Sub-custodian
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CASS Anatomy™
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A topic of some recent interest in light of AIFMD and UCITS V legislation. Under both regimes a single depositary must be appointed having strict liability for the safe keeping of assets.
Delegate versus sub-contractor
Note though that being delegated a custody function - where you agree to act as main custodian to a fund on behalf of the depositary whom the fund has appointed to carry out that function — quite common for AIFs, whose local depositary is obliged to be nominal custodian, but whose prime broker is usually very keen to have custody of fund assets it has lent against, so it can rehypothecate them — is a different thing from the depositary (or, for that matter, the prime broker) appointing another entity as a sub-custodian.
- A delegating depositary won't hold the assets at all: it will pass that responsibility to the prime broker, who will record the end client's interests in the custody assets directly in its books and records. It may have to report this all to the depositary, but the depositary will not carry record of the client’s assets in its own books and records.
- A subcustodian is an entity who stands behind the main custodian and holds the custodian's client assets in a single omnibus account, in the custodian's name but marked as "client assets" and therefore unavailable for the prime broker's creditors. A sub-custodian won’t know who the custodian's clients are, let alone which assets are attributable to which clients, much less have a contractual relationship with those clients, and won’t be in a position to rehypothecate any assets it holds.
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.