Shedding Light on Non-Financial Risks – a European Survey

Shedding Light on Non-Financial Risks – a European Survey — January 2012

3. The Need for Change in Regulation and Risk Management Practices

level II implementing measures are worth reading.

and rules harmonisation on centre stage. Restitution may be rendered impossible, at least under reasonable delays, in extreme cases such as the default of an institution — reputable as it might have been. In the case of Lehman, what came to light is that clients’ assets had not been properly segregated. Prime brokers are used to lend securities (when a security is lent is usually is excluded from the assets of the fund and the depositary has no more responsibility of restitution), but also have the right to rehypothecate assets they hold as collateral or as (sub-)custodian. And “the practice of rehypothecation naturally limits the effectiveness of segregation and the ability to return assets lent to other firms immediately (prime brokers usually did not commit to immediate restitution)” (Amenc and Sender, 2010b, p. 20). The unfolding of MF Global case (Meyer and Braithwaite, 2011), a more recent case that parallels the Lehman situation in some aspects, will be interesting to analyse. Amenc and Sender (2010b) recall the events that finally triggered the political and regulatory agenda aimed at homogenising depositary liabilities in Europe (see also Aboulian, 2009a and 2009b, and Masters and Pignal, 2009). Subsequent regulatory works were needed, and have allowed for a better understanding of the role of depositaries, the limitation of its power to restore assets depending on asset classes, geographies, custody arrangements and discrepancies in legal frameworks with Europe and around the globe. Most associations now contribute to the process, and responses of industry group to the ESMA consultation on proposed

EFAMA, the representative of the fund industry, is more inclined to favour protection, and underlines the responsibility of depositaries regarding restitution. It favours the following proposal by the ESMA that the depositary and the AIF write an agreement including notably: “A statement that the depositary’s liability shall not be affected by any delegation of its custody functions unless it has discharged itself of its liability in accordance with the requirements of Article 21 (13) or (14); and where applicable, the conditions under which the AIF or the AIFM may allow the depositary to transfer its liability to a sub‐custodian including the objective reasons that could support that transfer; A statement that the depositary’s liability shall not be affected by any delegation of its custody functions unless it has discharged itself of its liability in accordance with the requirements of Article 21 (13) or (14); and where applicable, the conditions under which the AIF or the AIFM may allow the depositary to transfer its liability to a sub- custodian including the objective reasons that could support that transfer.” Depositaries, for their part (see the answer from the European Trustee and Depositary Forum, ETDF, 2011) point out the needed clarifications, the central responsibility of the fund management industry and that depositaries should not interfere with the management decisions and responsibilities: “The scope of “assets held in custody” should be clearly defined. In this respect, “option 2”of the advice, amended for further clarification, should

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An EDHEC-Risk Institute Publication