Growing interest in depo-lite model

Fund Administration
03 Oct, 2013

INDOS Financial, the depositary oversight business, has submitted formal proposals to more than 35 funds with collective Assets under Management (AuM) of just under $10 billion, as interest in the depo-lite model continues to grow.

AuM at these managers varies from between $10 million to $3.5 billion.

INDOS has also received a “subject to authorisation” from the UK’s Financial Conduct Authority, which appears to be a positive sign the firm is likely to obtain final authorisation shortly.

Under Article 36 of AIFMD,  managers of non-EU hedge funds marketing through private placement to EU investors will be subject to less onerous depositary arrangements whereby strict liability for loss of assets does not apply to the depositary. This has been dubbed the “depo-lite” model. This model requires the appointment of one or more firms – “depo-lites” – to monitor the safekeeping of assets, cash flow monitoring and oversight in what is effectively a trustee function.

While INDOS’s FCA approval is making headway, the UK regulator has been urged to hurry up its approval process. One lawyer, speaking in September 2013, warned that non-EU hedge funds hoping to operate as AIFMs could be forced to delay their applications for their Variation of Permission (VOP) forms with the FCA if these depo-lites have not been given regulatory approval. The issue has been made more pressing as the FCA has advised managers submit their VOPs no later than January 22, 2014 if they want to ensure their application is approved before AIFMD takes effect on July 22, 2014.

INDOS is at present the only firm offering a depo-lite service but some standalone fund administrators are reportedly taking an interest too, according to industry sources. This, however, has challenges. An independent fund administrator with a depo-lite business would find itself facing similar conflicts of interests inherent at depositary banks overseeing their own administration businesses. One difference, however, is that most existing depositaries are wholly different divisions within large banking groups and there are clear Chinese walls separating the businesses.

While depo-lites are shielded from the strict liability provisions of AIFMD under Article 21, this does not exempt them from liability through negligence. The FCA does force these firms to adhere to basic capital requirements and maintain extensive insurance coverage but many institutional investors would probably feel more comfortable with a bank-backed depositary equipped with a sizeable balance sheet.

Furthermore, there is a future possibility the European Securities and Markets Authority (ESMA) could force all non-EU hedge funds marketing to EU investors to be compliant with the full depositary regime under Article 21, which would require these managers’ depositaries to be subject to strict liability. This, of course, would wreck the depo-lite model.





INDOS Financialdepo-litesAIFMDFCAESMA