Delegation by the depositary of its custody function
When a depositary delegates the custody function to a sub-custodian, the depositary must:
- implement and apply an appropriate documented due diligence procedure for the selection and ongoing monitoring of the sub-custodian. Such procedure must be reviewed regularly, at least once a year, and made available upon request to competent authorities;
- exercise all due skill, care and diligence to ensure that entrusting financial instruments to the sub-custodian provides an adequate standard of protection. The depositary must:
- assess the regulatory and legal framework, including country risk, custody risk and the enforceability of the sub-custodian’s contracts. That assessment must in particular enable the depositary to determine the potential implication of an insolvency of the sub-custodian for the assets and rights of the AIF. If a depositary becomes aware that the segregation of assets is not sufficient to ensure protection from insolvency because of the law of the country where the sub-custodian is located, it must immediately inform the AIFM;
- assess whether the sub-custodian’s practice, procedures and internal controls are adequate to ensure that the financial instruments of the AIF or of the AIFM acting on behalf of the AIF are subject to a high standard of care and protection;
- assess whether the sub-custodian’s financial strength and reputation are consistent with the tasks delegated. That assessment must be based on information provided by the potential sub-custodian as well as other data and information, where available;
- ensure that the sub-custodian has the operational and technological capabilities to perform the delegated custody tasks with a satisfactory degree of protection and security;
- devise contingency plans for each market in which it appoints a sub-custodian. Such a contingency plan must include the identification of an alternative provider, if any;
- exercise all due skill, care and diligence in the periodic review and on-going monitoring of the sub-custodian to ensure that the sub-custodian continues to comply with the requirements for delegation. To this end the depositary must:
- monitor the sub-custodian’s performance and its compliance with the depositary’s standards;
- ensure that the sub-custodian exercises a high standard of care, prudence and diligence in the performance of its custody tasks and in particular that it effectively segregates the financial instruments in line with the requirements of the Directive;
- review the custody risks associated with the decision to entrust the assets to the sub-custodian and without undue delay notify the AIF or AIFM of any change in those risks. That assessment must be based on information provided by the sub-custodian and other data and information where available. During market turmoil or when a risk has been identified, the frequency and the scope of the review must be increased. If the depositary becomes aware that the segregation of assets is no longer sufficient to ensure protection from insolvency because of the law of the country where the sub-custodian is located, it must immediately inform the AIFM;
- take measures, including termination of the contract, which are in the best interest of the AIF and its investors where the sub-custodian no longer complies with the requirements.
- ensure that the sub-custodian:
- keeps such records and accounts as are necessary to enable it at any time and without delay to distinguish assets of the depositary’s AIF clients from its own assets, assets of its other clients, assets held by the depositary for its own account and assets held for clients of the depositary which are not AIFs;
- maintains records and accounts in a way that ensures their accuracy, and in particular their correspondence to the assets safe-kept for the depositary’s clients;
- conducts, on a regular basis, reconciliations between its internal accounts and records and those of any third party to whom the sub-custodian has delegated its functions; and
- introduces adequate organisational arrangements to minimise the risk of loss or diminution of financial instruments or of rights in connection with those financial instruments as a result of misuse of the financial instruments, fraud, poor administration, inadequate record-keeping or negligence.
Where the sub-custodian is a bank, the depositary must ensure that any cash of the AIF held with the sub-custodian is booked in cash accounts opened in the name of the AIF, in the name of the AIFM acting on behalf of the AIF, or in the name of the depositary acting on behalf of the AIF.
The depositary must monitor the sub-custodian’s compliance with its segregation obligations to ensure that the financial instruments belonging to its clients are protected from any insolvency of the sub-custodian, and assess the need for any additional arrangements to minimise the risk of loss and maintain an adequate standard of protection.
Where the sub-custodian sub-delegates the safekeeping of an AIF’s assets, the sub-delegate must also comply with the requirements set out above.