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Amendments of Level 2 Regulations regarding safekeeping obligations for AIF and UCITS depositaries

January 2019 - Finance. Legal Developments by Chevalier & Sciales .

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Commission delegated regulations (EU) 2018/1618 and (EU) 2018/1619, both of July 12, 2018 and regarding the safe keeping duties of depositaries, were published in the European Official Journal on October 30, 2018. The measures amend previous delegated regulations from 2013 and 2016 respectively.

The revised regulations impose stricter rules on depositaries delegating their safekeeping obligation applicable from April 1, 2020, giving institutions a grace period of 18 months to adapt their arrangements with third-party providers to which they have delegated their obligations.

Depositaries must review all delegation arrangements and negotiate amendments that ensure they can fulfil their oversight and due diligence obligations. The written agreement should notably enable the depositary to identify all entities within the custody chain.

They should also be able to verify that the quantity of identified financial instruments recorded in the financial instruments accounts opened in the depositary's books in the name of the UCITS or alternative investment fund or in the name of the management company acting on the fund’s behalf matches the quantity held in custody by the third party for that fund as recorded in the financial instruments account in its books.

Depositaries must also verify that the quantity of identified financial instruments registered and held in a financial instruments account at the issuer's Central Securities Depository or its agent, in the name of the third party on behalf of its clients, matches the quantity in the financial instruments accounts in the depositary's books in the name of each of its fund clients or that of the management company.

The same requirements will apply between the third-party and any other contracted providers in the case of a further delegation of custody functions. The agreement between the depositary and the third party delegate must indicate whether sub-delegation is permitted and if so, under what conditions.

The delegated regulations clarify the frequency of reconciliations between the financial securities accounts and the records of the depositary of a UCITS or alternative fund client and the third party, or between the third parties, where the custody function has been delegated further down the custody chain.

Depositaries must also ensure and verify that the third party delegate complies with the segregation requirements laid down in point (iii) of Article 21(11)(d) of the Alternative Investment Fund Managers Directive (2011/61/EU).

Where the third party is located in a non-EU country, the depositary must obtain independent legal advice confirming that the applicable insolvency law recognises the segregation of the assets of the depositary's clients from the assets of the third party to which custody functions have been delegated in accordance with Article 21(11) of the AIFMD, the assets of the third party's other clients and those held by the third party for the depositary's own account; that the assets of the depositary's fund clients do not form part of the third party's estate in the event of insolvency; and that the assets of the fund clients are not available to the third-party’s creditors or realised for their benefit.

Managers of alternative and UCITS funds will be required to check whether amendments to their existing depositary agreements will be necessary.

The full text of the delegated regulations are available in English at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018R1618&from=EN for (EU) 2018/1618 and at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018R1619&from=EN for (EU) 2018/1619.