May 2014

BACK OFFICE VIEW: Depo lite: Reducing the burden

David OKeeffeOne of the key conditions of the Alternative Investment Fund Managers Directive (AIFMD) requires EU-domiciled alternative fund managers (AIFMs) to appoint a single independent depositary for all funds that fall under the scope of the directive. The deadline for compliance, July 22, is rapidly approaching by which date any fund captured by AIFMD must meet the requirements. EU regulators have clarified that even in a situation where the AIFM is not authorised under AIFMD by the deadline, compliance is required by that date. The implications of non-compliance are very significant, and may prevent the manager from marketing any such fund within the EU, even on a private placement basis, until compliance can be achieved. The magnitude of this challenge is equally great. The requirement to appoint an independent depositary applies to all managers running money out of an office inside the EU, with funds domiciled in the EU, currently marketing to investors within any EU country, or with the intention to market. It applies to all non-Ucits regulated funds, to hedge funds above a $100 million assets under management threshold, private equity funds above a $500 million threshold excluding leverage, to real estate funds and investment trusts. It is perverse, therefore, that at the time of writing this article multiple industry sources are predicting that a large number of managers are likely to miss the July compliance deadline for registering the appointment of an independent depositary. Fortunately for EU managers with non-EU-domiciled funds, there is a less onerous route to AIFMD compliance as these managers can take advantage of the “depository lite” provisions, or “depo lite”, contained in the AIFMD. However, there is still an urgent need for these managers to meet the requirements of the depo lite regime as the same deadline applies. Depo lite is attractive as it enables non-EU funds to retain their existing custodian and prime broker relationships (to hold safe custody of their assets) and fund administration arrangements (to monitor cash flows) while bolting on a new trustee function to perform the oversight role which is the third pillar of the AIFMD depositary rules, a function similar to the oversight currently undertaken by the trustee to a Ucits fund. Depo lite meets the requirements of the AIFMD in relation to the protection of client assets, while offering qualifying managers a less disruptive, more cost-effective and faster implementation route to AIFMD compliance instead of appointing a full depositary bank to undertake these roles. The full depositary liability provisions of the AIFMD impose a strict liability on the depositary in the event of any client’s loss of financial assets while in the custody of the depositary. This liability standard applies to any depositary that is appointed by an EU-domiciled AIFM. Under the depo lite regime the depositary is subject to a different standard of liability, one based on negligence rather than strict liability with regard to assets which are in its custody. Whichever route, the clock is ticking. Investment managers, both EU-domiciled and non EU-domiciled, have little time meet the deadline. They must quickly put in place the depositary service support arrangements if they are to ensure there is no interruption in the marketing of funds. This could be the most pressing operational issue facing fund managers in Europe. Given the time pressure remaining on the AIFM to comply by July, some depositaries have taken to preparing extensive due diligence on themselves along with providing draft AIFMD compliant depositary agreements to alleviate some of the burden on the AIFM. David O’Keeffe Director, SMT Trustees (Ireland) ©2014 funds europe

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