Twitter Logo Youtube Circle Icon LinkedIn Icon

Publishing firms

Legal Developments worldwide

Maltese Depositary Liability Post-AIFMD

May 2013 - Corporate & Commercial. Legal Developments by Chetcuti Cauchi Advocates.

More articles by this firm.

With the transposition of the Alternative Investment Fund Managers Directive ("AIFMD") in the offing, analysis on the transformation and legal implications of such on the role of the Depositary as a key and core service provider to Alternative Investment Funds ("AIFs") is significant, given the central function and responsibility this position was conferred within this industry. 


A blanket set of requirements was created by the AIFMD’s prerequisite that every Alternative Investment Fund Manager (“AIFM”) was now required to appoint a single depositary.  With the aim of ensuring a high standard of protection, the directive bestowed two main duties on the depositary function in addition to the conventional custody of assets and record-keeping; the duty of oversight and cash monitoring responsibilities. These responsibilities were then backed by a high standard of safeguards by way of the strict liability regime encompassing the directive.  Put simply, the Directive envisages two scenarios where depositary liability arises; either by way of loss of financial instruments held in custody, or losses as a result of the negligence or failure to carry out the duties prescribed specifically for the services as provided by depositaries. 

Liability for the loss of assets held by the depositary of an AIF is binding under the directive, whether the assets are held directly by the depositary or whether the assets are being held by the sub-depositary.  Although this is not a new concept, it is novel to the realm of AIFs since the requirement for a depositary for these types of funds has been made compulsory specifically by this directive.  Failure to adhere to the mandated requirements and limitations imposed on depositaries and which failure results in a loss by the depositary or its delegate of a financial instrument under its safekeeping, brings into affect the obligation to replace the equivalent and corresponding amount of assets as held in its custody with undue delay.  As an unprecedented liability provision, this provision in particular and the directive generally, set a precedent for similar conditions to be placed on other legislation in the sphere of funds with UCITS V being brought in line with this directive and particularly in terms of depositary liability.

While the AIFMD allows a depositary the ability to delegate this service, the directive states that the core depositary must have an objective reason for requiring such delegation of the function. Even in doing so, the primary depositary remains entirely and solely responsible for exercising all due skill, care and diligence wherein the choice of sub-depositary is concerned and also in terms of the monitoring and oversight duties as delegated.  Indeed, the liability for loss of financial instruments held in custody is strict; the directive holds depositaries liable for the failures of their sub-depositaries, and the depositary’s liability shall not be alleviated by delegation therefrom, though subject to exceptions.


The directive limits the circumstances when the liability of custodians may be cleared and there exists the possibility for a depositary to discharge itself from liability.  This is based on evidence provided by the depositary proving that the loss of the financial instruments was a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary.  

A much required clarification and in-depth analysis of what constitutes an external event was provided by the Regulations published December, 2012.  Effectively, the Regulations assert that the loss must be definitive and there exists no possibility of retrieving the financial instruments lost.  On this premise, financial instruments that become temporarily unavailable do not then fall under what is considered to be a loss as designated by the directive, which places such liability on the depositary. Further clarifying where the loss becomes definitive, the Regulations specify three main scenarios:

  • where the financial instrument no longer exists or never did (such as where the financial instrument disappeared following an accounting error or as such never existed where documents were falsified to show AIF’s ownership);
  • where the financial instrument exists, yet the AIF has definitively lost its right of ownership over it; 
  • where the AIF has the ownership right but is unable to transfer title of or create limited property rights in the financial basis on a permanent basis. 


The loss of financial instruments not caused by any of these failures, fraud or inadequacy to carry out the responsibilities as duly required by the directive, but, which loss instead transpired from an external event beyond the depositary’s reasonable control, allows the depositary to exclude liability upon sufficient evidence being provided.  Indeed, the depositary must verify that the event causing the loss of assets was not set off by any action or omission related to the depositary and/or sub-depositary’s function, itself. The depositary is responsible for providing all supporting evidence demonstrating that it could not have reasonably been expected to prevent the loss.   

Additionally, where the depositary can show records of the communications between itself and the manager concerning the known risks associated with assets incorporated in the fund highlighting the possibility of a threat to the loss of the financial instruments, a limitation of liability may become available.  Of course, more detailed and thorough due diligence documentation will allow the depositary to be able to prove that the loss of financial instruments could not reasonably be prevented.  Ultimately, the liability provisions under the directive require the depositary to have undergone all reasonable efforts to prevent the loss of financial instruments and to avoid the liability associated with this loss, the events leading to the loss off assets must have been inevitable even after all reasonable efforts to the contrary.  It would be less likely for a court of law to hold a depositary liable if it can show that it had diligently selected the sub-custodian and that it has with all due care and diligence monitored its performance, and that notwithstanding these measures the sub-custodian still suffered a loss of financial instrument.

Importantly, the distinction between the loss of assets within the fund holding legal and beneficial ownership is made in the Regulations and which had not been made by the directive. The Regulations clarified that the loss of financial instruments would be a considered a loss where this loss concerns the beneficial ownership.  


Certainly, the major changes to the framework affecting depositaries and the consequences of implementing them in accordance with the Directive will be experienced most at national level.  In jurisdictions were the depositary function is already a requirement of national legislation in terms of UCITS, satisfying the AIFMD requirement for the appointment of a depositary and the responsibilities conferred to the role for non-UCITS, is expected to be somewhat less challenging than in others.

In Malta, the respective authorities have prepared considerably for the transposition of the directive by also designing an AIF Handbook aiming to ease the industry into the legislative change amongst other ongoing legislative updates. Malta is rapidly being recognised as a prime location for these service providers in such a growing industry.  Indeed, Malta already has many existing provisions as found under the directive in relation to depositaries already in place.


Due to be transposed by July, depositaries servicing AIFs are immediately set to comply with the requirements under the AIFMD and there are is no transitional timeframe for the depositary liability framework to begin.  Depositaries should be geared up in affecting the necessary changes internally so as to be in full observance of the directive’s requirements. It would also be essential for depositaries to reconsider and evaluate existing contracts to attend to the AIFMD issues relating to the new responsibilities and obligations as well as to go over the details pertaining to liability and limitations thereof.


Related Articles:

MFSA issues AIFMD self-assessment questionnaires

Malta hedge funds domicile presentation

Securitisation in Malta

Malta funds tax

The Malta Financial Services Industry