Discharge of depositary’s liability - event beyond the depositary’s reasonable control

Discharge of depositary’s liability - event beyond the depositary’s reasonable control (Article 21(12) of the Directive, Article 100 and 101 of the Level 2 Regulations)

A loss of a financial instrument held in custody by a depositary is deemed to have taken place when any of the following conditions is met:

  • a stated right of ownership of the AIF is demonstrated not to be valid because it either ceased to exist or never existed;
  • the AIF has been definitively deprived of its right of ownership over the financial instrument, unless instrument is substituted by or converted into another financial instrument(s);
  • the AIF is definitively unable to directly or indirectly dispose of the financial instrument.

Where the loss of an AIF’s financial instruments is the result of the depositary’s negligence or intentional failure to properly fulfil its obligations, the depositary is strictly liable. However, in the case where the loss of financial instruments has not resulted from accounting errors, operational failures, fraud, failure to apply the segregation requirements at the level of the depositary or a sub-custodian, but has instead resulted from an external event beyond the depositary’s reasonable control, the consequences of which were unavoidable despite all reasonable efforts to the contrary, the depositary may be able to discharge its liability for the loss provided the depositary can prove that all the following conditions are met:

a)     the event which led to the loss is not the result of any act or omission of the depositary or a sub-custodian. Such events include:

  • natural events beyond human control or influence;
  • the adoption of any law, decree, regulation, decision or order by any government or governmental body, including any court or tribunal, which impacts the financial instruments held in custody;
  • war, riots or other major upheavals;

b)     the depositary could not have reasonably prevented the occurrence of the event which led to the loss despite adopting all precautions incumbent on a diligent depositary as reflected in common industry practice. Such events include the ones listed in paragraph (a) above;

c)     despite rigorous and comprehensive due diligence, the depositary could not have prevented the loss. Such rigorous and comprehensive due diligence includes:

  • establishing, implementing, applying and maintaining structures and procedures and insuring expertise that are adequate and proportionate to the nature and complexity of the assets of the AIF in order to identify in a timely manner and monitor on an ongoing basis external events which may result in loss of a financial instrument held in custody;
  • assessing on an ongoing basis whether any of the events identified under the first indent presents a significant risk of loss of a financial instrument held in custody;
  • informing the AIFM of the significant risks identified and taking appropriate actions, if any, to prevent or mitigate the loss of financial instruments held in custody, where actual or potential external events have been identified which are believed to present a significant risk of loss of a financial instrument held in custody.

In the case where the depositary has delegated the safekeeping of an AIF’s assets to a sub-custodian, and the depositary has contracted out of its liability and transferred it to the sub-custodian, the sub-custodian may discharge its strict liability provided it can fulfil the conditions listed in paragraphs (a) to (c) above.