26 June 2018

ALFI response to the European Commission consultation on depositary safekeeping duties

ALFI published its analysis of the two drafts issued by the European Commission amending the Delegated Regulation in relation to depositary safekeeping duties towards AIF and UCITS clients in case of delegation.

ALFI understands that, as stated in Part 1 of the Explanatory Memorandum, the European Commission aims, with this initiative, at harmonising insolvency laws at EU level in order to ensure protection of assets safe-kept by depositaries or custodians for their clients.

Firstly, ALFI considers that a depositary should be able to rely on the record-keeping of its delegate when delegating safe-keeping functions. There is no practical reason for the depositary to maintain a custody record that is already recorded and reconciled in the books of its delegate. This model, known in the industry as ‘’reliance model’’ has a proven track record in a number of jurisdictions. Moreover, ALFI is not aware of any case of depositary failure in the European Union. As such, the reliance model coupled with the strong liability regime applicable to depositaries provide, in its view, enough protection for the assets safe-kept by depositaries or custodians for their clients.

Secondly, the draft CDRs propose implementing one single standard of challenging operational procedures. This proposal leaves without consideration the practical organisation of the custody chain which not only differs from one jurisdiction to another, but also and most importantly depending on type of underlying asset. While some of these provisions presented in the draft CDRs were suggested and hinted at in the ESMA opinion, ESMA certainly being aware of these national and asset-based discrepancies, did not provide at the time a clear description of the full contemplated set-up. As such, ALFI strongly suggests to retain the current risk-based approach proper to and conscious of each custody model.

Thirdly, ALFI deems that the scope of a depositary’s safe-keeping versus its record-keeping obligations should be reviewed. As such, it is crucial to maintain the main focus on the depositary’s responsibilities for the financial instruments that can be technically safe kept rather than extending the safe-keeping responsibilities to any type of asset, thereby including assets that cannot technically be safe-kept. For these assets, the solution of choice needs to be recordkeeping taking into account that this is the only solution technically possible.

ALFI further believes that harmonised safe-keeping provisions that apply to assets that cannot technically be safe kept do not take into account the operational reality of the custody functions. To such extent this does not provide additional safeguards for the end-investor. In addition, if the draft CDRs were approved as such, these new requirements would become applicable in the first quarter of 2019. This very short timeline cannot be met in terms of implementation of the corresponding operational processes without regression and impacts on the current conduct of business.

Moreover, the draft proposal for independent legal advice on insolvency in CDR 2013/231 does not take into account the nuances typically found in such advice, and shifts the obligation to the depositary. ALFI strongly suggests sticking in this respect to the current UCITS approach.

Conclusively, ALFI considers that a restriction on the right of the depositary to delegate the maintenance of books and records is not beneficial to investors or the funds industry in general. It neither improves investor protection nor the asset safe-keeping controls. As such, it fails to match the Commission’s asset segregation objectives. On the contrary, the current proposals would introduce market inefficiencies, as well as increase investor costs, thereby resulting in significant market disruption, including, for example, depositaries refusing any investment with a counterparty that cannot be mirrored.

Full publication

© ALFI - Association of the Luxembourg Fund Industry