AIFMD, UCITS V and depositary liability

One area of intrigue around depositary liability under AIFMD and UCITS V is CSDs (central securities depositories). CSDs, as systemically important financial market infrastructures, come in different guises that hold the key to the depositary liability regime under both Directives. The difference between Issuer and Investor CSDs is a crucial component.

“The definition and interpretation of what a CSD does under AIFMD and UCTIS V has not been linked up properly to the evolving reality of what CSDs are going to be doing and where they will be used as a direct sub-custodian by depositary banks in certain markets, which is definitely within the strategies of some of the global custodians,” says Jim Micklethwaite, director of capital markets at Thomas Murray Data Services.

“Does the CSD then come under AIFMD in terms of it being defined as a sub-custodian? To my mind, it is very vague.”

The crucial difference lies in whether the CSD is an Issuer or an Investor CSD, explains Koen Vanderheyden, a partner at the law firm DLA Piper. “What is in the recital of UCITS V is that when a CSD is acting as an Investor CSD rather than an Issuer CSD, then the depositary will be liable for it,” he says. “From our most recent communications with ESMA (the European Securities Markets Authority, the European regulator responsible for overseeing AIFMD and UCITS V), it appears that they are of the opinion that the same is applicable for alternative investment funds.

“As soon as a CSD starts to act as an intermediary, according to ESMA they should be treated as a sub-custodian and, therefore, the depositary would be liable and the regime would be the same as for other sub-custodians.

“With Issuer CSDs there will only be one choice possible, so depositaries should not be liable. But if the CSD is linking to another Issuer CSD – accessing a market through another CSD – then this would be seen as a delegation of custody and would carry a liability for the depositary. The problem with this is that, according to us, this is not in line with the AIFMD text, which says in Article 21(11), that if there are services certified by the SFD (Settlement Finality Directive) provided by a Securities Settlements System designated under the SFD, that this is not considered to be a delegation of custody. So this recital, UCITS V and the answers we are getting from ESMA, are really worrying because this seems to be an indication that where a CSD is acting as an Investor CSD, as a custodian instead of an Issuer CSD, that these activities would not be covered by SFD which would of course create a huge liability for CSDs.”

CSDs are finding themselves at a regulatory crossroads, involved in EMIR, MiFID, CSDR, T2S, Solvency II and these Directives, AIFMD and UCITS V. Theirs is a landscape that has altered dramatically in the post financial crisis years. As well as falling under the liability regime being placed upon depositaries, they are also taking on more liability themselves. “One of the key factors here is the arrival of T2S and the changing role of CSDs in Europe,” says Jim.

As their role is changing, so is the liability around them. Depositaries will find themselves liable for losses Investor CSDs and some Issuer CSDs going forward – it is not yet, however, an entirely transparent picture in this evolving environment.

What are the risks for depositaries in CSDs and should they be shouldering liability for losses at them? We will look into this in our next article.

Jim Micklethwaite and Koen Vanderheyden were talking at the Thomas Murray Data Services webinar, Country and Financial Market Infrastructure Risk Monitoring Under AIFMD & UCITS V. You can learn more about the session and listen to a re-run here:

Tags: AIFMDUCITS VDepositary liabilityCSDRegulation