Various directives have been occupying us over the past few years. Now, can there be anything worse than having too many guidelines?
By Günter Schnaitt, Head of GSS Austria
Yes there can: contradictory guidelines! You have recognised that I am talking about UCITS V and AIFMD. Let me try to recap the main differences as known today. (Unfortunately we do not know the details of Level 2 of UCITS V but recalling the implementation of AIFMD, some of the toughest topics have only been regulated under Level 2.)
Liability for CSDs
One of the most critical points is the liability regime for CSDs. Under AIFMD the usage of a CSD is “not regarded as a delegation”, therefore custodians are not liable for CSDs. There are a number of monitoring duties, but provided that they are properly conducted, there is no liability. CSDs are classified as a Securities Settlement System, and there is no differentiation as to whether the CSD offers only services for securities issued with this very CSD or the CSD hosts links to other CSDs.
UCITS has a liability regime for CSDs too, but here the usage of a CSD is regarded as a delegation. Therefore, users bear full liability for the CSDs (with the exemption of securities which have been issued with the respective CSD). Consequently, all CSDs that cover areas other than their domestic markets are regarded as “ordinary” custodians and hold full liability. It has yet to be seen if there will be any exemptions for T2S settled securities.
Asset segregation under discussion
The segregation of assets is another hot topic. While the AIFMD rules stipulate that AIFMD assets must be segregated from any other assets, it is not yet clear how far down the line segregation has to take place; we guess that there won’t be any such duties with CSDs. Our assumption is based on the fact that using a CSD is not regarded as delegation.
Furthermore, there is an ongoing discussion, also on the ESMA level, on what segregation shall encompass in the future. Some European countries have neglected it entirely as their existing laws offer the same protection for assets as under an omnibus structure. (I have much sympathy for this assumption!)
Some countries and depository banks request segregation at the first agent bank, while some even prescribe segregation on levels further down the chain. The upcoming ESMA guidelines will provide some clarification; however, I do not expect any further or better protection.
And what about asset segregation under UCITS V? We simply do not know because the regulation does not specify any segregation efforts and Level 2 regulation is not out yet. In the worst case, UCITS will require segregation as well, resulting in an obligation for depositories to segregate even at the ICSD level, because the CSD is not regarded as a delegation. This is not a requirement as of today.
Variation in shift of liability
There is one further important difference between UCITS and AIFMD, namely the shift of liability. Under AIFMD it is possible to shift liability away from the depository when 3 prerequisites have been met: Agreement with the asset manager, agreement with the agent bank and an objective reason.
Such a shift is not an option under UCITS. At first sight, this makes sense as AIFMD fund holders supposedly have more “flexibility” in their investments, including the possibility to discharge the depository bank. In practise this is hardly ever the case since agent contracts differ according to a depository’s client base. Hence, we are anticipating additional effort to cover the legal aspects.
Market users hope that the two regulations will be aligned to make our lives easier. Call me a naysayer but I fear that such an exercise will lead to adopting the more painful one.
Huge impact from CSDR
Finally, I would like to touch upon another brand-new regulation, which will potentially have a huge impact: CSDR and the related penalty regime for failed trades.
On top of the existing penalty regime for delayed settlement of stock exchange trades cleared via a CCP, this rule will be expanded towards OTC trades. It will be the CSDs’ duty to penalise the responsible party. A tough job to identify who was ultimately responsible for the delay! The CSD will also be required to prevent issuing new instructions to circumvent those penalties (possibly inducing a huge operational impact) with the question of timing notwithstanding.
According to our level of information, we assume CSDR will become effective even before the full launch of T2S. This will put a heavy burden on CSDs as well as on those markets that have to implement penalty regimes. It would definitely make more sense to implement it together with T2S, but regulators have indicated that they do not want to wait. Introducing a new tool parallel to the T2S implementation will increase not only costs but also the operational risk of a CSD.
In my opinion, this speed contradicts the regulation itself, considering the main goal of the regulation is to make the infrastructure environment more stable and safer. I am sure the regulatory developments will provide us with enough input to discuss down the road. We will stay tuned!