Could a multi-depositary regime emerge under AIFMD?

There is debate as to whether a multiple-depositary model could emerge under the EU’s Alternative Investment Fund Managers Directive (AIFMD) once the national private placement regime expires in 2018.

AIFMD obligates fully-compliant AIFMs to appoint a single depositary to provide safe-keeping of assets, cash-flow monitoring and oversight. “Allowing a multiple-provider full depositary model would be an interesting development," said Bill Prew, chief executive officer at INDOS Financial, an independent depositary-lite in London. "It would be a natural extension of the existing depositary-lite model since instead of prime brokers performing the safe keeping and custody duty, multiple depositaries could be appointed that would, in turn, delegate custody to prime brokers. The depositaries could still take on the strict liability for loss of assets but would do so only for the pool of assets under their appointment.”

Some have argued the single depositary requirement, whilst improving the protection of institutional investor assets, does lead to a concentration of risk at a handful of already systemically important financial institutions (SIFIs). A multi-depositary model would also make it easier for fund managers to port business if they are receiving a suboptimal service from their main provider, or if that provider runs into difficulty. "A multi-depositary model would result in more flexibility and choice for managers," said Prew. "Competition among depositaries could also diversify counterparty and supplier risk, since under the current full depositary model many managers may have little choice but to consolidate custody, depositary and fund administration services with one group."

Others believe the situation is not straightforward and oppose the multi-depositary model as being too unwieldy. “The depositary is, in its nature, performing an oversight role for which it is strictly liable under Article 22 of the AIFMD," said Roger Fishwick, chief risk officer at Thomas Murray Data Services in London. "If there are multiple providers carrying out the different roles of safe-keeping, oversight and cash-flow monitoring, it becomes harder for the depositary to perform its role and it becomes an operational nightmare, particularly for the manager. I do not believe we should overcomplicate the model.”

An argument where a multi-depositary set-up could hold swing is if a manager is simultaneously running vanilla and esoteric strategies across different portfolios. For example, a depositary bank could struggle to oversee, safe-keep and provide cash-flow monitoring for a strategy containing bespoke swap transactions or hard-to-value illiquid assets. “There is nothing in AIFMD forbidding a fund manager from asking its depositary to use a second administrator to oversee certain assets, then reporting into the depositary as for any other service provider, if the fund manager feels the instruments are not in the depositary’s primary area of expertise," said Fishwick. "This would, however, be contingent on the primary depositary’s approval.”

One area which is proving contentious is the bundled offering provided by some universal banks whereby depositary services are offered in addition to administration, prime brokerage and tri-party collateral management. In addition to presenting a counterparty risk, there are also potential conflicts of interest as some suggest that the depositary might be more reluctant – in its oversight function – to report issues or mistakes at the in-house administration arm, preferring to work internally to resolve the problem.

Another area of conflict could possibly be if a bank-owned asset manager appointed other group companies to provide depositary services, as well as administration and prime brokerage. “There are provisions under AIFMD around delegation and conflicts of interest, but they may not be strong enough," added Fishwick. "I believe regulators should focus on these challenges and potential conflicts, to avoid another Bernard Madoff style situation where there are no external organisational boundaries and everything is, in effect, self-administered."

Tags: AIFMDRegulationEuropeEUDepositariesDepositary BanksDepositary liability