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Any measure that seeks to increases investor confidence – in the case of AIFMD, through the reduction of systemic risk and the enhancement of investor protection – is to be welcomed. That said, AIFMD has been greeted with some degree of scepticism since it was first mooted back in 2009. Its detractors – including industry bodies like the European Fund and Asset Management Association and the Association of Global Custodians – contend that complying with AIFMD adds cost and complexity to a system that did not need fixing in the first place. Institutional investors – particularly alternative investment fund (AIF) managers – are well aware of the risks involved, say the detractors, and there are effective measures already in place at both individual investor and market-level to mitigate them. There have also been concerns expressed about the impact AIFMD will have on the competitiveness of the EU’s AIF industry.
The obvious impact is that depositaries, for the first time, will be underwriting potentially huge levels of risk – substantially more than under the current regulatory regime. As they will be required to delegate sub custody to prime brokers (for which they still retain liability), there will be increased scrutiny on the operational effectiveness of both the prime broker and the prime broker’s sub custodian network. As a result, it’s feasible that liability concerns may lead some to withdraw from certain geographical markets and/or asset classes. Only depositaries with sufficient size, geographic reach and capital will be able to make the necessary provision for their potential liabilities.
Together, these factors are expected to fuel significant industry consolidation – an unintended, and perhaps undesirable, consequence of the Directive. Those that remain will have to adapt to the operational demands integral to this more central role in the value chain. Almost all depositaries will need to upgrade – to varying degrees – their existing capabilities. As depositaries prepare to become responsible for the restitution of financial instruments in the event of a loss, such enhancements will need to focus on three key areas.
AIFMD shifts liability – and therefore risk – on to the depositaries. This is likely to lead to consolidation and, for many of those depositaries that remain, the need to improve their systems and processes to meet the requirements of the Directive and deliver the service-levels expected by fund managers.
See also: AIFMD-implementation guide, 24.7.13