On 30 October 2018, the European Commission amended the Undertakings for Collective Investment Transferable Securities Directive 2009/65/EC (the UCITS Directive) and Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD) governing the custodial function of depositaries for open-ended investment funds, collective investment schemes and alternative investments funds (the Funds). These amendments (which came into force on 19 November 2018 and will apply from 1 April 2020) have the aim of:
- introducing a set of common rules to ensure protection of assets held in custody by depositaries or delegated sub-custodians for their Fund clients; and
- creating a clear identification system for assets belonging to a particular Fund in case of insolvency of the depositary or delegated sub-custodian.
Depositaries, custodians, sub-custodians, prime brokers or any other entity that is holding assets in custody for a Fund should be aware of the following three key changes that will take effect from 1 April 2020:
Minimum Contractual Requirements in Delegated Safekeeping Arrangements:
The updated UCITS Directive and AIFMD now set out the details that should be included in the contract between a depositary and any third party sub-custodian to which there has been a delegation of the custody function in relation to assets belonging to Fund clients. In particular, the depositary must be able to:
- identify all the entities in the custody chain;
- secure access to all relevant information in the third party sub-custodian's possession to verify the quantity of the assets held in custody; and
- if the third party sub-custodian wishes to delegate its custody function to another entity, the sub-custodian must contractually secure equivalent rights to access such information from the third party.
Clarification on Segregation Levels:
The level of segregation of Fund assets has been clarified and now expressly permits a third party sub-custodian to hold the assets of Fund clients and the assets belonging to other clients of the same depositary in one single omnibus account.
- the third party sub-custodian's own assets;
- the proprietary assets of the relevant depositary; and
- assets belonging to clients of other depositaries,
must be held in different accounts.
In light of these clarifications, third party sub-custodians accepting the delegation of the custody function in relation to assets belonging to Fund clients will be required, at a minimum, to open the following on its books and records:
- one omnibus account for each depositary to hold the assets belonging to the clients of such depositary;
- an account for each depositary to hold the proprietary assets of such depositary;
- an account for any non-Fund clients of such third party sub-custodian; and
- an account for the third party sub-custodian's own proprietary assets.
Non-EU Custodian Condition:
If a depositary delegates safekeeping functions to a third party sub-custodian located outside of the EU, the depositary is required to obtain legal advice on the insolvency laws relating to such third party sub-custodian. The purpose of the depositary obtaining such advice is to enable it to ensure that the relevant third party sub-custodian is complying with the laws applicable to it when securing the benefits of asset segregation.
Depositaries will therefore need to consider the cost associated with obtaining such legal advice from the outset of entering into such an arrangement with a non-EU third party sub-custodian.
How Dentons Can Assist
To ensure ongoing compliance with AIFMD and the UCITS Directives, our experienced team at Dentons would be happy to discuss and advise on the updates to these regulations, as well as on any changes that may be required to documentation relating to custody and safe-keeping functions, on agreements between depositaries and delegated sub-custodians and on agreements between sub-custodians and their ongoing custody chain participants.
- via Delegated Regulation (EU) 2018/1619 of 12 July 2018 (for UCITS) (UCITS Amended Regulation) and Delegated Regulation (EU) 2018/1618 of 12 July 2018 (for AIFs) (AIF Amended Regulation).↩
- Article 15(a) of the UCITS Amended Regulation and Article 98 of the AIF Amended Regulation.↩
- Article 16 of the UCITS Delegated Regulation and Article 99 of the AIF Delegated Regulation.↩
- Article 99 of the AIF Delegated Regulation↩