Depositary obligations relating to custody of financial instruments
The depositary must hold in custody:
- all financial instruments belonging to the AIF (or the AIFM acting on behalf of the AIF) that are capable of registration (i.e. transferable securities (including those which embed derivatives), money market instruments and units in collective investment undertakings). These must be held in segregated accounts opened in the depositary’s books in the name of the AIF or the AIFM acting on behalf of the AIF;
- all financial instruments belonging to the AIF (or the AIFM acting on behalf of the AIF) that can be physically delivered to the depositary.
The depositary’s custody obligation does not, however, extend to financial instruments which, in accordance with applicable national law, are only directly registered in the name of the AIF with the issuer itself or its agent, such as a registrar or a transfer agent.
The scope of the depositary’s custody duty covers the following:
- proper registration of those financial instruments that are capable of registration in an account;
- maintaining records and segregated accounts relating to financial instruments and cash in an accurate manner;
- conducting regular reconciliations between the depositary’s internal accounts and records and those of any sub-custodian;
- exercising due care in relation to the financial instruments held in custody in order to ensure a high standard of investor protection;
- assessing and monitoring all relevant custody risks throughout the custody chain, and informing the AIFM of any material risk identified;
- introducing adequate organisational arrangements to minimise the risk of loss or diminution of the financial instruments, or of rights in connection with those financial instruments as a result of fraud, poor administration, inadequate registering or negligence;
- verifying the AIF’s ownership right, or the ownership right of the AIFM acting on behalf of the AIF, over the assets.
Where a depositary has delegated custody functions to a sub-custodian, the depositary will nonetheless be required to maintain accurate records and segregated accounts, to conduct regular reconciliations between its internal accounts and records and those of the sub-custodian, to exercise due care so that the exercise of the custody function ensures a high standard of investor protection, to assess and monitor all relevant custody risks, and to inform the AIFM of any material risk. The depositary will also need to ensure that the sub-custodian duly performs the custody functions listed above (with the exception of registration of financial instruments), and complies with the segregation obligations in the Level 2 Regulations.
The depositary’s duties above apply on a look-through basis to underlying assets held by financial and/or legal structures controlled directly or indirectly by the AIF (or the AIFM acting on behalf of the AIF), although they do not apply to fund-of-funds structures or master-feeder structures where the underlying funds have a depositary which keeps the assets of these funds in custody