On 16 April 2019, the European Parliament voted in favour to introduce a Directive and Regulation to amend existing regimes with the aim of improving cross-border distribution of AIFs and UCITS in the EU.
New EU legislation has been introduced amending the AIFMD and UCITS frameworks specifically in the area of safekeeping of assets by depositaries. This follows the publication of ESMA's Opinion in July 2017 outlining enhancements required to be made to the rules on safekeeping and segregation of assets held by depositaries and the practical application of the required segregation at the level of third party delegates.
Depositaries of UCITS and AIFs have until 1 April 2020 to comply with new rules on safekeeping duties following the publication of:
- Commission Delegated Regulation (EU) 2018/1618 amending Delegated Regulation (EU) 231/2013 (the "AIFMD Delegated Regulation"); and
- Commission Delegated Regulation (EU) 2018/1619 amending Delegated Regulation (EU) 2016/438 (the "UCITS Delegated Regulation") (together the "Delegated Regulations").
Background
These new rules are in addition to existing safekeeping obligations. Divergent application by national competent authorities and market participants of existing safekeeping duties and a lack of harmonisation of EU securities and insolvency laws created the impetus for the Commission to prescribe these additional common rules.
The AIF Delegated Regulations bolster the existing rules by providing further clarity in relation to the safekeeping obligations of depositaries and any sub-delegates to whom safekeeping functions have been entrusted (i.e. custodians or prime brokers acting as custodians).
The changes
In particular, the changes prescribe new rules in relation to
the identification of assets and their protection in the case of
insolvency of the depositary. These enhancements include:
Reconciliations
Both the trading frequency of the depositary's client and the
trades carried out by other clients, whose assets are held in the
same omnibus financial instruments account, must be considered when
determining the frequency of reconciliations between the
depositary's internal accounts and records and those of the
third party to which safekeeping functions have been delegated.
Recordkeeping
Where the custody of assets has been delegated to a third party,
records must be kept and maintained to enable the depositary:
- At any time and without delay to distinguish assets of the depositary's clients from the third party's own assets, assets of the third party's other clients and assets held for the depositary for its own account; and
- To identify the precise nature, location and ownership status of those assets.
Contractual terms
The minimum contractual terms that should feature in the contract
between a depositary and a third party on delegation of custody of
assets are also prescribed. The depositary must be able to identify
all the entities in the custody chain. It must also secure a
guarantee to information, inspection and access to all relevant
records and accounts of the third party to fulfil its oversight and
due diligence obligations and verify the quantity of the identified
financial instruments kept in custody by the third party. Should
the third party delegate the custody function to another, the
delegating party must contractually secure equivalent rights and
obligations from that other third party.
Asset Segregation
Detailed asset segregation requirements for third parties to which
the custody of assets has been delegated are set out. Assets of
UCITS clients, AIF clients and other clients of one depositary may
be held in an omnibus account provided these are separated from the
delegate's own assets, the depositary's own assets and from
the assets belonging to the other clients of the delegate.
Third Country Depositary
In line with existing requirements for UCITS, depositaries of AIFs,
which delegate the custody of assets to non-EU third parties, are
for the first time obliged to obtain a legal opinion from an
independent party as to the adequacy of the insolvency laws of the
third country. Depositaries should also ensure that the third party
complies with their national laws securing the benefits of
segregation of assets; informs the depositary when any of those
conditions are not met; and communicates any changes to any
applicable insolvency laws to the depositary.
How the Maples Group can help
Depositaries will need to consider the implications of these changes as they relate to existing delegation agreements and whether any necessary amendments should be negotiated in advance of 1 April 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.