A single depositary must be appointed for each EU AIF. Core duties are cash-flow monitoring, safe-keeping, record-keeping and oversight functions.
A single depositary must be appointed for each EU AIF.
Alternative investment fund managers (AIFMs) are required to ensure that a single depositary is appointed for each alternatiave investment fund (AIF) they manage, before they can be authorized under the Directive. The appointment should be evidenced in a written contract. The AIFM cannot act as a depositary for any AIFs.
For European Union (EU) AIFs, the depositary must be an EU credit institution (e.g. a bank), a Markets in Financial Instruments Directive (MiFID) investment firm or another type of institution determined by the Member State to be eligible and that is subject to regulation and ongoing supervision. A prime broker may be appointed as a depositary if it has functionally and hierarchically separated its prime broker tasks from its depositary functions. For non-EU AIFs, the depositary must be established in the home Member State of the AIFM or the Member State of Reference of a non-EU AIFM or the country of establishment of the AIF. Also, certain conditions apply, such as the existence of a co-operation agreement between the national regulators.
The depositary should not carry out any activities with regard to the AIF or the Alternative Investment Fund Manager Directive (AIFMD) on behalf of the AIF that may create conflicts of interest between the AIF, the AIFM and itself, unless it has functionally and hierarchically separated the performance of its depositary tasks from its other potentially conflicting tasks, and the potential conflicts of interest are properly identified, managed, monitored and disclosed to the AIF’s investors.
Core duties of the depositary
The depositary is responsible for properly monitoring the AIF’s cash flows and for ensuring that payments from investors and all AIF cash are booked in cash accounts opened in the name of the AIF, or the AIFM or the depositary on behalf of the AIF. If the cash account is opened in the name of the depositary, none of the depositary’s own cash may be booked in the account.
The regulation requires the depositary to perform daily reconciliations of all AIF cash flows on an ex-post basis. There is the flexibility to perform less frequent reconciliation as and when cash flows occur. The depositary is also required to identify significant cash-flows that are inconsistent with the AIF’s normal activity.
The AIFMD makes a distinction between ‘financial instruments that can be held in custody’ and ‘other assets’ and in the ensuing duties for each category.
The regulation defines that those transferable securities, money market instruments and fund units that can be registered or held in an account directly or indirectly in the name of the depositary are to be considered as instruments held in custody. The same applies to all financial instruments of the AIF that are able to be physically delivered to the depositary. Only an outright transfer of ownership would put the financial instruments outside the scope of custody. Assets subject to collateral arrangements with no title transfer cannot be excluded from the scope of custody. The depositary must ensure that the assets are held in segregated accounts to clearly identify all assets belonging to the AIF at all times.
For all other assets the depositary is required to verify ownership and to maintain an up-to-date record of the AIF’s assets. The assessment of ownership should be based on information and documents provided by the AIF and on reliable external evidence. Examples of other assets are derivatives, cash deposits, investments in privately held companies and real assets.
The Regulation requires the depositary to apply a ‘look-though basis’ to assets held by financial or legal structures controlled directly or indirectly by the AIF/AIFM, but exempts Funds of Funds and Master-Feeder structures provided that they have a depositary.
The depositary is required to perform certain oversight functions, to ensure that the AIF acts in accordance with applicable national law, AIF rules or instruments of incorporation. The oversight procedures should take into consideration the nature, scale and complexity of the AIF's strategy and the AIFM's organization. The depositary is expected to perform ex-post controls and verifications of processes and procedures under the responsibility of the AIFM, the AIF or an appointed third party.
The depositary cannot delegate its functions other than safe-keeping, and it can delegate safe-keeping only provided certain conditions are met:
The delegate may in turn sub-delegate its functions, subject to compliance with the same conditions.Where the law of a third country requires certain financial instruments to be held in custody by a local entity and no local entity fulfils these requirements, it may delegate to a local entity provided that the investors of the AIF are duly informed of these legal constraints and provided the AIF (or the AIFM activing on behalf of the AIF) has instructed the depositary to delegate the custody of such financial instrument to such entity.
The liability regime
The Directive foresees two scenarios in which the depositary is liable: the loss of financial instruments held in custody; and other losses suffered as a result of the depositary’s negligent or intentional failure properly to fulfil its obligations.
Loss of financial instruments held in custody
The depositary is liable to the AIF or to the investors of the AIF for the loss by it, or by a third party to whom the custody of financial instruments was delegated, of the AIF’s assets. The strict liability regime obliges the depositary to return a financial instrument of identical type or the corresponding amount of cash to the AIF without undue delay.
The depositary may be exempted from liability if it can prove that the loss of a financial instrument arose as a result of an external event, which fell beyond its reasonable control, and was unavoidable despite all reasonable efforts to the contrary.
A contractual liability exclusion is possible only if the depositary can prove that:
the requirements for delegation of custody tasks are met ;
The depositary is also liable for any other loss as a result of its negligent or intentional failure properly to fulfil its obligations. There is no possibility to discharge this liability. This strict liability regime covers cases of fraud, accounting errors, operational failure and failure to segregate assets held in custody by the depositary or by a third party to whom custody has been delegated.