Template:Aifmddepositarydelegation
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. A specialist will find you out if you do.
“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.”[1]. 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 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.
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 sub-custodian;
- The sub-custodian to whom it delegates:
- 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.
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.