Disagreement between PBs and depositaries over liability frustrating depositary agreement progress
Depositaries and prime brokers need to find common ground on the liability implications of AIFMD if managers are to sign their depositary agreements on time, it has been warned.
Prime brokers currently act as sub-custodian to their hedge fund clients’ assets giving them right to fund their own balance sheets through client collateral. Under AIFMD, depositaries are liable for all of their clients’ assets and some of the more conservative institutions are reluctant to let prime brokers have so much control over hedge fund assets. Predictably, both sides have struggled to find common ground, which has prevented hedge funds from signing depositary agreements.
“There has to be a common, tri-party understanding before hedge funds can sign the legal agreements with their depositaries. There has to be an agreement by the summer. Certain prime brokers are reluctant to change course and want the status quo whereas the depositaries, which are inherently conservative custodian banks, are obviously concerned with the liability, which that entails. The prime brokers understandably don’t want assets held at a depositary as they perceive a risk that the depositary might not deliver those assets while the depositaries don’t want to be held accountable if assets got lost at a prime broker,” one industry expert commented.
Some experts have warned signing depositary agreements is unlikely to be a straightforward process for hedge funds. Others have predicted there could be a last minute dash to sign depositary agreements while there is a risk some depositaries might suffer capacity issues. Chris Adams, head of hedge fund services at BNP Paribas Securities Services, highlighted there was only a “finite number of legal firms in a position to help hedge funds with their depositary agreements.”
Nonetheless, Adams was confident that once compromise is reached between depositaries and prime brokers, the options will be fairly clear-cut for managers. “Depositary agreements are not an alien concept and the AIFMD is closely aligned with many of the French depositary regulations so the rules are not a complete rewrite. Furthermore, some of the requirements such as cash monitoring are similar to standard practice in France. We have signed these sorts of agreements with onshore funds on the same day, but recognise that hedge funds are more complex,” he said.