Questions over depositaries pricing risk into fees

03 Nov, 2014

A number of depositaries may not be pricing the costs of strict liability into client fees with many under-charging because they are discharging the liability to their prime brokers acting as sub-custodians.

Article 21 of the Alternative Investment Fund Managers Directive (AIFMD) requires depositary banks appointed to fully-compliant alternative investment funds (AIFs) to provide safe-keeping of client assets, cash-flow monitoring and oversight, and subjects them to strict liability for any loss of assets  held in custody through fraud or negligence. Nonetheless, a number of these organisations are discharging the liability for loss of assets on grounds of “objective reason.” A number are also obtaining an indemnity from their sub-custodians such as prime brokers against any losses.

Early projections showed the industry expected the costs of a full depositary service to be as high as 30 to 40 basis points (bps) but today some depositary banks are understood to be charging clients two to three bps. 

“The actual costs for full depositary service are a far cry from the early estimates but then the level of liability discharge that has taken place was probably not factored into those estimates. Given the discharge of liability has not been tested, there must be a risk that some depositaries are not pricing in the real potential liability into their fees,” said Bill Prew, chief executive officer at INDOS Financial,  an independent depositary-lite in London.

While a number of firms have contractually discharged their liability, many believe this practice is open to legal or regulatory challenges. If a liability claim were to arise following the loss of assets, it would likely prompt a legal challenge to the discharge of liability.

Meanwhile, UCITS V – unlike AIFMD - explicitly prohibits depositary banks from discharging liability for loss of assets to sub-custodians and there is widespread speculation this could be extended to AIFMD once the European Securities and Markets Authority (ESMA) conducts its wholesale review of the Directive in 2015. “UCITS V does not permit discharge of liability. Therefore the current practices for many AIFMD funds may be short lived. If this were to occur, we could see an increase in depositary costs over time,” said Prew.

AIFMs – unlike UCITS fund structures – can adopt more esoteric, complex strategies and are not subject to leverage and liquidity restrictions. This makes them a far riskier proposition for depositary banks to service.

Others, however, question whether depositaries are under-priced. “There is quite a competitive market in depositary services, which is why the costs are low. A lot of the major custodians have extended their range of EU countries where they offer depositary services. I think that this is all competitive activity and not to do with whether or not liability is priced in,” said Roger Fishwick, chief risk officer at Thomas Murray Data Services. 


depositariesAIFMDESMAINDOS FinancialThomas Murray Data Services