When the concept of a depositary for Alternative Investment Funds (AIFs) was first introduced in the Alternative Investment Fund Managers Directive (AIFMD), it is fair to say there were some different views expressed about the role the depositary would take, the scope of their responsibility and the cost of this new function. And that's before you even got to the views of managers and investors as to whether the depositary would add any value, particularly for real estate and private equity investors who had not previously experienced this requirement for their funds.
As we approach the second anniversary of the introduction of AIFMD, it is interesting to look back and see how the role has evolved and consider how it might continue to adapt to the needs of managers, investors and regulators.
One of the early debating points was how far down the structure a depositary would need to go when verifying an AIF's ownership of assets. The regulations state that a depositary's safekeeping duties shall apply on a look through basis to underlying assets held by structures established by the AIF for the purposes of investing in those assets which are controlled by the AIF. When you consider the complexity of some AIF structures, both in terms of vehicles and jurisdictions, this is quite an onerous responsibility and leads to some very punchy ideas on pricing. We’ve heard stories from one manager telling us that their depositary wanted a higher basis point fee than they themselves were getting!
There has also, and continues to be, debate about what is required to meet the cash monitoring obligations of a depositary. It is quite clear from talking to other depositary providers and legal advisors that there are diverse approaches being taken to the cash monitoring function.
Many have spent significant time developing policies, procedures and client agreements in conjunction with professional advisors to deliver a clear strategy for how to perform the monitoring and oversight functions of a depositary. For example, our policies state we will look through to the Target Entity, which we define as being, in the absence of guidance from the National Competent Authority or otherwise, the top operating company within the investment structure. Of course this is with an appreciation that few funds and structures are the same, so flexibility is paramount.
Overall we see the situation settling down. Experience suggests that the introduction of a depositary by the regulators is not as much of an obstruction as was first imagined when the regulations were announced. Undoubtedly this has been helped by the fees being charged not reaching the levels indicated by some at the outset.
We have also been able to demonstrate that by establishing a good understanding of our requirements at the outset of an engagement – which in turn requires us to have a good understanding of the funds – we can have lines of communication and the transfer of information that do not interfere with the daily operations of the manager and still enable us to meet our regulatory duties.
What would help further is greater clarity from the regulators regarding the duties and functions of the depositary. Clearer guidance on what the regulators expect from the depositary when it is performing its monitoring and oversight duties would go some way in convincing the Industry of the value of the depositary.
Paul Lawrence and Neil Townson, based in Luxembourg and London respectively, are directors with Elian, a provider of depositary services.