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Editor's letter: Confusion in custody market
03 December 2013
The progress of the Alternative Investment Fund Managers (AIFM) directive provides a microcosm of the state of the modern regulatory process, writes Alastair O'Dell
In the era of light-touch regulation, the same story played out
with the introduction of each new initiative. Something bad
happens, the legislators and regulators form new rules to
prevent it happening again and firms immediately set about
finding loopholes that allow them to carry on as normal.
The only variable was the degree of success that each side
enjoyed. This game of cat and mouse is not played out with
undue cynicism. Indeed, firms have little choice but to sail
close to the regulatory wind in highly competitive financial
Banks would not be able to offer their services at competitive
prices if they engaged in expensive practices that were not
required by regulators, such as holding larger capital buffers
or providing additional oversight.
It is the role of the regulator to set reasonable rules that
protect markets without imposing unnecessary costs. If they
carry out their role properly, everyone benefits.
The progress of the Alternative Investment Fund Managers (AIFM)
directive provides a microcosm of the state of the modern
regulatory process [see December cover story http://bit.ly/1beImdO].
The European Commission was concerned about the risk to
investors from problems occurring in entities that they have
not chosen or able to monitor, such as sub-custodians. It was
decided that depositary banks should be held liable for such
problems, as they appoint sub-custodians and various other
entities and have deep enough pockets to provide compensation
if things go wrong.
The problem was that this exposes depositary banks to
potentially huge liabilities and, in reality, little real
ability to conduct due diligence on a subcustody network of
perhaps 200 entities scattered around the world. Banks set
about looking for the most efficient way of complying with the
letter of the coming new law.
The loose and conflicting language in the AIFM directive left
open a few ways of mitigation liability and businesses have
understandably been organising themselves accordingly. This is
the point at which our modern regulatory tale parts company
with the usual script.
The European Commission seems determined to apply liability in
accordance with the strictest interpretation of the directive.
It says that this was always its intention, but the fact this
point was discussed at a meeting hosted by German regulator
BaFin and is on the European Securities and Markets Authority's
(Esma) radar suggests that no one outside Brussels' hallowed
halls enjoyed such certainty.
Confusion reigns in the market. The AIFM directive, and
presumably Ucits V when it is finalised, will impose tougher
rules on depositary banks than they currently expect. The
commission has already shocked the market once in 2012 when it
decided to go much further than the official advice, based on
extensive consultation, provided by Esma. Prepare to be shocked
Since the publication of this letter in the December issue,
Global Investor/ISF has learned that confusion
over the loosely-worded article in the AIFM directive
has resulted in a sudden rewording of the
corresponding section in the Ucits V draft [http://bit.ly/1ivCdnt].