Compulsory licensing for AIF depositaries in the Netherlands
Part of a EU wide focus on systemic risks of the asset management sector?
The Alternative Investment Fund Managers Directive (AIFMD) requires managers to appoint a depositary for each (alternative) investment fund (AIF) in scope of the AIFMD1. The rationale behind this requirement, succinctly put, is that such depositary will protect investors against a loss of their assets. To this end, the AIFMD introduced oversight requirements and provisions on the liability of depositaries for the loss of the (financial) instruments brought in custody2.
Just before the 2017 Christmas recess, the Dutch Authority for the Financial Markets (AFM) announced in its newsletter3 the introduction of a compulsory licensing for AIF depositaries4 with effect from 18 March 2018. This is a logical next step on the path towards the objective of the EU to protecting to the extent possible the interests of investors (and their assets). The measure is in line with an EU-wide focus on the risks attached to the asset management sector and custodians in particular. Last year, for example, the UK supervisory authority FCA launched an investigation into the systemic risks run by the custody sector which investigation is ongoing. The FCA posed that amongst others custodians provide critical services to the funds industry which require them to be accurate, secure and resilient and argued that a lacking supply of parties, low profit margins, bundling of banking services (such as transfer agency and fund accounting) and custody services as well as a lack of investment in modern technology - triggered by the low profit margins - are factors posing a risk to the asset management sector and a stumbling block for managers to obtain compatible offers. The introduction of compulsory licensing will enable the AFM to test depositaries, reviewing those risks, but also governance and capitalisation.
So as of March 2018 licensing will be compulsory for all AIF with a few exceptions only5. In short, banks that are licensed to amongst others have in custody and manage securities as well as investment firms with a prescribed minimum share capital (in compliance with CRD) that also provide depositary services are exempt from the compulsory licensing scheme.
Depositaries of AIFs which for the first five years after acquiring the units do not offer any repurchase or redemption option and generally (i) do not invest in assets that can be given in custody or (ii) do invest in (unlisted) issuers in order to acquire governance and control6 need not apply for a licence either.
It follows from the above that the consequences of compulsory licensing will chiefly be felt by depositaries of regulated open-ended AIFs that have appointed depositaries not being banks or investment firms.
A depositary that intends to assume the duty of safekeeping an AIF would be well-advised to heed the new requirements. Compulsory licensing also affects managers of such AIFs and ultimately the investors. Of particular importance is the fact that the AFM will apply stricter tests to governance, operation (organisation (integrity and conduct), AIF acceptance policy, implementation of the depositary duties in compliance with the AIFMD, policy on conflicts of interests, due diligence in the event of delegation, compliance and audit functions) and business plans of depositaries. There is also more focus on sub-delegation of custody tasks.
The depositary will obviously have to take account of initial and ongoing supervisory fee relating to - the application for - the licence. And last but not least, the AFM will also apply stricter screening of capital requirements by shifting the focus on minimum equity capital requirements to the minimum capital to be held in relation to the (custody) risks attached to the specific AIFs. Potentially, this shift in focus could lead to an increase in capital requirements for depositaries which would not only affect the entire custody industry but ultimately investors as well.
This focus on adequate own capital would fit the EU wide trend of the shifted focus by legislators and regulators to the systemic risks of the asset management sector.
the consequences of compulsory licensing will chiefly be felt by depositaries of regulated open-ended AIFs