Custodian
Generally
- A custodian’s main liability to its client is for the safekeeping and timely return of the client’s assets.
- A custodian generally will segregate clients assets from its own assets.
- The legal theory is that the client is the beneficial owner of the custody assets at all times. Therefore, assuming the custodian diligently performs its role:
- Custody assets will not form part of the Custodian’s insolvency estate.
- The Custodian has no economic exposure to the custody assets.
Appointment of sub-custodians
- Where a custodian does not have a physical presence in a local market, it will appoint a sub-custodian in that market to hold client assets on its behalf.
- Generally the custodian will require the sub-custodian to hold assets on the same terms that the custodian does – i.e.
- Segregated in the sub-custodian’s records from the sub-custodian’s (and the custodian’s) own assets
- Designated as client assets held for clients of the main custodian
- Taking no beneficial interest in ownership of the assets and therefore isolated from the sub-custodian’s bankruptcy.
- In certain jurisdictions (particularly emerging markets), local regulation and market practice may differ so that the custodian does not segregate its own assets from client assets.
- Custody rules would generally exclude the custodian’s liability for losses in this case provided it had diligently selected and monitored the subcustodian in question.
Escrow agents and account control agreements
Custodians sometimes act to hold pledged collateral away from its owner, but outside the bankruptcy estate of the pledgee, under an account control agreement. This can put the custodian in an invidious position, because when the treacle hits the fan, everyone will be shouting at it at once, and it won't know what to do. That will mean it won't do anything. Unless you are prepared to give an indemnity.
- AIFMD and UCITS require custodians to accept strict liability for all losses from safe keeping (even where they have diligently selected and monitored a custodian which is insolvent). Therefore, regardless of how diligent the custodian has been if either:
- A sub-custodian has negligently failed to respect appropriate segregation and insolvency remoteness; or
- The sub-custodian is in a jurisdiction where it cannot,
and there is a loss to the client, the main custodian would have to accept some or all liability for that loss.
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