Discharge of depositary’s liability – transfer of liability to a sub-custodian

Discharge of depositary’s liability – transfer of liability to a sub-custodian (Article 21(13) of the Directive, Article 102 of the Level 2 Regulations)

When a depositary delegates the custody of an AIF’s asses to a sub-custodian, the depositary remains strictly liable for any loss of financial instruments. However, the depositary may discharge its of liability if it can prove that:

a)     the delegation complies with the Directive;

b)     a written contract between the depositary and the sub-custodian expressly transfers the liability of the depositary to the sub-custodian and makes it possible for the AIF or the AIFM acting on behalf of the AIF to make a claim against the sub-custodian in respect of the loss of financial instruments or for the depositary to make such a claim on their behalf; and

c)     a written contract between the depositary and the AIF or the AIFM acting on behalf of the AIF expressly allows a discharge of the depositary’s liability and establishes the objective reason to contract such a discharge. Such an “objective reason” must be established each time the depositary intends to discharge itself of liability, and must be:

  • limited to precise and concrete circumstances characterising a given activity; and
  • consistent with the depositary's policies and decisions.

In addition, in situations (as described below) where the depositary has no other option but to delegate its custody duties to a sub-custodian, the depositary will be deemed to have objective reasons for contracting the discharge of its liability:

  • the law of a third country requires that certain financial instruments be held in custody by a local entity and local entities exist that satisfy the delegation criteria laid down in the Directive (see paragraph (d) below); or
  • the AIFM insists on maintaining an investment in a particular jurisdiction despite warnings by the depositary as to the increased risk this presents;

d)     where the law of a third country requires that certain financial instruments are held in custody by a local entity and there are no local entities that satisfy the delegation requirements laid down in the Directive, the depositary can discharge itself of liability provided that the following conditions are met:

  • the rules or instruments of incorporation of the AIF concerned expressly allow for such a discharge under the conditions set out in this paragraph (d);
  • the investors of the relevant AIF have been duly informed of that discharge and of the circumstances justifying the discharge prior to their investment;
  • the AIF or the AIFM on behalf of the AIF instructed the depositary to delegate the custody of such financial instruments to a local entity;
  • there is a written contract between the depositary and the AIF or the AIFM acting on behalf of the AIF, which expressly allows such a discharge; and
  • there is a written contract between the depositary and the sub-custodian that expressly transfers the liability of the depositary to that local entity and makes it possible for the AIF or the AIFM acting on behalf of the AIF to make a claim against that local entity in respect of the loss of financial instruments or for the depositary to make such a claim on their behalf.