The Alternative Investment Fund Managers Directive (AIFMD) is bringing about some major changes in attitude, if not methodology, at depositary banks in regards to their counterparty network. Whilst they ‘have always been on the hook for our stupidity,’ as one head of a depositary bank told us, they have never had to assume strict liability for the restitution of losses in a fund’s assets before.
It is not, however, all bad news for the depositaries, as we discussed in our webinar, AIFMD and the relationship between depositary banks and prime brokers last week. “The depositary banks have gained a clear commercial opportunity,” said Roger Fishwick, director at Thomas Murray Data Services. There was unanimous agreement with a note of caution from a depositary.
“We have to be careful,” added Ian Headon, senior vice president of Northern Trust Depositary Services. “Investors have not sprinted headlong toward EU funds and there remains a question around whether this Directive and the protection that investors ostensibly get, is going to formalise into real investor demand. Unless investors vote with their feet, it does not matter – there is only an opportunity here if we, collectively as the industry and regulators, construct something that is sensible. Investors are not going to start paying big fees unless they can see tangible benefits.”
Without investors actually investing, there is no opportunity for anyone. The prime brokers, however, do not see any opportunity for themselves however it pans out. “The opportunity for us is increased overheads and staff costs!” laughed Jane Masen, director, EMEA Head Bank Network Management, Citi Bank.
“I think that it creates the opportunity for more transparency between the prime brokers and their third parties,” said Gildas Le Treut, global director of Prime Clearing at ABN AMRO Clearing. “We have a joint interest, with the depositary banks, to create transparency on the protection of assets as long as both work together. But I do agree with Jane about the increased costs. The set up and the way that we will be forced into asset segregation by ESMA will have a huge impact on the cost if we cannot provide stock lending services in a proper and cost efficient way.”
Across the pond in the US, AIFMD is not mandatory and the landscape is slightly different. “In the US, the custody banks have become part of the prime brokerage process,” Chris J. Caruso, founder of Pangaea Business Solutions. “Most large to mid-size funds do use depositaries in much the same way as AIFMD prescribes. We probably won’t get that uniform type of structure unless there is regulation, though, and I think that there are enough other regulations going on here in the US that they are probably not going to move onto this just yet. I think that the depositaries, though, are the only ones to benefit from this – I see no advantages for the prime brokers.”
Indeed, US prime brokers are not compliant with AIFMD and cannot be used by firms seeking compliance with the Directive. “From what we are seeing, US prime brokers are not in a position to be complaint with AIFMD,” said Richard Frase, a partner at the law firm Dechert. “This means that funds will have to use London-based prime brokers until such a time that the US prime brokers decide whether or not to become compliant with AIFMD.”
As Chris suggested, however, this seems unlikely, at least for the immediately foreseeable future.
It is clear that there are little to no opportunities for prime brokers under AIFMD. They may well be forced to individually segregate client accounts which will, ultimately, impinge on their ability to re-hypothecate assets for their own gain. Theirs is a model undergoing change at the hands of AIFMD, where the depositary model is evolving. If the investment floods in, the depositary opportunity is very much a commercial one.