INDOS forecasts alternative investment fund depositary market
Bill Prew, founder and CEO of INDOS Financial, the UK AIFMD depositary, sets out his predictions for the alternative investment fund depositary market in 2017.
Managers to continue to review performance of depositaries leading to further provider change
In 2016, we saw
a number of high profile managers evaluate and change depositary as they sought
to improve the service quality and value they obtain from their providers. We
expect this change to gather further momentum in 2017.
Increasing focus and investor awareness about the role of the depositary
Awareness of the role and benefits of the depositary among investors and
consultants continues to grow. When introduced in 2014, the depositary was an
entirely new requirement for many funds. Given the depositary’s fiduciary duty
to protect their interests, investors are asking more questions about the role
of the depositary. As a result, there is an increasing level of investor due diligence
on depositaries which will continue in 2017.
Increasing
focus on the conflicts of interest in the affiliated fund administrator/depositary model
Investors and managers will continue to focus more on the potential conflicts
of interest between depositaries and other service providers. Very few
depositaries are willing to act unless an affiliated entity is the fund
administrator. This presents a conflict of interest particularly in the area of
oversight around NAV calculation and shareholder transactions. Depositaries are
being required to demonstrate how they manage this conflict to ensure that the
interests of the fund and its investors take priority over the interests of the
depositary and affiliates within the same group.
Depositary
businesses will continue to reassess their commitment to the market
In 2016, one
provider affiliated to a large global fund administrator exited the depositary
market, with the administrator preferring to partner instead with INDOS
Financial as an independent depositary. Further exits are possible in 2017,
particularly for firms that have not achieved scale or profitability in those
non-core business units.
Continued
delays to the extension of the AIFMD passport to non-EEA funds and managers
We expect
continued delays to the extension of the Alternative Investment Fund Managers Directive (AIFMD) marketing passport to non-EEA
funds and managers, in large part due to Brexit. At present the passport is
only available to EU managers of EU funds. If the passport is extended, and
managers wish to avail of it as opposed to continuing to market via private
placement on a country by country basis, managers will need to comply with the
full depositary requirements, rather than the so-called depositary-lite model.
The European Securities and Markets Authority (ESMA) has now made
recommendations that equivalence be given to a handful of third countries under
review. However, the decision lies with the European Commission and no word has
come from them yet on the topic. Brexit
will most likely lead to further delay.
Private
placement and the depositary-lite model set to continue
Under AIFMD
private placement can be phased out three years after the extension of the
passport. Depositary-lite will continue for as long as there are delays in the
extension of the passport and certainly beyond the original 2018 phase out
date. Brexit may also have some impact
on the future of private placement in Europe for UK managers.
Depositaries
will start to adapt for the outcome of Brexit
Brexit poses
immense uncertainty, but depositaries are already beginning to adapt.
Depositary is one of the major components of AIFMD and UCITS V, but these
Directives require depositaries for EU funds to be located in the relevant EU
member state. Some UK-headquartered depositaries have multiple branches and
offices throughout the EU, and this will require these providers to reorganise
themselves if they service EU funds outside the UK. A lot also depends on how
much of AIFMD legislation, including the depositary requirements, is ultimately
retained by the UK. The UK may retain depositary in order to demonstrate
equivalence to access European markets, or because it sees the depositary
function as important for investor protection and component of good fund
governance.
Depositary derogation to end by 22 July 2017
Article 61(5)
of the AIFMD contained a derogation which allows, until 22 July 2017, an EU
credit institution to act as a depositary to an EU alternative investment fund
in another member state. After this date, EU domiciled funds are required to
appoint a depositary domiciled in the same country. Some depositaries that
currently act for these funds will establish depositary businesses in new EU
countries to enable continuity of service however, managers in a number of
countries that initially made use of this derogation may need to make
alternative arrangements from July.
ESMA to
conclude asset segregation review
We expect ESMA will finally conclude its review of asset segregation under
AIFMD. Article 90 of the AIFMD imposes asset segregation obligations on
depositaries and any appointed sub-custodian. ESMA first consulted on asset
segregation under the AIFMD in December 2014 but the majority of respondents
objected to the options on which ESMA consulted and therefore it carried out a
further consultation in July 2016. It remains to be seen whether ESMA will
require more segregation through the custody chain which would have a
significant operational impact for managers, custodians and prime brokers or
whether firms will be able to opt in to increased segregation.
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