodic audit, the depositary can discharge itself of liability provided that the following conditions are met:

  • the rules or instruments of incorporation of the AIF concerned expressly allow for such a discharge under the conditions set out in this paragraph;
  • the investors of the relevant AIF have been duly informed of that discharge and of the circumstances justifying the discharge prior to their investment;
  • the AIF or the AIFM on behalf of the AIF instructed the depositary to delegate the custody of such financial instruments to a local entity;
  • there is a written contract between the depositary and the AIF or the AIFM acting on behalf of the AIF, which expressly allows such a discharge; and
  • there is a written contract between the depositary and the sub-custodian that expressly transfers the liability of the depositary to that local entity and makes it possible for the AIF or the AIFM acting on behalf of the AIF to make a claim against that local entity in respect of the loss of financial instruments or for the depositary to make such a claim on their behalf.