Questions over depositaries pricing risk into fees

A number of depositaries may not be pricing the costs of strict liability into client fees with many under charging because they are discharging the liability to their prime brokers acting as sub-custodians.

Article 21 of AIFMD (the Alternative Investment Fund Managers Directive) requires depositary banks appointed by fully compliant AIFs to provide safekeeping of client assets, cash flow monitoring and oversight, as well as subjecting them to strict liability for any loss of assets held in custody through fraud or negligence. Nonetheless, a number of these organisations are discharging the liability for loss of assets on grounds of 'objective reason'. A number are also obtaining an indemnity from their sub-custodians such as prime brokers against any losses.

Early projections showed the industry expected the costs of a full depositary service to be as high as 30 to 40 basis points (bps) but today some depositary banks are understood to be charging clients two to three bps. 

“The actual costs for full depositary services are a far cry from the early estimates, but then the level of liability discharge that has taken place was probably not factored into those estimates," said Bill Prew, chief executive officer at INDOS Financial, an independent depositary-lite in London. "Given that the discharge of liability has not been tested, there must be a risk that some depositaries are not pricing in the real potential liability into their fees.”

While a number of firms have contractually discharged their liability, many believe this practice is open to legal or regulatory challenges. If a liability claim were to arise following a loss of assets, it would likely prompt a legal challenge to the discharge of liability.

Meanwhile UCITS V, unlike AIFMD, explicitly prohibits depositary banks from discharging liability for loss of assets to sub-custodians and there is widespread speculation this could be extended to AIFMD once the European Securities and Markets Authority conducts its wholesale review of the Directive in 2015. “UCITS V does not permit discharge of liability," said Prew. "Therefore the current practices for many AIFMD funds may be short lived. If this were to occur, we could see an increase in depositary costs over time.”

AIFMs, unlike UCITS fund structures, can adopt more esoteric, complex strategies and are not subject to leverage and liquidity restrictions. This makes them a far riskier proposition for depositary banks to service.

Others, however, question whether depositaries are under priced. “There is quite a competitive market in depositary services, which is why the costs are low," said Roger Fishwick, chief risk officer at Thomas Murray Data Services. "A lot of the major custodians have extended their range of European Union countries where they offer depositary services. I think that this is all competitive activity and not to do with whether or not liability is priced in.”

Tags: AIFMDDepositary BanksDepositary liabilityDepositariesUCITS VRegulation