EU Consultation on Duties of Third-Party Custodians Safe-Keeping Fund Assets

The European Commission is consulting on revisions to the Delegated Regulations on the safekeeping duties of depositaries under both the Alternative Investment Fund Managers Directive and the Undertakings for Collective Investment in Transferable Securities Directive. Both the AIFMD and the UCITS Directive require that where a depositary delegates safekeeping functions to third party custodians, the assets also need to be segregated at the level of the delegate. The respective Delegated Regulations set out how that obligation should be fulfilled to ensure a clear identification of assets belonging to a particular AIF or UCITS and the protection of assets in the event of the depositary or custodian entering insolvency.

The proposed changes follow the European Securities and Markets Authority's Opinion, "Asset segregation and application of depositary delegation rules to CSDs", issued on July 20, 2017. In its Opinion, ESMA identified that the delegation rules are being applied in different ways by EU Member States' national regulators and market participants and invited the Commission to make clarifications to the rules. The Commission concurs that the Delegated Regulations need to be amended to ensure a more uniform approach is adopted across the EU.

The proposed changes clarify that UCITS, AIFs and other client assets can be comingled at the level of the first custodian provided that they are initially held by the same depositary or by the same custodian in the event of further delegation. This amendment should prevent the erroneous interpretation of the segregation obligations as requiring separate accounts per depositary and per type of fund at each level of the custody chain.

The proposed revisions to the respective Delegated Regulations also prescribe that the contract delegating safekeeping of the assets between a depositary and a custodian must guarantee the depositary's rights to information, inspection and access to records so as to enable the depositary to fulfill its oversight and due diligence obligations. A depositary should be able to identify all entities within the custody chain (including such entities' respective rights and obligations where further delegation of custody functions by third parties takes place) and verify that the quantity of financial instruments recorded in its own books matches the records of the third party custodian.

Where delegation of the custody functions relating to AIF clients occurs, before delegating this function to a third party located outside of the EU, the depositary should receive an independent legal opinion assessing the insolvency law of the third country where that third party is located. The Commission suggests that an opinion provided by relevant industry federations or by law firms for the benefit of several depositaries will be acceptable. Furthermore, the depositary should ensure that the third party located outside the EU informs it of any change in circumstances or in that third country's insolvency law that may affect the status of the assets of the depositary's AIF clients.

Custodians will be required to provide the depositary with a statement when a change relating to the assets occurs. The proposed revisions also provide for the factors determining the frequency of reconciliation between the depositary's accounts and internal records and those of the custodian.

Feedback to the proposals can be provided via the European Commission's website by June 26, 2018.

View the proposed revisions to the AIFMD Delegated Act and feedback page.

View the proposed revisions to the UCITS Delegated Act and feedback page.

View ESMA's Opinion.

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