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===[[Delegate]] versus [[Sub-contract|sub- | [[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]].]] | ||
[[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]].]] | |||
===[[Delegate]] versus [[Sub-contract|sub-custodian]]=== | |||
''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==== | ====The difference betwixt==== | ||
Delegation, according to a natural definition, means | [[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: | ||
*A | :''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.'' | ||
*A [[subcustodian]] | |||
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 delegate?==== | ||
Why do depositaries delegate their custody functions under AIFMD and UCITS then? Market structure is why. | 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 | *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. | *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 | *[[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. | *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?”'' | ::''“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: | ::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 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. For [[rehypo]] to work, I have to have a direct contractual relationship with the | ::''“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. | *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. | ||