On 4 February 2011, the Association of Investment Companies (AIC) published a guidance paper for boards of investment companies exploring the risks associated with third party custody of an investment company's assets.

Custody risk is described as the risk that an investment company's assets which are held in custody are lost, or access to them is compromised, as a result of the custodian's insolvency, negligence, misuse of assets, fraud, poor administration or poor record-keeping. The guidance paper points out that that the custody market is dominated by a small number of global players, including major banks, which hold a wide range of assets and that applying the right framework and understanding the relationships involved is key to managing custody risk.

The guidance note sets out guidance on a variety of areas including:

  • The role of the board of directors.
  • Board review of custodial arrangements.
  • Reporting to shareholders.

Annex 1 to the guidance paper sets out a list of questions for the board's consideration when examining and evaluating its custodial arrangements so as to help boards ask necessary, challenging questions of their service providers. Annex 2 summarises the provisions in the AIFM Directive relating to depositary arrangements, which will come into effect in 2013.