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").
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).
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:
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.
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.
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.
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.