Template:Delegate vs subcontractor: Difference between revisions

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-===[[Delegate]] versus [[Sub-contract|sub-contractor]]===
+[[File:Depositary delegation.png|thumb|right|When a [[depositary]] ''[[delegation|delegates]]'' its safe-keeping function. It remains responsible for it, but is not in the [[custody chain]].]]
-Being ''[[Delegation|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 [[margin loan|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]].
+[[File:Depositary subcontracting.png|thumb|If a [[depositary]] [[sub-contract]]s its safe-keeping function. The depositary stays in the [[custody chain]]. This is not so appealing for a [[prime broker]] with designs on [[security]] and [[rehypothecation]].]]
-*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.
+===[[Delegate]] versus [[Sub-contract|sub-custodian]]===
-*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.
+''Be warned: There are people more learned in the ways of the world than [[your correspondent]] who do not share this view.''  Let’s call it a ''dissenting judgment'' therefore. Or a piece of ''contrarianism''. But it’s a cracker.
+====The difference betwixt====
+[[Delegation]], according to a natural definition, means “to entrust (a task or responsibility) to another person, typically one who is less senior than oneself.”<ref>{{google2|Define|Delegation}}</ref> So:
+:''Dear Sir/Madam: Let me introduce you to my glamorous assistant, Igor, who will carry out this work for you under my supervision. while your day-to-day interaction will be with Igor, I remain your loyal servant, and shall be answerable to you for Igor’s timely and competent performance.''
+Being ''[[Delegation|delegated]]'' a [[custody]] function — agreeing to act, as {{t|AIFMD}} puts it, “at the first level of a [[custody chain]]”, as the direct [[custodian]] to a [[fund]] ''[[on behalf of]]'' the [[depositary]] whom the [[fund]] has appointed to carry out that function is, in this old fool’s view, not the same being the [[depositary]]’s [[sub-custodian]]. It is really quite different:
+*'''Delegate''': A [[depositary]] who delegates its custody function ''steps out of the custody chain''. It won’t hold the client’s assets ''at all''. It will instead pass that responsibility to the [[delegate]] — usually, a [[prime broker]] with designs on a spot of [[rehypothecation]]. The delegate will record the end-client’s interests in the [[custody asset]]s directly in its own books and records — that is, the [[delegate]] itself, ''and not the [[depositary]]'', will be “at the first level of the [[custody chain]]”.
+:*True; the [[delegate]] may have to report everything it does to the [[depositary]], but the [[delegate]]’s record, not the [[depositary]]’s will be the “golden source” record of the safekeeping client’s assets. The [[depository]] might ''copy'' the [[delegate]]’s report, but the [[delegate]]’s books will be what count.
+:*Note that a custody [[delegate]] can see the ultimate client and, should it have lent money to that end client, it has enough control over that client’s assets to (i) take [[security]] over them, and (ii) defray its financing costs by [[rehypothecating]] them. For someone in the business of [[margin lending]] — say, a [[prime broker]] — these are pretty fundamental abilities, so expect [[prime broker]]s to be ''very'' enthusiastic about being [[Delegate|delegated]] a [[depositary]]’s [[safekeeping]] function. They will be a lot less keen on being the depositary’s ''sub custodian'', on the other hand.
+*'''Subcustodian''': A [[subcustodian]], by contrast, stands ''behind'' the “first level” [[custodian]]. The [[ultimate client]] cannot (directly) see it, and it cannot see the [[ultimate client]]. A sub-custodian 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 [[main custodian]]’s creditors. If the main custodian were not obliged to tell you about its sub-custodians, you would not even know they were there. A [[sub-custodian]] holds assets for the main [[custodian]], only ''sees'' the [[main custodian]], and won’t know who its individual clients even are, let alone which assets it holds for the main custodian belong to which clients, much less have a direct interpersonal or contractual relationship with those clients. Since it doesn’t know to whom they belong, a sub-custodian won’t be in a position to take security over or [[rehypothecate]] any assets it holds<ref>Except to cover its own direct custody costs.</ref> — hence it ought to be happy enough signing a [[no lien letter]].
+'''Careful though''': Both CASS  and {{tag|AIFMD}}/{{tag|UCITS}} are a little sloppy in their use of the word “[[delegation]]”, using it on occasion to mean something that is probably meant to refer to a [[subcontract]]ing arrangement<ref>See, for example {{tag|CASS}} {{cassprov|6.3.4}}, and the flush text after {{tag|AIFMD}} Article {{aifmdprov|21(11)}}(d).</ref>. {{tag|CASS}} only really talks about [[subcontract]]s, though {{tag|AIFMD}} and {{tag|UCITS}} deal with true [[delegation]] ''and'' [[subcontract]]s.
+====Why delegate?====
+Why do depositaries delegate their custody functions under {{tag|AIFMD}} and {{tag|UCITS}} then? Market structure is why.
+*AIFs and UCITS funds are required to have a local [[depositary]] to look after the fund’s interests, make sure it is properly managed, and to look after its assets. The depositary must be independent and must avoid [[conflict of interest|conflicts of interest]] with the fund, such as would arise if the [[depositary]] lent to or traded with the fund. A [[depositary]] typically cannot act as a prime broker (a bank who lends on margin to hedge funds).
+*Funds — particularly hedge funds and AIFs, but sometimes UCITS too — like to invest “on margin”, borrowing funds from a prime broker against the security of the assets it purchases with the margin loans.
+*[[Prime broker]]s like to have assets to it can use them, defray its funding costs and manage its balance sheet.
+*Structural problem therefore: [[Depositary]] is meant to hold the assets, but it can't lend against them. [[PB]] wants to lend against assets, but the [[depositary]] is meant to hold them.
+::''“Hold on,”'' says the PB. ''“If the [[depositary]] holds the assets, then I can hardly [[rehypothecate]] them, can I, and we know how important [[rehypothecation]] is to my business model, don’t we?”''
+::The [[depositary]] shrugs. ''“So, I'll make you my [[sub-custodian]],”'' he says, ''“There: [[rehypothecate]] to your heart’s content.”''
+::''“No can do,”'' says the [[PB]]. ''“I can only rehypothecate against [[indebtedness]], and ''you'', dear depositary, don't owe me anything. Only the fund does. And besides, as a [[sub-custodian]] I only see an [[omnibus account]]. I don't know who owns what inside it. For [[rehypo]] to work, I have to have a direct contractual relationship with the fund. That’s the deal.”''
+*Answer: the [[depositary]] ''delegates'' the custody function to the [[prime broker]]. Both {{tag|AIFMD}}<ref>Art {{aifmdprov|21(11)}} AIFMD.</ref> and {{tag|UCITS}}<ref>Art {{ucits5prov|22a}} UCITS V.</ref> allow this in certain circumstances, but there are complicated rules as to whether the depositary can shift responsibility to the PB.