No reuse of assets by depositary - UCITS V Provision

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UCITS V Anatomy™


In a Nutshell™ Clause 22(7):

22(7). Neither the depositary nor any delegated custodian may reuse the UCITS’ assets for its own account. “Reuse” includes transferring, pledging, selling and lending the assets.
The UCITS’ assets can only be reused where:

(a) for the UCITS’ own account;
(b) on the instructions of the management company on the the UCITS’ behalf;
(c) the reuse is for the UCITS’ benefit and in the interest of the unit holders; and
(d) the transaction is covered by high-quality liquid collateral received by the UCITS under a title transfer arrangement having a market value at least equal to the market value of the reused assets plus a premium.

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UCITS V full text of Clause 22(7):

22(7). The assets held in custody by the depositary shall not be reused by the depositary, or by any third party to which the custody function has been delegated, for their own account. Reuse comprises any transaction of assets held in custody including, but not limited to, transferring, pledging, selling and lending.
The assets held in custody by the depositary are allowed to be reused only where:

(a) the reuse of the assets is executed for the account of the UCITS;
(b) the depositary is carrying out the instructions of the management company on behalf of the UCITS;
(c) the reuse is for the benefit of the UCITS and in the interest of the unit holders; and
(d) the transaction is covered by high-quality and liquid collateral received by the UCITS under a title transfer arrangement.

The market value of the collateral shall, at all times, amount to at least the market value of the reused assets plus a premium.
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The famous rule which rules out PB style rehypothecation for UCITS 5 funds.

Expect optimistic prime brokerage salesfolk 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 UCITS funds to participate in fully collateralised 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” depositary acting as agent — like, as an agent lender — on behalf of the fund, rather than as the fund’s principal (in which case reuse would be for the account of the depositary). 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 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 PB-style rehypothecation is that the fund avoids a steeper financing charge from the Prime broker that would be implied were the prime broker not allowed to rehypothecate the assets it has financed. and in any case 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 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.

See also

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