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===Delegation of {{aifmdprov|depositary}}’s functions===
===Delegation of {{aifmdprov|depositary}}’s functions===
You will see from {{aifmdprov|21(4)}} the {{aifmdprov|depositary}}’s role ''[[in toto]]'' is not really suitable for a [[prime broker]]. However, the {{aifmdprov|depositary}} may delegate some of its functions, and a prime broker may act as:
You will see from {{aifmdprov|21(4)}} the {{aifmdprov|depositary}}’s role ''[[in toto]]'' is not really suitable for a [[prime broker]]. However, the {{aifmdprov|depositary}} may [[delegate]] some of its functions, and a prime broker may act as:
*A '''{{aifmdprov|custodian}}''', but will have certain conditions to that appointment (set out in Art {{aifmdprov|21(11)}}, including the famous “{{aifmdprov|objective reason}}”), and you may expect the {{aifmdprov|depositary}} will seek to delegate the safe-keeping function on those exact conditions, and (as far as it can) transfer outright its liability for those responsibilities to the [[prime broker]], on exactly the terms required by [[AIFMD]] and [[AIFMR]].
*A '''{{aifmdprov|custodian}}''', but will have certain conditions to that appointment (set out in Art {{aifmdprov|21(11)}}, including the famous “{{aifmdprov|objective reason}}”), and you may expect the {{aifmdprov|depositary}} will seek to delegate the safe-keeping function on those exact conditions, and (as far as it can) transfer outright its liability for those responsibilities to the [[prime broker]], on exactly the terms required by [[AIFMD]] and [[AIFMR]].
*A “{{aifmdprov|depositary lite}}” to certain non-EU domiciled {{aifmdprov|AIF}}s who aren’t obliged to have a full-blown {{aifmdprov|depositary}}. The depo-lite regime, and the delegated safe-keeping regime, are different but in many respects quite similar things and it is easy to conflate them. A specialist will find you out if you do.
*A “{{aifmdprov|depositary lite}}” to certain non-EU domiciled {{aifmdprov|AIF}}s who aren’t obliged to have a full-blown {{aifmdprov|depositary}}. The [[depo-lite]] regime, and the delegated safe-keeping regime, are different but in many respects quite similar things and it is easy to conflate them.  
 
===“[[Delegation]]” versus “sub-contracting”===
So this is a weird one. Delegation, according to a natural definition, means “to entrust (a task or responsibility) to another person, typically one who is less senior than oneself.”<ref>{{google2|Define|Delegation}}</ref>. A custodian ''delegating'' its safekeeping responsibility to a second custodian means (to the Jolly Contrarian, at any rate) that it will not be the first custodian that is looking after your assets, kind sir, but the second one. Your custody arrangement, and your claim, will be with the second custodian directly though, thanks to the ministrations of AIFMD, you may still have a pop at the first one if the second one proves to be a dolt.
 
This accounts perfectly for delegation to a [[prime broker]].
 
:“Hold on,” says the PB. “If your [[depositary]] holds the assets, then I can hardly [[rehypothecate]] them, can I, and we know how important [[rehypothecation]] is to my business model, don’t we?”
 
:The [[Depositary]] shrugs. “So, I'll make you my sub-custodian,” he says, “re-hypothecate to your heart's content.”
 
:“No can do, Depo,” says the PB. “I can only rehypothecate against indebtedness, and you don't owe me anything. And besides, as a sub-custodian I only see an omnibut account. I don't know who owns what. I have to have a direct contractual relationship with the fund. That's how the whole thing works.”
 
Contrast that with a [[custodian]] who ''sub-contracts'' his responsibility to a [[sub-custodian]]. This is not a delegation in the same way: the [[custodian]] stays liable the whole time, whatever the [[sub-custodian]] does, and unless the contract says otherwise<fref>Okay, I grant you: this is a big ''unless''.</ref> the client has not [[privity|direct claim]] against the subcustodian at all.
 
Yet AIFMD appears to conflate these two, especially in its chat about “where the law of a third country requires that certain financial instruments be held in custody by a local entity ...”. This is much more akin to a [[subcustodian]] arrangement.


===“[[Delegation]]” versus “[[sub-contract]]ing”===
These terms are easily conflated. Indeed, [[AIFMD]] conflates them. But, in [[this commentator]]’s view, they are different in important ways. Read more about this [[Delegation|here]].
But in any case our — well, ''contrarian'' — view is that a custodian who appoints a [[sub custodian]] in its  sub custody network is ''not'' “delegating” its [[AIFMD]] custody obligations “at the first level of the custody chain”, as Art {{aifmdprov|21(11)}}contemplates, and hence [[sub-custodian]]s do not have to:
*Segregate the AIF’s assets from the [[depositary]]’s assets in their books (as would be required of a delegate custodian under Art 21(11)(d)(iii)),
*Hold assets in their books in the name of the AIF (or the AIFM acting on behalf of the AIF) (as would be required of a delegate custodian under Art 21(11)(d)(v), incorporating as it does Art 21(8)(a)(ii)).
===Conditions to delegation by a {{aifmdprov|depositary}}===
===Conditions to delegation by a {{aifmdprov|depositary}}===
The {{aifmdprov|depositary}} can only delegate in certain circumstances:
The {{aifmdprov|depositary}} can only [[delegate]] in certain circumstances:
*It must have an “{{aifmdprov|objective reason}}” for the delegation.
*It must have an “{{aifmdprov|objective reason}}” for the delegation.
*it must exercise due skill, care and diligence in the selection, appointment and ongoing monitoring of the {{aifmdprov|sub-custodian}};
*it must exercise due skill, care and diligence in the selection, appointment and ongoing monitoring of the {{aifmdprov|delegate}};
*The {{aifmdprov|sub-custodian}} to whom it delegates:
*The {{aifmdprov|delegate}}:
**must have structures and expertise proportionate to the nature, scale and complexity of the assets of the AIF  
**must have structures and expertise proportionate to the nature, scale and complexity of the assets of the AIF  
**must be subject, in acting as a custodian, to effective prudential regulation and supervision in its local jurisdiction and periodic external audits;  
**must be subject, in acting as a [[custodian]], to effective prudential regulation and supervision in its local jurisdiction and periodic external audits;  
**must segregate {{aifmdprov|AIF}} assets from its own and the {{aifmdprov|depositary}}’s assets  
**must segregate {{aifmdprov|AIF}} assets from its own and the {{aifmdprov|depositary}}’s assets  
**may not reuse the AIF’s assets without the AIF’s express consent.
**may not reuse the AIF’s assets without the AIF’s express consent.
We read this as referring only to a delegation of the “head” custody function, not to a custodian’s holding of assets in its own sub-custody network: it can’t do; sub-custodians operate on an omnibus basis and don’t segregate assets belonging to the main custodian’s individual clients’ interests in their books (so can’t segregate, for example, the depositary’s assets from the AIF’s assets: they don’t have enough information to do this.


===Conditions to discharge of liability when delegating by a {{aifmdprov|depositary}}===
===Conditions to discharge of liability when delegating by a {{aifmdprov|depositary}}===

Latest revision as of 14:31, 14 July 2021

Delegation of depositary’s functions

You will see from 21(4) the depositary’s role in toto is not really suitable for a prime broker. However, the depositary may delegate some of its functions, and a prime broker may act as:

  • A custodian, but will have certain conditions to that appointment (set out in Art 21(11), including the famous “objective reason”), and you may expect the depositary will seek to delegate the safe-keeping function on those exact conditions, and (as far as it can) transfer outright its liability for those responsibilities to the prime broker, on exactly the terms required by AIFMD and AIFMR.
  • A “depositary lite” to certain non-EU domiciled AIFs who aren’t obliged to have a full-blown depositary. The depo-lite regime, and the delegated safe-keeping regime, are different but in many respects quite similar things and it is easy to conflate them.

“Delegation” versus “sub-contracting”

These terms are easily conflated. Indeed, AIFMD conflates them. But, in this commentator’s view, they are different in important ways. Read more about this here. But in any case our — well, contrarian — view is that a custodian who appoints a sub custodian in its sub custody network is not “delegating” its AIFMD custody obligations “at the first level of the custody chain”, as Art 21(11)contemplates, and hence sub-custodians do not have to:

  • Segregate the AIF’s assets from the depositary’s assets in their books (as would be required of a delegate custodian under Art 21(11)(d)(iii)),
  • Hold assets in their books in the name of the AIF (or the AIFM acting on behalf of the AIF) (as would be required of a delegate custodian under Art 21(11)(d)(v), incorporating as it does Art 21(8)(a)(ii)).

Conditions to delegation by a depositary

The depositary can only delegate in certain circumstances:

  • It must have an “objective reason” for the delegation.
  • it must exercise due skill, care and diligence in the selection, appointment and ongoing monitoring of the delegate;
  • The delegate:
    • must have structures and expertise proportionate to the nature, scale and complexity of the assets of the AIF
    • must be subject, in acting as a custodian, to effective prudential regulation and supervision in its local jurisdiction and periodic external audits;
    • must segregate AIF assets from its own and the depositary’s assets
    • may not reuse the AIF’s assets without the AIF’s express consent.

We read this as referring only to a delegation of the “head” custody function, not to a custodian’s holding of assets in its own sub-custody network: it can’t do; sub-custodians operate on an omnibus basis and don’t segregate assets belonging to the main custodian’s individual clients’ interests in their books (so can’t segregate, for example, the depositary’s assets from the AIF’s assets: they don’t have enough information to do this.

Conditions to discharge of liability when delegating by a depositary

It is one thing for a depositary to delegate performance of a safekeeping function to a prime broker (21(11)); it is another for it to discharge its liability for the safekeeping of assets (21(13)). That can only happen if:

  • All the conditions to delegation are met;
  • There is a written contract transfers that liability so the AIF can claim directly against the PB — which contractual privity freaks will immediately realise will require either artful use of the Contracts (Rights of Third Parties) Act 1999, or that the AIF should be party to that contract. In practice the AIF will of course be party to a contract with its prime broker.
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