The Alternative Investment Fund Management Directive (AIFMD) is due to take force by the end of 2013. Its overall shape is known; detail on implementation will be announced this summer. Amid a tsunami of banking regulation meant to reduce what regulators like to term ‘systemic risk’, the AIFMD has received only fitful attention outside the hedge and private equity communities. “This is a mistake. The Directive may have the effect on banks of turning assets into liabilities”, warns Bill Scrimgeour, global head of regulatory and industry affairs at HSBC Securities.
Central to the regulatory intent of the AIFMD is a requirement that alternative funds marketed in the EU must use a depositary. Primarily intended to capture and regulate hedge funds and private equity funds that do not at present have to appoint a depositary, the Directive will also capture any fund not regulated as a UCITS fund. There will be exemptions based on funds with small assets under management and small numbers of investors, but the qualifying threshold is expected to be set low. Depositaries will be required to accept hugely elevated levels of liability in relation to the assets they safeguard for clients.
Traditionally, depositary liability has been based on negligence – loss of records, acceptance of a forgery, failure to act, or acting without instruction, and so on. In the wake of the credit crunch, regulators decided to alter radically the definition of depositary liability. This became evident in the earliest, 2009 draft of the AIFMD which extended the definition to include loss of investment value. There was a tactical retreat from this extended definition due to strong resistance from industry lobbyists, but this might be reversed after the outcome of consultation on ‘level 2’ implementation measures. As matters stand, the AIFMD looks to be a curate’s egg, good and bad in places. Some of it is a codification of current best practice for depositaries.
At one end there are settlement failures in non-delivery-versus-payment (DvP) markets, non-exclusive control of accounts under client hypothecated account structures and any transaction reversals or other unilateral actions taken by central securities depositories (CSDs). Then there are deficiencies in market infrastructure, such as systemic market failures, sub-standard market infrastructure, and fraud by a sub-custodian or other agent out with the custodians standard duty of supervision.
More controversially, local market conditions such as extreme volatility, abnormal levels of default, not to mention sudden market closures and abnormal currency devaluation, could all serve as grounds for litigation. Presumably, the regulators were thinking about the example of Iceland when framing this part of the Directive.
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