Depositary lite - AIFMD Provision

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AIFMD Anatomy™


Texas book depository.png


In a Nutshell Section 36:

36(1). Member States may allow an authorised EU AIFM to market non-EU AIFs to professional investors, in their territory only as long as:

(a) Depositary-lite: the AIFM complies with all of AIFMD except for having a depositary — though it must appoint someone to perform the following depositary functions:
(i) Cashflows: monitor cashflows (art. 21(7)),
(ii) Custody: hold assets in custody (art. 21(8)), and
(iii) Subscriptions and redemptions: issue and cancel units and calculate NAV (art. 21(9))
and the AIFM may not do this itself. It must tell the regulator who it has appointed.
(b) Regulatory cooperation: there must be suitable arrangements between regulators in the AIFM’s member state and the AIF's home regulator to exchange information and cooperate to monitor systemic risks;
(c) No dodgy money-laundering types: the AIF’s home jurisdiction is not listed as a Non-Cooperative Country and Territory by FATF.

36(2). Member States may impose stricter rules on the AIFM on marketing of units non-EU AIFs to investors in their territory.
36(3). The Commission must adopt measures to cooperate with third countries.
36(4). ESMA must develop guidelines as to what counts as regulatory cooperation arrangements referred to in paragraph 1.

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Full text
This is an unoffical transcription, may be wrong, buggered up, out of date etc. You should Google the original.

Article 36 Conditions for the marketing in Member States without a passport of non-EU AIFs managed by an EU AIFM
36(1). Without prejudice to Article 35, Member States may allow an authorised EU AIFM to market to professional investors, in their territory only, units or shares of non-EU AIFs it manages and of EU feeder AIFs that do not fulfil the requirements referred to in the second subparagraph of Article 31(1), provided that:

(a) the AIFM complies with all the requirements established in this Directive with the exception of Article 21. That AIFM shall however ensure that one or more entities are appointed to carry out the duties referred to in Article 21(7), 21(8) and 21(9). The AIFM shall not perform those functions. The AIFM shall provide its supervisory authorities with information about the identity of those entities responsible for carrying out the duties referred to in Article 21(7), 21(8) and 21(9);
(b) appropriate cooperation arrangements for the purpose of systemic risk oversight and in line with international standards are in place between the competent authorities of the home Member State of the AIFM and the supervisory authorities of the third country where the non-EU AIF is established in order to ensure an efficient exchange of information that allows the competent authorities of the home Member State of the AIFM to carry out their duties in accordance with this Directive;
(c) the third country where the non-EU AIF is established is not listed as a Non-Cooperative Country and Territory by FATF.

36(2). Member States may impose stricter rules on the AIFM in respect of the marketing of units or shares of non-EU AIFs to investors in their territory for the purpose of this Article.
36(3). The Commission shall adopt, by means of delegated acts in accordance with Article 56 and subject to the conditions of Articles 57 and 58, measures regarding the cooperation arrangements referred to in paragraph 1 in order to design a common framework to facilitate the establishment of those cooperation arrangements with third countries.
36(4). In order to ensure uniform application of this Article, ESMA shall develop guidelines to determine the conditions of application of the measures adopted by the Commission regarding the cooperation arrangements referred to in paragraph 1.

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Directive 2011/61/EU (EUR Lex) | Implementing regulation 231/2013 (EUR Lex)
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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) |

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For EU AIFMs that market non-EU AIFs to professional investors in the EU, AIFMD does away with the need for the fund to have a full-blown depositary, but you do need to monitor cash flows, look after custody assets and manage subscriptions and redemptions.

These three functions don’t have to be carried out by the same dude. An administrator might handle subscriptions and redemptions and cashflow monitoring, and a prime broker might handle the custody function. When a prime broker does this, we call this a “depositary lite”, or “depo-lite” function. Unlike a full-blown depositary, a depo-lite does not have strict liability for loss of a Non-EU AIF’s assets, but it still has to give some commitments, and — it being the labyrinthine European Union and everything — these are described in a convoluted way, involving

“carrying out the Article 21(8)(a) [custody] function, as it applies to an entity appointed under Article 38(1)(a) [as a depo-lite] and in compliance with the technical standards laid out in Article 88 - 91 of the delegated regulation. [reporting and safekeeping obligations]

This is drastically tiresome, and made only more so by the United Kingdom’s unexpected and lamentable decision to leave the European Union, while trying its best to stay subject to its financial services regulations. as to which:

The Brexit bugger’s muddle

If you wanted an example of the bugger’s muddle that Brexit created, look no further than the depositary lite regime under AIFMD. Already, beyond a shade of doubt, a bugger’s muddle; now some kind of pan-dimensional bugger’s muddle.

So the UK has left the EU, but has adopted its directives into UK law, while EU regulations, which were automatically incorporated into municipal UK law, were the law anyway, so didn’t need to be specifically adopted.

AIFMD, like many financial services regulations, is composed of a directive, but is supported by regulatory technical standards imposed by regulation. I’m sure there was a good reason for this, but I don’t have the energy to find out what it was.

Basis between “Non-EU AIF” and “third country AIF”? We don’t think so.

AIFMD’s depositary lite regime is designed for innie fund managers — those resident inside the EU — marketing outie funds — funds incorporated outside the EU — to innie investors, resident in the EU.

UK, of course, used to be an innie, and the idea is, as nearly as possible, for all the damage Brexit has done, we remain an innie afterwards, with harmonised alternative fund management regulation.

But there’s a little gap: a UK domiciled fund is an innie for UK AIFMR, but an outie for EU AIFMD. But conversely, an fund domiciled in the EU is an innie for the EU, but also an innie for the UK, because a “third country” AIF means one resident outside the EEA.

Now a “third country AIF” under UK regulations means one outside the UK and the EEA. But a “Non-EU AIF’ under AIFMD means just one outside just the EEA. So a UK-domiciled AIF would not be a “third country AIF”, but it would be a “Non-EU AIF’. This did my head in for a short while but the upshot is that this does not matter. Here is why:

Under EU AIFMD, a UK AIF marketed under national private placement rules would qualify for EU depo-lite treatment, but it would not qualify for depo-lite treatment under UK rules — being its own primary regulation — so would have to appoint a full depositary the same way a fully blown EU AIF would anyway. The UK is saying, effectively, “my Non-EU AIFs will behave as if they were EU AIFs, even though the EU regulations don’t require them to, because I require them to”.

Which is nice.

Appointment language

You could, and many fastidious legal eagles will, descend into the pit of a cavernous drafting oubliette trying to explain exactly what a depositary lite does — the interplay between full depositaries and custody only, and full and lite depositary status is enough to send many of them into a funk; interjecting mirroring UK legislation into the game will put them into a bottomless pit of despair. In a fit of affection, we humbly offer the following:

Depositary lite:

(a) Where, for the purposes of the Alternative Investment Fund Managers Regulations 2013 (“UK AIFMR”), you are a “third country AIF” you may appoint us to act as your “Article 36 custodian”. We will carry out that appointment according to prevailing regulations and technical standards as they apply to Article 36 custodians.
(b) Where the EU Alternative Investment Fund Managers Directive (“EU AIFMD”) applies, an “Article 36 custodian” means an entity appointed under Article 36(1)(a) of EU AIFMD to carry out the safekeeping of financial instruments that can be held in custody.

Prime broker as depositary lite

A prime broker will be keen to act as custodian for a AIFMD, where it can get its grubby hands on all those lovely rehypothecatable custody assets, but it will not want to assume all liability — since it isn’t required to — so will accept this the role of custodian under 21(8)(a) as it applies to a person carrying out the safe-keeping function under Art. 36(1)(a).

Tedious, isn’t it.

In any case where the PB is a depo-lite custodian:

  • There is no need for the usual delegation agreement transferring responsibility and liability from the AIFMD to the prime broker, because there isn’t a AIFMD - the AIFMD appoints PB directly to carry out the safe keeping;
  • The PB won't want to sign an equivalent acceptance of all responsibility and liability directly to the AIFMD because it isn't obliged to, and why would you?

Does a margin-holder who receives collateral under a pledge count as a delegated custodian?

It is one thing for a prime broker, who definitely is safe-keeping for its client, to accept responsibilities as a AIFMD’s delegate (or, per the above, on a more limited basis as a depo-lite), but what about a futures clearing broker or a swap counterparty who receives margin under a pledge? It is hard to see why they would avoid the general drafting under AIFMD, but there are plenty of reasons it doesn’t make any sense. For one thing, a title transfer collateral arrangement, which is economically the same thing, wouldn’t be caught. Practically that may be the answer: just don’t take collateral under a pledge — or don't take non-cash collateral at all — but under the forthcoming Regulatory IM regime that might be difficult, right?

WE SHALL SEE.

By the way, the picture is of the Texas Book Depository, where there is a light on. Geddit??