Some EU member states could permit depo-lite post-2018
Hedge fund managers could be allowed to use depository-lites in some of the more liberal EU member states in order to market to European investors beyond 2018, according to Citco Fund Services.
At present, EU managers of non-EU funds can market to European investors through national private placement regimes if they appoint a depository-lite, which unlike a full depository, is exempt from the strict liability for loss of assets as mandated under Article 21 of the Alternative Investment Fund Managers Directive (AIFMD).
Some have said the European Securities and Markets Authority (ESMA) could force all non-EU hedge funds marketing into the EU to be compliant with the full depository regime under Article 21 by July 2018 when it reviews its position on the AIFMD marketing passport in 2015.
“Depository-lites will exist until at least 2018 when private placement regimes may be closed off entirely. However, certain countries may lobby ESMA to retain flexibility so that individual member states are free to determine whether or not they will permit non-EU hedge funds to continue marketing to investors in their countries via private placement and use depository-lites beyond July 2018,” said Michael Regan, general counsel at Citco Fund Services.
Regan identified the UK, Holland and Sweden as those member states most likely to be amenable to allowing managers to use depository-lites after 2018.
A number of fund administrators have talked about launching depository-lites in order to make AIFMD compliance more palatable for their non-EU hedge fund clients. SS&C GlobeOp confirmed last year it was seeking regulatory approval from the UK’s Financial Conduct Authority (FCA) to set up a depository-lite.
SS&C GlobeOp hopes to obtain approval in the first quarter of 2014 and will run the depository-lite as a separate subsidiary which will perform what is largely a trustee role whereby it will carry out cash flow monitoring, oversight and safekeeping of assets. HedgeServ is also reported to be considering whether to establish a depository-lite. Centaur Fund Services, a Dublin-based hedge fund administrator also launched a depository-lite at the end of 2013.
“The benefits of allowing depository-lites to continue operating beyond 2018 are substantial. Firstly, it allows hedge fund managers to run their businesses substantially as they did pre-AIFMD by allowing them to select the best-in-class service providers to perform the respective depositary functions which, in turn, helps to ensure cost efficiencies and quality service delivery for investors. I suspect some of the large-scale pension funds in the UK, which embrace hedge funds, will prefer to continue investing in offshore entities rather than being constrained to higher-cost, onshore vehicles come 2018,” continued Regan.
Whether or not ESMA allows individual member states to adopt this approach remains to be seen. “There are a significant number of managers which are not interested in the passport and would like to continue marketing to EU investors via private placement as they do today. I believe trade associations, managers and investors are going to have to lobby and educate politicians about the benefits of keeping private placement regimes and depository-lites. Furthermore, depository-lites allow managers to use multiple providers to carry out the safekeeping of assets, oversight and cash-flow monitoring rather than just one entity, which means firms can spread their counterparty risk,” commented Regan.