No reuse of assets by depositary - UCITS V Provision: Difference between revisions

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 {{ucits5anat|22(7)|UCITS}}
-The famous rule which rules out PB style rehypothecation for UCITS 5 funds. Optimistic PB Salesfolk may try to argue that they can get home under the limited exception as long as you limit rehypo to 100% of indebtedness or less, but this is wishful thinking. The exception is designed to allow {{tag|UCITS}} funds to engage in fully collateralised [[Agent lender|agent lending]], whereby a custodian lends assets into the market on the UCITS’ behalf (as its agent) to earn a positive additional return for the fund, rather than to allow a a custodian to defray its own financing costs from margin lending. To wit:
+The famous rule which rules out [[PB]] style [[rehypothecation]] for [[UCITS V|UCITS 5]] funds.
-*Reuse is defined to include transfer, sale and loan
+===“But I can still [[rehypothecate]] up to 100% of a {{tag|UCITS}} fund’s [[indebtedness]], right? ''Right?''”===
-*Reuse is expressed to be “for the account of” the UCITS. This is consistent with the “reuser” depository acting as [[agent]] — like, an [[agent lender]] —on behalf of the fund, rather than as principal. Agent lending is a very different kettle of fish, where the custodian has not financed the asset, but rather is offering to obtain some yield enhancement by lending it out into the market against collateral.
+Wrong.
-*Agent lending reuse is explicitly for the benefit of the principal, in that it earns a positive return by doing it. The best you could say of a PB [[Rehypothecation|rehypothecating]] your assets is that you are avoiding a steeper financing charge you would incur if you didn't allow rehypo.
-*Likewise, the theory of [[rehypothecation]] is that it isn't [[Collateral|collateralised]], and certainly not with high-quality collateral: to the contrary, the prime broker’s right to take assets is dependent on the fund’s indebtedness to the PB, so that there is nothing to collateralise. Arguing that by effectively eliminating indebtedness is kind of like being collateralised (as long as you limit yourself to 100% of indebtedness) is, as I say, a stretch.
+“But, I mean, the fund ''owes'' me, man. It ''owes'' me.”
+Expect optimistic [[prime brokerage]] [[sales]]folk to argue that the limited exception will cover PB rephypothecation as long as the PB limits itself to 100% of the fund’s [[indebtedness]]. Alas, this is wishful thinking. The permitted exception to the bar on reuse is designed to allow {{tag|UCITS}} funds to participate in fully collateralised [[Agent lender|agent lending]] programmes. In that case a custodian lends client assets into the market on the client’s behalf (and as its [[agent]]) to earn a positive additional return for the fund. This is a very different thing to allowing a prime broker to play with the fund’s assets to defray its own financing costs from its margin lending on those very assets. To wit:
+*“[[Reuse]]” is defined to include transfer, sale and loan
+*“[[Reuse]]” is expressed to be “for the account of” the UCITS. This is consistent with the “reuser” {{ucits5prov|depositary}} acting as ''[[agent]]'' — like, as an [[agent lender]] — on behalf of the fund, rather than as the fund’s counterparty or banker (in which case [[reuse]] would be “for the account of the counterparty”, not the fund). [[Agent lending]] is a very different kettle of fish: there, the custodian has not (necessarily) financed the asset — that is to  say, an agent lending arrangement is in no sense a function of the principal’s indebtedness to the {{ucits5prov|depositary}} — but rather is a custodian offering to generate some yield enhancement for its clients by lending their assets out into the market, for a fee, against collateral provided by those market borrowers.
+*[[Agent lending]] “[[reuse]]” is, thus, explicitly for the benefit of the fund [[principal]], in that the fund earns a positive return by doing it. The best you could say of {{tag|PB}}-style [[rehypothecation]]  is that the fund avoids a steeper financing charge from the {{tag|PB}} that would be implied were the [[prime broker]] not allowed to [[rehypothecate]] the assets it has financed. In any case {{tag|UCITS}} have fairly strict limits against [[leverage]] so generally shouldn't be financing assets in the first place.
+*Likewise, the theory of [[rehypothecation]] is that it isn't [[Collateral|collateralised]], and certainly not with high-quality collateral: to the contrary, the [[prime broker]]’s right to take assets is dependent on the fund’s indebtedness to the PB, so that there is nothing to collateralise. Arguing that by effectively eliminating [[indebtedness]] is kind of like being [[Collateralised transaction - Basel II Provision|collateralised]] (as long as you limit yourself to 100% of [[indebtedness]]) is a stretch.
+===What about assets posted as margin?===
+It’s one thing hocking off assets which your client bought with the proceeds of your loan and has asked you to look after: what about assets a client has posted to you explicitly by way of margin for unrelated exposures or liabilities? Surely you can use those, right? Here it depends what kind of margin it was ([[Initial margin|initial]] or [[Variation margin|variation]]) and how the {{tag|UCITS}} transfers it to you in the first place. In a nutshell, [[variation margin]] is easy; [[initial margin]] a bit more of a trick.
+*'''[[Title transfer]]''': Needless to say<ref>Well, it ''should'' be needless to say, at any rate.</ref> if a UCITS fund posts non-cash assets by [[title transfer]], they are the [[broker]]’s to do with as it pleases. But [[variation margin]], these days, tends to be cash, and [[initial margin]] presents a problem, because [[title transfer]] opens up an unsecured exposure to the [[broker]] for the return of the posted assets, and {{tag|UCITS}} funds have tight [[concentration limit]]s for counterparty exposure. So you may find [[title transfer]] is not really on the cards for [[initial margin]].
+*'''[[Pledge]]/[[security interest]]''': Well, if you read literally, Art {{ucits5prov|22(7)}} makes this a non-starter too. Even for [[variation margin]]. Here's a [https://www.esma.europa.eu/sites/default/files/library/esma34-45-277_opinion_34_on_asset_segregation_and_custody_services.pdf legal opinion] on use of assets in {{tag|AIFMD}} and {{tag|UCITS}}:
+:''The regime for {{tag|UCITS}} assets is different [to {{tag|AIFMD}}]: pursuant  [Quotes Article as set out in the panel] It is worth recalling the above rules [in Article {{ucits5prov|22(7)}}], in particular to the extent that the ban on the [[reuse]] of the UCITS assets for the {{ucits5prov|depositary}} account should be ensured throughout the chain as it is part of the {{ucits5prov|depositary}}’s [[due diligence]] requirements. Indeed, Article 15(3) of the UCITS V Regulation 2 explicitly foresees that “A {{ucits5prov|depositary}} shall exercise all due skill, care and diligence in the periodic review and ongoing monitoring to ensure that the third party continues to comply with the criteria provided for in paragraph 2 and the conditions set out in [...] Article 22a(3)(a)-(e) of {{t|UCITS V}} and shall at least: […] (d) monitor compliance with the prohibition laid down in [...] Article {{ucits5prov|22(7)}}”.
+For [[Regulatory margin|Regulatory IM]] it is probably no biggie that you can’t do anything with it, since you are not meant to do anything with it anyway. The assets are meant to be immobilised, away from the clutches and rehypothecatory designs of your [[broker]] and the fragile, feather-weight, jacked-up-on-[[vega]] credit-quality of its [[client]].  But for [[ETD]] it’s  a different story: your [[clearing broker]] will need to the margin you posted to it down the line to satisfy its own [[IM]] requirements to the [[clearing house]] and [[intermediate broker]]s. If it can’t freely [[reuse]] your [[initial margin]], it will have to fund its own. ''And guess who’s going to pay for that''.<ref>A free bag of sweeties for you if you answered “me”.</ref>
+{{sa}}
+*[[Rehypothecation]]
+*[[Agent lending]]
+*[[Prime broker]]
+*[[UCITS Anatomy]]
+*[[AIFMD Anatomy]]
+{{ref}}