Standalone administrators offering full depo must have balance sheet capital strength

Fund Administration
02 Jun, 2014

Standalone fund administrators offering full depository services subject to strict liability for the restitution of assets under the Alternative Investment Fund Managers Directive (AIFMD) must ensure they have sufficient balance sheet capital to handle such an eventuality.

The majority of standalone administrators are taking advantage of Article 36 of AIFMD and establishing depository-lite models available to managers of non-EU funds marketing into the EU via national private placement regimes. These depository-lites provide safekeeping of assets, cash-flow monitoring and oversight duties, but are not bound by the strict liability provisions for loss of assets. However, SEI and Citco are the exceptions and both provide full depository services under Article 21 of the AIFMD. 

One industry expert, speaking anonymously, said standalone administrators offering full depository services needed to show they had sufficient balance sheet capital to make right any investors were assets to be lost. He added there were widespread concerns among the investor community that these standalone administrators could struggle to fulfil this requirement given their lack of balance sheet strength compared to an investment or wholesale bank.

Both Citco and SEI are significant players in the hedge fund administration space. Citco is the second largest fund administrator in the world with $740 billion in Assets under Administration (AuA) while SEI oversees $343 billion. Were strict liability to be invoked against a standalone administrator offering depository services, it could potentially threaten the operations of these organisations, which in turn might prevent managers from striking their net asset values (NAV), and facilitating redemptions and subscriptions and investor reporting. Worse, a depository failure would leave an AIFM unable to trade.

The industry expert argued banks are simply better placed to deal with strict liability given their strong balance sheets. It is also something institutional investors prefer too, he continued.

Anne Deegan, managing director at SEI Investments Trustee and Custodial Services in Dublin, said SEI was in a strong position to offer full depository services. “We demonstrated to the Central Bank of Ireland (CBI) that we have substance and sufficient capital to be a depository, and we are doing this on an on-going basis. We have a substantial cash balance sheet and our organisation is risk averse. We are not likely to suffer from contagion, something which could occur at investment banks offering depository services,” she said.

Deegan added SEI was undergoing stress tests to determine the impact strict liability would have on its balance sheet.  “Our clients are not worried about our balance sheet and no single client has approached us on this issue. Were we to be impacted by strict liability and required to replace lost  assets, SEI would be capable of replacing those assets,” she said.

One institutional investor highlighted it was essential standalone administrators offering full depository services discharge liability with their sub-custodians to minimise the risk of strict liability. This is something Citco confirmed it had done. "Where Citco is appointed to provide full depositary services, we have worked with the funds' counterparties so that we can contractually discharge the liability for loss of assets of an AIF to the prime brokers or sub-custodians holding such assets as permitted under AIFMD. Citco will continue to perform the remainder of our obligations under the Directive. Effectively, Citco will be fully indemnified by the prime brokers or sub-custodians if there is a loss of assets which would result in strict liability to an AIF. Accordingly, Citco's balance sheet will not be relevant where it acts as depositary. Instead, the creditworthiness and balance sheet of an AIF's trading counterparties holding the AIF's assets will be what the risk management groups of AIFMs need to monitor in the same way they do today," said Michael Regan, general counsel at Citco. 

However, indemnification agreements of this type are not necessarily fail-safe and they are untested.  Furthermore, discharge of liability is not permitted under UCITS V, and there is speculation this could be extended to AIFMD when the European Securities and Markets Authority (ESMA) reviews the Directive in 2015.


AIFMDCitcoSEIESMAstrict liabilityDublinCBIUcits V