ALFI Luxembourg: AIFMD Level 2 stance on cash flow monitoring alarms depositaries

Fund AdministrationLegalOperational RiskRegulationTechnology
21 Nov, 2012

AIFMD Level 2 requirements forcing depositaries to “implement” cash flow monitoring will seriously ramp up costs and could prove nigh on impossible to enact for certain strategies, experts at BNY Mellon and BNP Paribas have said at the ALFI Conference in Luxembourg.

The previous text required depositaries to “ensure” the proper monitoring of cash flows in what would have been a largely supervisory role. The European Commission’s latest version will require them to take a more active role and in effect duplicate what the fund administrator is doing.

“Implementing cash flow monitoring is a huge step up for the depositaries and will cost millions of dollars across the industry to get up and running. It will require us to check all of the managers’ cash flow transactions to ensure there are no frauds or errors,” said Chris Adams, head of hedge fund solutions at BNP Paribas Securities Services. The likelihood is banks will pass these costs onto their hedge fund clients.

“This rule is going to pose a huge operational challenge for depositaries, particularly for high-frequency strategies across listed instruments and derivatives,” he continued. Adams added derivatives transactions were often netted off and traded with multiple counterparties thereby making it a major challenge for depositaries to confirm the accuracy of the cash transaction. “How do we prove that this number is correct? This requirement is not just forcing us to act as a secondary fund administrator but to go one step significantly deeper,” he said.

Depositaries are fretting about meeting the July 2013 deadline, as well as bolstering their staff and upgrading technology to ensure compliance. “It appears that the depositary may not just have to supervise cash movements but also to replicate them on their system.  Supervision in itself is relatively onerous but replication would be a significant additional burden.  It would require the establishment of new interfaces which would need to be in place by July of next year,” said Mark Mannion, head of client relationship management and sales at BNY Mellon AIS.

There is also a risk of potential conflicts of interest, particularly if the depositary is an administrator to the fund although one industry expert said Chinese Walls should prevent any issues from arising. Nonetheless, it does raise questions about what a depositary would do if it discovered errors made by the administrator within the same organisation.

Despite complaints from depositaries, regulators are unlikely to make amendments to the rules. “The regulation will remain,” said Adams.

AIFMDALFIBNP ParibasBNY Melloncash flow monitoringderivativesHigh frequency tradingLevel 2Luxembourgtechnology