The robust ownership verification that a good depositary provides is vital to supporting new AIFMs and protecting investors against unprecedented economic volatility, writes TMF Luxembourg's Jean-Francois Flamant.
The Alternative Investment Fund Managers Directive (AIFMD), introduced in 2013 after the financial crisis fueled by events such as the Madoff investment scandal and Lehman Brothers collapse, was largely designed to bolster investor protection.
Now, COVID-19 is pushing the financial world towards another crisis, putting independent oversight roles in the spotlight again. Depositary roles are particularly confidence-enhancing for new alternative investment fund managers (AIFMs), reassuring investors that they aren't exposed to negligent fund management.
The AIFMD requires AIFMs marketing funds to European investors to appoint a third-party depositary for each alternative investment fund (AIF). The Directive prohibits delegation of a depositary's duties, except those relating to safe-keeping or verification of ownership of assets if certain requirements are met. This permits an effective sub-custody network to be established, while ensuring that the duly-appointed depositary retains primary responsibility and liability.
Relieving a heavy burden for new managers
The depositary ensures the fund is the rightful owner of the assets, monitors and reconciles cash flows with supporting documents, and makes sure all fund procedures are appropriately carried out in compliance with the law, regulations and fund terms and conditions. Two of the most important duties of depositaries are verifying whether an asset is rightfully owned by a fund and keeping an asset register up to date. If the depositary doesn't verify this correctly, or is negligent, it can lead to serious restitution liabilities.
Fund managers have not always appreciated the need for "yet another supervisor" and associated additional costs. But seven years after its introduction, the depositary role is now accepted by them as vital. While existing AIFMs have had time to become familiar with the depositary role and its requirements, new managers have not, so will, again, see it as an additional burden – and a source of confusion: because depositaries don't usually publish anything on their findings and operate in the background, requests for many documents may appear unexpectedly, especially where funds with complex structures featuring multiple layers are concerned.
Ownership verification is a tedious task
A depositary has an important duty of care to investors financing assets, which is why ownership verification is an onerous task going beyond simply looking at sales and purchase agreements.
Good depositaries don't treat it as a box-ticking exercise, taking the time to diligently review board approvals, valuation reports, and conduct ongoing due diligence. They will look at whether asset purchases are in line with fund investment policies and restrictions, and whether transactions are settled in a timely fashion. Experienced depositaries will properly understand the AIF's valuation policies to monitor them effectively, and go a step further, confidently questioning valuation policies – and enforcing them.
Streamlining ownership verification
Good communication, and good technology to facilitate that communication, is key to streamlining ownership verification. Confidence that your depositary is using the best investment management systems is critical, allowing fund managers to adjust to the new operating environment shaped by COVID-19.
The operating memorandum put in place by the depositary at the outset should emphasise transparency. Signed by all parties involved, the document defines the operational flow between the fund, its stakeholders, timeframes and the full list of documentation that depositaries need to fulfil their regulatory obligations.
Partner with TMF Group
The AIFMD can increase fund costs. However, our streamlined depositary services help AIFMs create structures that are compliant yet cost-effective.
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Originally published 29 April 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.