21(13) - AIFMD Provision

AIFMD Anatomy™ Go Premium {{{2}}} In a Nutshell™ Section 21(13): 21(13) Liability not affected by delegation except in certain circumstances: The depositary’s liability won’t be affected by any delegation under paragraph 21(11). However the depositary may discharge itself of liability if it can prove that: (a) all requirements for the delegation of its custody tasks set out in paragraph 21(11) are met; (b) a written contract between the depositary and the delegate sub-custodian expressly transfers the liability of the depositary to that delegate so that the AIF can claim directly against it; and (c) AIF expressly discharges the depositary’s liability under a written contract and establishes an “objective reason” for a discharge. view template Full text This is an unoffical transcription, may be wrong, buggered up, out of date etc. You should Google the original. 21(13). The depositary’s liability shall not be affected by any delegation referred to in paragraph 21(11). Notwithstanding the first subparagraph of this paragraph, in case of a loss of financial instruments held in custody by a third party pursuant to paragraph 21(11), the depositary may discharge itself of liability if it can prove that: (a) all requirements for the delegation of its custody tasks set out in the second subparagraph of paragraph 21(11) are met; (b) a written contract between the depositary and the third party expressly transfers the liability of the depositary to that third party and makes it possible for the AIF or the AIFM acting on behalf of the AIF to make a claim against the third party in respect of the loss of financial instruments or for the depositary to make such a claim on their behalf; and (c) a written contract between the depositary and the AIF or the AIFM acting on behalf of the AIF, expressly allows a discharge of the depositary’s liability and establishes the objective reason to contract such a discharge. view template Directive 2011/61/EU (EUR Lex) | Implementing regulation 231/2013 (EUR Lex) Navigation directive - 21 (depositary) | 21(4) (conflict management) | 21(8) (custody function) | 21(11) (custody delegation) | 21(12) (liability for loss of assets) | 21(13) (discharge of liability on delegation) | 21(14) (discharge of liability for Non-EU subcustodians) | 36 (depo-lite) | 36(1) implementing regulation DR20 (Due diligence when appointing counterparties and prime brokers) | DR76 (objective reason) | DR89 (Safekeeping duties with regard to assets held in custody) | DR91 (reporting obligations for prime brokers) | DR98 (due diligence) | DR99 (segregation obligation) | DR100 (Loss of custody asset) | Comments? Questions? Suggestions? Requests? Insults? We’d love to 📧 hear from you. Sign up for our newsletter.

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.