Delegation of depositary’s functions - AIFMD Provision: Difference between revisions

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Now a big part of a [[prime broker]]’s business is [[margin lending]], which depends on the prime broker having not only custody but rights of reuse over the AIF’s assets. What to do? Well, [[AIFMD]] allows a depositary to ''[[delegate]]'' its custody/safekeeping function (but ''only'' that function) to a third party ''where there are [[objective reason]]s for it doing so''. There is more commentary [[Objective reason - AIFMD Provision|elsewhere]], but take it as read that “because the PB need to hold assets for [[margin lending]], [[reuse]], [[security]] and so on” ''does'' count as an objective reason.
Now a big part of a [[prime broker]]’s business is [[margin lending]], which depends on the prime broker having not only custody but rights of reuse over the AIF’s assets. What to do? Well, [[AIFMD]] allows a depositary to ''[[delegate]]'' its custody/safekeeping function (but ''only'' that function) to a third party ''where there are [[objective reason]]s for it doing so''. There is more commentary [[Objective reason - AIFMD Provision|elsewhere]], but take it as read that “because the PB need to hold assets for [[margin lending]], [[reuse]], [[security]] and so on” ''does'' count as an objective reason.


Right. So AIFMD says a depositary may (with such an [[Objective reason - AIFMD Provision|objective reason]]) delegate that responsibility to a third party and may even ''discharge'' its liability for asset safekeeping by transferring liability to a third party, but this is even more limited: see Article [[21(13) - AIFMD Provision|21(13)]]: the depositary can only discharge its liability where (i) it was entitled to delegate responsibility per 21(11), (ii) there is a written contract expressly transferring liability to the delegate, so the AIF can expressly claim against it, and (iii) the AIF expressly discharges the depositary’s liability under a written contract and there is an [[objective reason]] for doing so. 
Right. So [[AIFMD]] says a depositary may (with an [[Objective reason - AIFMD Provision|objective reason]]) delegate that responsibility to a third party and may even (with another [[Objective reason - AIFMD Provision|objective reason]]) ''discharge'' its liability for safekeeping by transferring it to its delegate: see Article [[21(13) - AIFMD Provision|21(13)]]: the depositary can only discharge its liability where  


The risk to the depositary is:
(i) it was entitled to delegate responsibility per [[21(11)(d) - AIFMD Provision|21(11)]] 
- That its delegation of the custody function is not permitted; or that
- that it is permitted to delegate the custody function, but that having done so, it is held responsible under AIFMD for the loss of assets by its delegate, for some reason (ie that any the purported discharge of liability is invalid)


Therefore what the depositary needs to achieve is
(ii) there is an express written transfer of liability to the delegate, so the AIF can claim directly against it, and 
- Establishing valid “objective reason” for delegating the custody function to UBS as prime broker. This we think is tried and true and not controversial: AIF depositaries delegate safekeeping to PBs all the time.
 
- To the extent allowed by AIFMD, discharging its personal liability to the AIF for the loss of assets held by its delegate custodian by transferring that liability directyly to that delegate custodian
(iii) the AIF expressly discharges the [[Depositary - AIFMD Provision|depositary]]’s liability under a written contract and there is an [[objective reason]] for doing so. 
 
==== Risk to depositary ====
The risk to the depositary is:
 
(i) That its delegation of the custody function is not permitted; or
 
(ii) It ''is'' permitted, but that having delegated, it is held responsible under AIFMD for the loss of assets by its delegate, for some reason (i.e., that its purported discharge of liability is invalid)
 
Therefore:
 
==== Depositary’s objectives ====
What the depositary needs to achieve is in its inter-contractual relations:
 
(i) Actually delegating custody function to the prime broker (and establishing a valid “[[Objective reason - AIFMD Provision|objective reason]]” for doing so).<ref>This is tried, true and not controversial: [[AIF]] [[Depositary - AIFMD Provision|depositaries]] delegate safekeeping to [[Prime broker|PB]]<nowiki/>s all the time. </ref>
 
(ii) Transferring its liability for safekeeping losses to the prime broker so that the [[Alternative investment fund|AIF]] has a direct claim against the delegate [[prime broker]];
 
(iii) Expressly discharging its liability to the AIF for delegated safekeeping to the AIF (and establishing a valid [[Objective reason - AIFMD Provision|objective reason]] for doing so).
 
(iv) In case the [[Depositary - AIFMD Provision|depositary]]’s intended discharge of liability does not work, being indemnified by the prime broker for liabilities the depositary incurs ''directly to the AIF'' as a result of safekeeping losses incurred by the prime broker (or its sub-custody network).
 
==== Prime broker’s objectives ====
The prime broker wants to achieve the following:
 
(i) A direct custody relationship with the AIF, on its regular terms, so that it can finance the AIF’s assets, reuse them, and take security over them.
 
(ii) It wants to hold the [[Depositary - AIFMD Provision|depositary]] [[Hold harmless|harmless]] against only the direct liabilities it suffers as a result of the [[prime broker]]’s mis-performance of the delegated custody function by [[AIFMD]]. It does ''not'' want to underwrite other liabilities (e.g. contractual ones) that the [[Depositary - AIFMD Provision|depositary]] may have volunteered to the AIF, and ''nor does it want to agree to the depositary’s own custody terms''.


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