knowledge 15 November 2018 |

New Rules Coming for UCITS/AIF Depositaries

The new rules seek to clarify the obligations imposed on depositaries relating to the safe-keeping of assets of AIF and UCITS clients and are set out in:

• Commission Delegated Regulation (EU) 2018/1618 which amends the safekeeping provisions of Delegated Regulation (EU) 231/2013 (the AIFMD Delegated Regulation); and
• Commission Delegated Regulation (EU) 2018/1619 which amends the safekeeping provisions Delegated Regulation (EU) 2016/438 (the UCITS Delegated Regulation).

Overview

Depositaries of both UCITS and AIFs are currently subject to a number of obligations relating to the safe-keeping of assets. However, there is a divergence in the level of protection for financial instruments held in custody by depositaries as a result of differing national and insolvency laws. The two Commission Delegated Regulations seek to ensure more clarity and consistency in how assets are kept separated so that investors are better protected and to ensure more market efficiency.

Key Changes

The new rules will apply to depositaries of UCITS and AIFs when delegating their safe-keeping obligations to a third party ("the Custodian"), including any further sub-delegation of those obligations. The new rules address: reconciliations; the delegation contract; asset segregation; and delegation to a depositary located in a third country. They follow up on ESMA’s opinion on asset segregation which was published in July 2017.

Reconciliations

Reconciliations must be conducted as often as necessary between the depositary’s internal accounts and records and those of the Custodian, taking into account the factors specified in the AIFMD/UCITS Delegated Regulations;

The Delegation Contract

The Delegation Contract between the depositary and the Custodian must guarantee the depositary’s right to information, inspection and access to the relevant records and accounts of the Custodian to enable the depositary to fulfil its oversight and due diligence obligations. Among other things, the depositary must be able to identify all entities within the custody chain.  Furthermore the depositary and the Custodian must formally agree whether the Custodian is allowed to further delegate the custody functions to a sub-custodian.  If so, the arrangement between the Custodian and the sub-custodian must be subject to rights and obligations which are equivalent to those established between the depositary and the Custodian.

Asset Segregation

A Custodian can hold assets of UCITS and AIF clients and other clients of one depositary in the same omnibus account, provided its own assets, proprietary assets of the depositary and assets belonging to other clients of the Custodian are held in segregated financial instruments accounts.

Third Country Custodian

Where a depositary delegates its custody functions for its clients to a Custodian outside of the EEA, the depositary must obtain a legal opinion as to the adequacy of insolvency law protection in the relevant non-EEA country, including an evaluation of the level of protection afforded by segregated financial instruments accounts in that country.  Under the AIFMD Delegated Regulation the depositary must also ensure that the non-EEA custodian informs the depositary of any change in circumstances or in that non-EEA country’s insolvency law that may affect the status of the assets of the depositary’s AIF clients.  Similar requirements were already set out in Article 17 of Delegated Regulation 2016/438, regarding UCITS.

Next Steps 

Both Commission Delegated Regulations will apply from 1 April 2020. Before that date depositaries will need to revisit any delegation arrangements with their Custodians and negotiate amendments where necessary to comply with the new changes.