22a(2) - UCITS V Provision

UCITS V Anatomy™ →Go uptown In a Nutshell™ Clause 22a(2): 22a(2). The depositary may delegate the safekeeping functions set out in Article 22(5) but only where: (a) there is no intent to end-run the UCITS rules; (b) the depositary can show an objective reason for the delegation; (c) the depositary has exercised all due care in appointing and monitoring the delegate delegate’s continued performance. view template UCITS V full text of Clause 22a(2): 22a(2). The depositary may delegate to third parties the functions referred to in Article 22(5) only where: (a) the tasks are not delegated with the intention of avoiding the requirements laid down in this Directive; (b) the depositary can demonstrate that there is an objective reason for the delegation; (c) the depositary has exercised all due skill, care and diligence in the selection and the appointment of any third party to whom it intends to delegate parts of its tasks, and continues to exercise all due skill, care and diligence in the periodic review and ongoing monitoring of any third party to which it has delegated parts of its tasks and of the arrangements of the third party in respect of the matters delegated to it. view template Resources: UCITS IV (2009/65/EC (EUR Lex)) | UCITS V (2014/91/EU (EUR Lex)) | ESMA Guidance on UCITS | Depositary comparison under AIFMD and UCITS Navigation - UCITS IV: 50(1)(g) Financial derivative instruments Navigation - UCITS V: 22(2) Written contract with depositary | 22(3) (subscriptions, redemptions, valuation by depositary) | 22(4) (cash monitoring | 22(5) (safekeeping by depositary) | 22(7) (no reuse of assets by depositary) | 22a (delegation of depositary functions) Tell me more Sign up for our newsletter — or just get in touch: for ½ a weekly 🍺 you get to consult JC. Ask about it here.

The standard of care a depositary has before appointing subcontractors or delegates to carry out its functions. Prudence, in a nutshell. Note that this colours, to an extent, the discussion below, interesting though it otherwise is.

Subcustodian risk

Custodians and depositaries will try to disclaim all risks of the failure of their custody network, as indeed they will try to disclaim all other risks, real and phantasmagorical. Be watchful of this.

Custody risks ought to be fairly minimal: Unless the sub-custodian is in a weird jurisdiction, it should never take beneficial title to the assets it holds, and should have segregated them from its own assets, therefore beyond the putative reach of its ordinary creditors — so the assets remain the client’s at all times — so they should return to the client even on the custodian’s insolvency. It follows that, if client assets are not where they are meant to be on a custodian’s insolvency, there must have been some kind of operational mismanagement, negligence or fraud on the custodian’s behalf (and its insolvency). Since the operating cause of the loss is the mismanagement, not the insolvency itself, any capital charge should reflect operational risk and not credit risk.

None of this will stop custodians invoking the “Lehman” horcrux, of course.

Now if a sub-custodian profoundly breaches its custody obligations — which it owes to the main custodian, of course — should that custodian be able to pass its loss back to its innocent client?

It will say “yes” — of course it will — but to what degree has it been complicit in its delegate’s failure? Was it properly monitoring the sub-custodian’s performance? Was it duly diligent in appointing it? The custodian will wail, chomp and complain that it can’t be expected to price flakiness of unaffiliated third parties in far-flung locales into its business offering. Fair, perhaps — but then it did hold itself out as being in some way competent in the safe-keeping of customer assets didn’t it? Wouldn’t that include being diligent in monitoring the performance and capabilities of its custody network? After all the custodian is usually a sophisticated global multinational with experience managing sub-custodians in far-flung locales and it does have contractual privity with them.

The one place it makes some sense is in one of those weird jurisdictions where, by law or market convention, one cannot isolate custody assets from a local custodian’s insolvency. There, it is fair for the client to bear that risk (as it is the client’s choice to take on that “country” risk, and the main custodian cannot avoid it however prudent or diligent it is).

In most jurisdictions, exposure to a custodian for the return of client assets is not a solvency risk as such, seeing as the custodian should not beneficially own client assets and should have segregated them from its own assets, therefore beyond the putative reach of its ordinary creditors. It follows that, if client assets are not where they are meant to be on a custodian’s insolvency, there must have been some kind of operational mismanagement, negligence or fraud on the custodian’s behalf (and its insolvency). Since the operating cause of the loss is the mismanagement, not the insolvency itself, any capital charge should reflect operational risk and not credit risk.