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Indos lists predictions for depositary market in 2017

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Bill Prew, CEO of AIFMD independent depositary firm Indos has created a list of predictions for the alternative investment fund depositary market in 2017.

He opens with the view that managers to continue to review performance of depositaries leading to further provider change. Prew writes: “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.”
 
Prew also predicts that there will be an 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.”

He also believes there will be an increasing focus on the conflicts of interest in the affiliated fund administrator/depositary model as investors and managers will continue to focus more on the potential conflicts of interest between depositaries and other service providers. Prew writes that 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.”

Prew believes that the 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 is also predicted. “We expect continued delays to the extension of the 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.”

The private placement and the depositary-lite model is set to continue, Prew believes. “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, which, while it poses immense uncertainty, is causing depositaries to begin 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,” Prew writes.

“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, Prew says. “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.

Finally, Prew believes that ESMA will conclude its asset segregation review. Prew writes: “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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