Important update UCITS/AIF depositary rules

UCITS and AIFs new segregation and safekeeping duties for depositaries

On 30 October 2018, following the opinion of the European Securities and Markets Authority (ESMA) on asset segregation, the European Commission (EC) released two amendments to the UCTS and AIFMD regulations: the Delegated Regulation (EU) 2018/1618 of 12 July 2018 amending Delegated Regulation (EU) No 231/2013 as regards safe-keeping duties of depositaries of AIFs and Delegated Regulation (EU) 2018/1619 of 12 July 2018 amending Delegated Regulation (EU) 2016/438 as regards safe-keeping duties of depositaries of UCITS (“Regulations”).

Last year, ESMA invited the EC to clarify certain obligations of depositaries when they delegate safe-keeping functions to third parties. ESMA proposed a new setup for the asset segregation requirements complemented by additional safeguards, in particular the requirement to contractually ensure a sufficient flow of information between the depositary and the custodian or sub-custodian. ESMA also suggested strengthening the requirement to maintain accurate record keeping and reconciliation systems, including calibrating the frequency of reconciliations with respect to the frequency of trading activities relating to all the assets that might be kept in an omnibus account.

Conceptually, the EC acknowledged that even if securities and insolvency laws are currently not harmonized on a European level there is a broad acceptance that fund’s financial instruments are out of reach in case of insolvency of an intermediary, it is nevertheless imperative to have common rules to ensure protection of assets safe-kept by depositaries or custodians for their clients. This should lead to the clear identification and traceability of assets belonging to a particular UCITS or AIF and to the protection of such assets in the case of insolvency of the depositary or the custodian. The dedicated provisions of Directive 2011/61/EU and Delegated Regulation (EU) No 231/2013 pursue these objectives.

Key amendments introduced by Delegated Regulation (EU) 2018/1619 on UCITS depositaries:

• Article 13(1)(c) is amended to provide for the factors that should determine the frequency of reconciliation between the depositary’s financial securities accounts and internal records and those of the third parties to which safe-keeping functions have been delegated. The trading frequency of the depositary’s UCITS client and the trades carried out by other clients, whose assets are held in the same omnibus account, must be taken into account.
• Article 13(2) is amended to require that the depositary maintains a record in its financial instruments account opened in the name of a UCITS client or in the name of the management company acting on behalf of the UCITS, showing that the assets kept in custody by a third party belong to a particular UCITS client. The depositary must at all times have a complete overview of the assets of its UCITS clients where the custody of assets has been delegated to a third party.
• Article 15 is accompanied by paragraph 2a to prescribe the minimum details that should feature in the contract between a depositary and a third party on delegation of custody of assets of the depositary’s UCITS clients. The depositary must be able to identify all the entities in the custody chain and secure access to all the relevant information in the third party’s possession to be able to verify the quantity of the identified financial instruments kept in custody by the third party. Should the third party need to delegate the custody function to another third party, the proposed provision requires the delegating third party to contractually secure equivalent rights from that other third party, as itself granted to the depositary.
• Article 16 is amended to clarify the asset segregation requirements for the third parties (custodians) to which the custody of UCITS assets has been entrusted. A custodian can hold assets of UCITS and AIF clients and other clients of one depositary in the same omnibus account, provided its own assets, proprietary assets of the depositary and assets belonging to other clients of the third party are held in segregated financial instruments accounts. To ensure increased asset protection and facilitate the depositary’s duty of oversight of the entrusted assets, custodians must issue depositaries with a statement whenever a change relating to the safe-kept assets occurs. New technological solutions might be particularly helpful in facilitating this process. Factors to determine the frequency of reconciliation mirror those set out in the amendment to Article 13(1)(c) of the Delegated Regulation.
• Points (d) and (e) of Article 17(2) and paragraph (3) of Article 17 are deleted because they are incorporated into Article 16(1) of the Delegated Regulation pertaining to the record-keeping obligations and transmission to the depositaries of relevant information affecting the status of safe-kept UCITS assets. This is relevant for the depositaries’ monitoring of assets safe-kept by any third party to whom this function has been entrusted, regardless of whether the third party is located inside or outside the EU.

Key amendments introduced by Delegated Regulation (EU) 2018/1618 on AIF depositaries:

• Article 89(1)(c) is amended to provide for the factors that should determine the frequency of reconciliation between the depositary’s financial securities accounts and internal records and those of the third parties to which safe-keeping functions have been delegated. The trading frequency of the depositary’s AIF client and also the trades carried out by other clients, whose assets are held in the same omnibus account, must be taken into account.
• Article 89(2) is amended to require that the depositary maintains a record in its financial instruments account opened in the name of an AIF client or in the name of the AIFM acting on behalf of the AIF showing that the assets kept in custody by a third party belong to a particular AIF client. The depository must at all times have a complete overview of the assets of its AIF clients where the custody of assets has been delegated to a third party.
• Article 98 is accompanied by paragraph 2a to prescribe the minimum details that should feature in the contract between a depositary and a third party on delegation of custody of assets of the depositary’s AIF clients. The depositary must be able to identify all the entities in the custody chain and secure access to all the relevant information in the third party’s possession to be able to verify the quantity of the identified financial instruments kept in custody by the third party. Should the third party need to delegate the custody function to another third party, the proposed provision requires the delegating third party to contractually secure equivalent rights from the other third party, as itself granted to the depositary.
• Article 99 is amended to clarify the asset segregation requirements for the third parties (custodians) to which the custody of AIFs assets has been entrusted. A custodian can hold assets of UCITS and AIFs clients and other clients of one depositary in the same omnibus account, provided its own assets, proprietary assets of the depositary and assets belonging to other clients of the third party are held in segregated financial instruments accounts. To ensure increased asset protection and facilitate the depositary’s duty of the oversight of the entrusted assets, custodians must issue depositories with a statement whenever a change relating to the safe-kept assets occurs. New technological solutions might be particularly helpful in facilitating this process. Factors to determine the frequency of reconciliation mirrors those set out in the amendment to Article 89(1)(c) of the Delegated Regulation.
• Article 99 is also amended to introduce new obligations for depositaries that delegate the custody of assets to third parties located outside the EU. Legal advice from independent parties on the insolvency laws of the third country is required. The depositaries should also ensure that the third party complies with their national laws securing the benefits of asset segregation and that the third party communicates any changes to the insolvency laws which are a part of the legal system in which they are operating.

Regulations shall enter into force on the twentieth day following that of publication in the Official Journal of the European Union and shall apply from 1 April 2020.

How can Deloitte help?

Deloitte can help depositaries to understand and comply with the regulatory constraints applicable to them through different services. We can also help you stay on top of regulatory trends with our Kaleidoscope Regulatory Watch service.

1. Governance Definition and Implementation

We work with you to design and calibrate your policies and procedures to fulfil your legal duties with practical implementation throughout your organization.

2. Regulatory healthcheck

We can review your compliance with each requirement of the regulation, identifying any gaps with remediation actions for depositaries as for their counterparties

3. Due Diligence support

Our teams of experts test the compliance of your business partners and ensure an external review of the adequacy of internal frameworks with the applicable laws and regulations.

4. ISAE 3402/SOC 1 examination

We conduct independent reviews on the adequacy and operating effectiveness of the depositary’s internal control procedures and provide “reasonable assurance” on the depositary’s control environment, including advice on best practices and improvement opportunities.

5. Remedial planning and implementation

We assist the depositary in organizing and planning the implementation of new requirements and provide guidance on key operational set-up decisions, control framework upgrades, or service offering reviews.

Contacts