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A word about credit risk mitigation

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It was common ground between counsel that rights properly classified in English law as a general lien were incapable of application to anything other than tangibles and old-fashioned certificated securities. — Briggs J in Re Lehman Brothers International

Liens are Security interests that usually arise by operation of the cold hard facts of life — in liberal democracies known as the common law, and without the need for any formal documentation. A banker has a lien over assets it holds for you in custody. A mechanic has a lien over your car, in that if you don’t pay your bill, you can’t have the car back. A custodian has a lien over your assets. You get the idea.

Liens can be creatures of common law or statute (in which case they’re forms of legal security) or they can be equitable.

to have a legal lien you must have possession over your asset. To have an equitable lien, not so much.

No lien letters

CASS 6 has a requirement that subcustodians provide a no lien letter to confirm they are not taking security of retaining any other rights over custody assets other than customary liens and charges as security for their ordinary fees and expenses.

These customary charges include the subcustodian's fees for holding assets and incidental expenses arising from its safe custody, but do not include liabilities arising from margin finance or other transactions between the subcustodian and the end client.

This is because, between an end client and a subcustodian, there should be none. A subcustodian will generally hold assets in an omnibus account in the name of the main custodian (but for its clients), therefore will not know the identity of the end clients, much less have a relationship with them, and therefore should not have any direct liabilities against them (at least that have anything to do with the subcustodian relationship).

This is in contrast to the main custodian, who necessarily knows who the individual clients are and, if it is a prime broker, is likely to have lent money to individual end clients to purchase those specific securities, and a term of that finance will be that the client grants security over the assets in question, as well as possession (hence they are held in custody) and rights of reuse. Because it will have individual custody records the prime broker as a head custodian will be able to take security directly over an individual's securities within its books and records, and not over the whole omnibus pool.

See also

Equitable lien