AIFMD – The custodian and his relation with the administrator

The custodian plays an important role within the AIFM Directive (AIFMD). In the Level 2 Implementing Regulation issued on 19 December 2012 by the European Commission a number of the requirements for custodians were further elaborated.

In this news item we will take a look at the most important of these requirements. First we look at the tasks attributed to the custodian and subsequently examine the relation between the administrator and the custodian.

Requirements of the custodian function

The AIFMD states that the administrator of an investment institution must appoint an external custodian for each investment institution or fund. This role can only be fulfilled by banks, investment companies, or other financial enterprises that are under prudential supervision and appointed specifically by the member states.

The Implementing Regulation specifies further rules regarding the custodian function. These concern 20 articles in total. Twelve of these articles are an elaboration of the norms concerning the tasks of the custodian. Other rules are specifically aimed at the outsourcing of tasks by the custodian along with his liabilities. To conclude, the agreements that need to be established between the administrator and the custodian are described in detail.

Tasks of the custodian

The custodian of an investment institution aims to protect the interests of the investment institution and its participants. To this end under the AIFMD, the custodian must take into custody the assets of the investment institution and perform inspections throughout it. The most important activities are:

1. Watching over all cash flows of the investment institution, including monies from parties entering and leaving. Daily signalling of any mutations, which are unusual with respect to the nature of the investment institution. In order to be able to perform tasks in this field a daily reconciliation of money flows shall take place and an evaluation of this reconciliation process shall occur at least annually.
2. Confirming that the investments of the investment institution (as far as these are non-financial instruments) belong to the investment institution and that this is recorded in an administration.
3. Monitoring that performed transactions are settled justly and timely.
4. Monitoring that the administrator complies with the investment policy as laid down in the prospectus, for instance with regard to restrictions in the field of leverage ratios.

The thoroughness of this monitoring depends on the nature and complexity of the investment institution and can therefore differ per investment institution.

1. The custodian needs to monitor whether the issue and procurement of participation rights of the investment institution takes place in accordance with the conditions of the investment institution and legal requirements. For this purpose the custodian shall periodically establish whether the administrator has adequate procedures in place for these processes.
2. The custodian should also check continuously whether the (intrinsic) value of the investment institutions are determined correctly and to verify periodically whether the procedures to determine these values still suffice.
3. To conclude the custodian needs to make sure that the proceeds of the investment institution have been calculated correctly and that their destination is in line with the legal requirements and the conditions of the investment institution. As part of this the custodian ensures that the administrator takes appropriate measures whenever the external accountant has expressed his doubts concerning annual figures of the investment institution.

In order to perform the above-mentioned tasks the custodian has to make an analysis of the nature, scale and complexity of the strategy of the investment institution(s) concerned, as soon as he is appointed as custodian. This analysis must be periodically repeated.

A stipulation, which should not be taken lightly, is that the custodian is to regularly evaluate the proper functioning of the processes and procedures of the investment institution’s administrator. De facto, this means that the custodian may perform ‘on-site’ inspections by the administrator. In the event of material abuse the custodian should inform the local supervisor.

The administrator and custodian relation
Resulting from the activities described, the administrator and the custodian have to make solid agreements regarding their cooperation.

To facilitate this the AIFMD stipulates that the administrator and the custodian must conclude an agreement, with a description of, among other things, the way the administrator enables the custodian to fulfil the tasks he has been attributed by the legislator. The topics that need to be incorporated in the agreement are described in detail in Art. 83 of the Implementing Regulation. For instance a description has to be made of the way the custodian role is fulfilled per type of (financial) instrument and per geographic region. In addition the procedures for information provision need to be described, including the administrator’s obligation to inform the custodian continuously so the latter can exercise his duties.

The administrator needs to provide the custodian with information about, among other things,

• the accounts of the investment institution, including new accounts opened for or on behalf of the investment institution
• the new participant money flows (on a daily basis)
• data that prove that the investment institution is the owner of the assets, which are not financial instruments.
• the sale, issue, procurement, repayment and withdrawal of participation rights
• the (intrinsic) value calculation of the participation rights and the investment institution
• the performed transactions and settlements of the investment institution
• paid dividends and other forms of profit appropriation.
• possible resistance or reticence from the accountant with regard to the justification of the proceeds.

Apart from the fact that the administrator must give information to the custodian the administrator is also obliged to allow the custodian, if so desired, to evaluate the accounting of the administrator. As far as the activities, such as fund administration, have been outsourced the administrator needs to guarantee that the custodian can perform the inspection activities at the external parties.

To conclude
In this news item a (rough) outline has been given of the AIFMD requirements for the custodian function and the cooperation between administrator and custodian. The requirements and obligations are substantial and have a considerable impact on custodians as well as administrators.

The AIFMD gives rights to custodians, but also apportions them with a great deal of work. Institutions with the intention of performing the role of custodian under the AIFMD, will receive a list of duties which are more stringent than those of the Wft-requirements.

In view of the impact of the custodian role under the AIFMD, it is important for administrators to get familiar with the custodian’s role and the institution that will fulfil this role before it is too late.

Charco and Dique can help administrators and custodians obtain a licence and organise the management to conform with AIFM Directive requirements. In addition, we can take on the role of external compliance officer or risk manager for you so that you can concentrate on your core activities.

For more information please contact us by calling +31 (0)20 4165403 or e-mail address info@charcoendique.nl