New IFIA Guidance Paper on AIFMD Depositary Duties

The Depositary Committee of the IFIA recently undertook a review of the existing IFIA Guidance Paper 3 called Trustee Duties. It published a supplementary Guidance Paper 3A (AIFMD Depositary Duties) on 21 October 2013 to reflect the new obligations on depositaries post- AIFMD. This client briefing provides a short summary of the details contained in the new Guidance Paper.

By way of background, Guidance Paper 3A outlines that an alternative investment fund manager or, in the case of an internally-managed alternative investment fund ("AIF") its board of directors, (each an "AIFM"), has the primary responsibility for ensuring that an AIF is managed in accordance with its constitutional documents and AIFMD. Under AIFMD, an AIFM must ensure that a single depositary is appointed in respect of each AIF it manages. The depositary is independent of the AIFM and has an oversight responsibility in that it must assess whether the AIF complies with its constitutional documentation and applicable regulations.

Cash Monitoring

The initial focus of Guidance Paper 3A is on the cash monitoring function. These rules are set out in Regulations 22(7)(a) and (b) of the AIFMD Regulations1 and Articles 85 to 87 of the Level 2Regulation2.

The Guidance Paper sets down proposed approaches that may be used by a depositary to fulfil its new obligations in respect of cash flow monitoring requirements introduced by the AIFMD. In particular, it describes a depositary's responsibility for cash and cash flow monitoring and its duties regarding subscriptions. The specific requirements of AIFMD are set out in Guidance Paper 3A followed by a commentary on how compliance by a depositary may be achieved. A depositary should conduct periodic reviews of an AIF's cash accounts to ensure that they are opened with eligible entities and it must implement appropriate reconciliation procedures and review the processes and procedures of the transfer agent in relation to these accounts.

Oversight

The latter part of the Guidance Paper focuses on the five AIFMD oversight duties set down in in Regulations 22(9) of the AIFMD Regulations and Articles 93 to 97 of the Level 2 Regulation. These duties mirror five of the seven existing duties applicable to custodians under the Central Bank's non-UCITS Notices. The Guidance Paper now includes more detail on each duty from the Level 2 Regulation and expands on the previous list of matters which a depositary should take into account in discharging its obligations.

The duty to issue a trustee report and the duty to notify material matters to the Central Bank are still applicable to depositaries and are referenced in the main body of the Guidance Paper. However, the duty to report has been widened to include a depositary enquiring into the conduct of the AIFM (as well as the management company, investment company or general partner) in each annual accounting period and reporting on this to the unitholders3.

The duty to notify material matters to the Central Bank has also been widened from notifying any material breach of the domestic fund legislation to notifying any material breach of the domestic fund legislation, the AIFMD Regulations and the Level 2 Regulation as well as any material breaches of the requirements imposed on the AIF or a depositary by the Central Bank or provisions of the AIF's prospectus. Accordingly, the scope of a depositary's review must broaden to allow it to be able to meet this requirement. A depositary is also obliged to check the processes and procedures that are the responsibility of the AIFM, the AIF or its delegates, as part of its oversight duties. The Guidance Paper sets out an expanded list of suggested procedures to assist a depositary in discharging this responsibility, which includes a depositary:

  • assessing and understanding the nature, scale and complexity of the AIF or AIFM in developing an oversight plan;
  • performing annual inspections of the AIFM and/or its delegates which can include fund administrator, transfer agent, and external valuer, if applicable4;
  • reviewing all relevant information and procedural documentation;
  • performing sample walk-through testing;
  • reviewing key performance indicators provided by the administrator; and
  • initial and on-going assessments of the AIFM's processes and control environment.

Frequency

The Guidance Paper advises that where the AIFMD Regulations specify a frequency of reviews in relation to a depositary's duties, this frequency should be applied by the depositary. Where no frequency is indicated in respect of a review, a depositary should have regard to the nature, scale and complexity of the AIF. A depositary's oversight control plan will be based on the initial assessment by the depositary of the risks associated with the nature, scale and complexity of the AIF's strategy and the AIFM's organisation. The Guidance Paper suggests that a depositary should take into account the following in relation to the AIF in considering a risk-based approach:

  • dealing frequency;
  • asset composition;
  • markets invested in;
  • any prime brokers appointed;
  • collateral arrangements;
  • securities lending arrangements;
  • use of exchange-traded or OTC derivatives;
  • performance fees; and
  • the AIFM's procedures and assets under management.

The precise frequency of a depositary's overall oversight control plan is not set out in the Level 2 Regulation and therefore generally is at the discretion of the depositary. In relation to certain specific oversight duties, the Level 2 Regulation states that the oversight should be consistent with certain specific operations of the AIF. By way of an example, the frequency of a depositary's checks on the sale, issue, repurchase, redemption and cancellation of units or shares should be consistent with the frequency of the AIF's dealing.

Escalation

A depositary is required to establish a clear and comprehensive escalation procedure to deal with situations where irregularities are detected in the course of its oversight duties. As mentioned above, the procedure should provide for notification to the Central Bank of any material breaches.

Ta x Update - Budget changes

With effect from 1 January 2014 the rate of tax for Irish individuals on distributions from Irish and other EU regulated funds will increase. In certain instances the total tax could be up to 52%. This is because the rate of income tax on distributions and on exit will increase to 41% from 33%/36%. Also Universal Social Charge will apply at rates up to 7%. Finally, Pay Related Social Insurance (PRSI) can be up to 4%.

The increased rates will apply to payments, including deemed payments, made on or after 1 January 2014. To avoid these higher rates, Irish resident investors may want to redeem their investments in funds before 31 December 2013 which may require the funds to ensure that they have sufficient liquidity to match these redemptions.

Footnote

1 European Union (Alternative Investment Fund Managers) Regulations 2013 (S.I. No. 257 of 2013)

2 European Commission Delegated Regulation (EU) 231/2013

3 The IFIA's Guidance Paper 2 provides guidance on the form and content of the trustee report.

4 The IFIA has issued an information note for a depositary in relation to On-Site Inspections of Fund Administrators and Transfer Agents

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.