08 March 2016

Hedgeweek: Considerations when selecting a depositary to an Alternative Investment Fund

Under Article 21 of the AIFMD, any AIFM running an EU-based Alternative Investment Fund is required to appoint a single full scope depositary to carry out four core duties: cash monitoring, safekeeping and verification of assets and general oversight of the AIF.

The obligations of a depositary lite are therefore broadly similar to a full depositary arrangement. However, one important point of difference is that there is no strict liability for the loss of any assets in the AIF. Instead, the liability standard is negligence for the depositary lite. 

For hedge funds and private equity funds that have never needed a custodian, there are understandably a lot of questions they need to consider, the most obvious being cost. 

As the depositary is only required to do the four core functions listed above, and nothing else, there is very little to differentiate among depositaries, as compared to when a fund manager appoints a fund administrator; in this situation, they will look at the skillset of the administrator, its experience and expertise across different fund strategies to ensure that they are a good fit. 

For an EU-based AIF, the full scope depositary will be on the hook for any liabilities suffered by the AIF as a result of asset misappropriation. This means that the depositary has to conduct a robust risk assessment of the AIF if the AIFM chooses to continue using an existing prime broker and administrator. Under this arrangement – referred to as an open architecture arrangement – the cost impact to the manager will be higher because the depositary will be required to enter into a discharge of liability arrangement with the prime broker and/or administrator. 

Alternatively, by using an integrated model, a lot of the risk can be internalised and the cost impact to the manager is reduced. In this arrangement, a single counterparty acts as the administrator and depositary to carry out the cash monitoring, safekeeping and oversight functions. 

Finding the right fit is vital for the AIFM when looking for a depositary. According to Warwick, AIFMs should consider the following criteria:

• Knowledgeable, experienced professionals with a thorough understanding of the alternative fund industry and who possess deep knowledge of the asset classes they service.

• Provision of flexible solutions and agile responses to meet the varying demands of each unique structure.

• Effective Systems and Controls with flexible reporting functions.

• Services tailored to ensure compliance with Depositary functions under AIFMD that are unobtrusive and minimise disruption to existing roles and relationships.

• Operational autonomy to enable it to provide depositary services to existing AIFM's who utilise in-house administration and also fund managers with an established third party administrator relationship seeking a segregated depositary function.

• A flexible operating model that delivers a service that is compliant with the Directive while ensuring that the needs and expectations of the client are met.

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