Delegation of depositary functions - UCITS V Provision

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UCITS V Anatomy


In a Nutshell Clause 22a:

22a(1). The depositary may not delegate to third parties the fund administrator functions set out in Article 22(3) and 22(4) (subscriptions and redemption, calculating NAV, cash monitoring etc).
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.

22a(3). The depositary may delegate safekeeping functions only where that delegate:

(a) is competent to look after the assets of the UCITS given to it;
(b) where it holds custodiable assets, the delegate is properly prudentially regulated in its it its own jurisdiction and regularly audited on its custody holdings;
(c) effectively segregates the UCITS assets from its own assets and those of the depositary so they can be clearly identified as belonging to clients of the depositary[1];
(d) takes steps to ensure that if it is insolvent, the UCITS’s assets that it holds are isolated from its creditors; and
(e) complies generally with Articles 22(2), 22(5), 22(7) and 25.
Where local rules require financial instruments to be held by a local custodian and none are effectively regulated or audited, the depositary may delegate to a non-compliant local custodian only as far as is required by those local rules, and only as long as there are no compliant local custodians, and only where:
(a) the UCITS investors are informed of these circumstances and the associated risks before they invest;
(b) the UCITS management company has instructed the depositary to make the delegation.
The delegate may sub-delegate on the same terms. In such a case, Article 24(2) shall apply mutatis mutandis to the relevant parties.

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UCITS V full text of Clause 22a:

Article 22a (Delegation by a UCITS depositary)
22a(1). The depositary shall not delegate to third parties the functions referred to in Article 22(3) and 22(4).
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.

22a(3). The functions referred to in Article 22(5) may be delegated by the depositary to a third party only where that third party at all times during the performance of the tasks delegated to it:

(a) has structures and expertise that are adequate and proportionate to the nature and complexity of the assets of the UCITS or the management company acting on behalf of the UCITS which have been entrusted to it;
(b) for custody tasks referred to in point (a) of Article 22(5), is subject to:
(i) effective prudential regulation, including minimum capital requirements, and supervision in the jurisdiction concerned;
(ii) an external periodic audit to ensure that the financial instruments are in its possession;
(c) segregates the assets of the clients of the depositary from its own assets and from the assets of the depositary in such a way that they can, at any time, be clearly identified as belonging to clients of a particular depositary;
(d) takes all necessary steps to ensure that in the event of insolvency of the third party, assets of a UCITS held by the third party in custody are unavailable for distribution among, or realisation for the benefit of, creditors of the third party; and
(e) complies with the general obligations and prohibitions laid down in Article 22(2), 22(5) and 22(7) and in Article 25.
Notwithstanding point (b)(i) of the first subparagraph, where the law of a third country requires that certain financial instruments be held in custody by a local entity and no local entities satisfy the delegation requirements laid down in that point, the depositary may delegate its functions to such a local entity only to the extent required by the law of that third country, only for as long as there are no local entities that satisfy the delegation requirements, and only where:
(a) the investors of the relevant UCITS are duly informed, prior to their investment, of the fact that such a delegation is required due to legal constraints in the law of the third country, of the circumstances justifying the delegation and of the risks involved in such a delegation;
(b) the investment company, or the management company on behalf of the UCITS, has instructed the depositary to delegate the custody of such financial instruments to such a local entity.
The third party may, in turn, sub-delegate those functions, subject to the same requirements. In such a case, Article 24(2) shall apply mutatis mutandis to the relevant parties.

22a(4). For the purposes of this Article, the provision of services as specified by Directive 98/26/EC (EUR Lex) of the European Parliament and of the Council by securities settlement systems as designated for the purposes of that Directive or the provision of similar services by third-country securities settlement systems shall not be considered to be a delegation of custody functions.
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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
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See also liability for delegation of safekeeping under Art 24 of UCITS V and the scintillating discussion of what counts as an “external event”

According to recital 15 of the level 2 delegated regulations under UCITS V (makes you weep, doesn't it) “when delegating safekeeping functions to a third party in accordance with Article 22a of 2009/65/EC (EUR Lex), the depositary is required to implement and apply an appropriate and documented procedure to ensure that the delegate complies with the requirements of Article 22a(3) of that Directive at all times. In order to ensure a sufficient level of protection of assets, it is necessary to set out certain principles that should be applied in relation to the delegation of safekeeping functions.

Custody delegation under UCITS and AIFMD looks kind of similar doesn’t it?

Yes, it does. The textual differences betwixt UCITS (Art 22a) and AIFMD (Art 21(11)) are largely formal, or mutatis mutandis in style. The substantive differences are that a UCITS depositary:

  • cannot reuse the UCITS’ assets at all, whereas an AIFMD depositary can, with prior notification and consent;
  • must take all necessary steps to ensure UCITS’ assets aren’t caught up in the bankruptcy estate of an insolvent delegate custodian — there isn’t an equivalent provision under AIFMD, though perhaps you might imply it;
  • must notify UCITS investors of the risks of delegation where a non-EEA jurisdiction requires use of a local custodian and no local entities satisfy the delegation requirements and not just the fact of, and circumstances justifying, it.

Article 13 level 2 delegated regulations under UCITS V

Safekeeping duties with regard to assets held in custody

1. A depositary shall be deemed to comply with the requirements set out in point (a) of Article 22(5) of 2009/65/EC (EUR Lex) with respect to financial instruments to be held in custody where it ensures that:

(a) the financial instruments are properly registered in accordance with Article 22(5)(a)(ii) of 2009/65/EC (EUR Lex);
(b) records and segregated accounts are maintained in a way that ensures their accuracy, and in particular record the correspondence with the financial instruments and cash held for UCITS;
(c) reconciliations are conducted on a regular basis between the depositary’s internal accounts and records and those of any third party to whom safekeeping has been delegated in accordance with Article 22a of 2009/65/EC (EUR Lex);
(d) due care is exercised in relation to the financial instruments held in custody in order to ensure a high standard of investor protection;
(e) all relevant custody risks throughout the custody chain are assessed and monitored and the management company or the investment company is informed of any material risk identified;
(f) adequate organisational arrangements are introduced to minimise the risk of loss or diminution of the financial instruments, or of rights in connection with those financial instruments as a result of fraud, poor administration, inadequate registering or negligence;
(g) the UCITS’s ownership right or the ownership right of the management company acting on behalf of the UCITS over the assets is verified.

2. Where a depositary has delegated its safekeeping functions, with regard to assets held in custody, to a third party in accordance with Article 22a of 2009/65/EC (EUR Lex), it shall remain subject to the requirements of points (b) to (e) of paragraph 1 of this Article. The depositary shall also ensure that the third party complies with the requirements of points (b) to (g) of paragraph 1 of this Article.

The carve out for local regulations

Is a lot narrower than it would seem to be, and seems on its face to preclude delegating to a local custodian in a jurisdiction where there is no market practice to fully segregate custodian assets from client assets. Perhaps the EU boxwallahs thought such a jurisdiction was too inherently dangerous for UCITS funds to invest in at all. but at any rate the carve-out literally only applies to the lack of effective prudential regulation and capitalisation, rather than the wider segregation criteria:

Notwithstanding point (b)(i) [i.e., prudent regulation and capitalisation] of the first subparagraph, where the law of a third country requires that certain financial instruments be held in custody by a local entity and no local entities satisfy the delegation requirements laid down in that point [i.e., prudent regulation and capitalisation] ...

See also

  1. Does this leave the door open for omnibus segregation of different funds managed by the same depositary?