CUSTODY: views from Luxembourg

There will be political pressure for Ucits to follow the Alternative Investment Fund Managers (AIFM) Directive’s example. I expect custodians to adapt, seeking to re-price upwards, not only in markets where risk is perceived to be higher, but generally because the fall in their securities lending revenue has obliged them to rethink their pricing models.

The largest funds ought to be able to use their scale to resist this pressure; smaller funds will not.
Global custodians may consider expanding their operations to provide custody directly in strategic emerging markets, reducing their exposure to sub-custodians.

Anything that supports the harmonisation of investment products marketed to investors, promoting choice and competitiveness, can only be a good thing. However, we do not believe that differences between depositary obligations proposed under the AIFM Directive and those required for Ucits funds are necessarily sensible or desirable.

Instead we would prefer a fully transversal depositary regime for all relevant products so that obligations, even where they differ across products, are defined in a consistent manner.

The market welcomes the initiative to get further clarification of the Ucits depositary duties and responsibilities as it will reassure both investors and market players on their respective rights and duties.

These proposals must nevertheless be carefully balanced and should not result in the depositary providing full insurance coverage to investors. Indeed, disproportionate requirements would put Ucits at a competitive disadvantage compared to other retail products, in terms of operating costs and product innovation.

The obvious response (and possible short-term result) might be that certain Ucits may decide to no longer invest in those countries deemed to be of ‘higher risk’, or higher custodian fees for those Ucits that decide to do so.

But my guess is that over the medium/longer term it will be a key driver to motivate regulators/politicians of those countries to improve the quality of their local custodian services as they will not wish to have Ucits prevented from investing in their markets.

Custodians may need to maintain additional capital on their books, to cover third-party liabilities, and conduct further due diligence of sub-custodians and networks potentially leading to fee increases.

Some custodians may exit the market which will result in less choice, increased cost and increased systemic risk. Fund groups may seek lower-cost domiciles in Europe for their fund ranges.