Esma proposes two options for PB asset segregation

AIFMD consultation to be followed by final report in Q2 2015

accounting

The European Securities and Markets Authority (Esma) has published a consultation paper on asset segregation requirements under the alternative investment fund managers directive (AIFMD).

Following much debate at its board level, the paper sets out Esma's proposals for possible guidelines regarding the asset segregation requirements in case of delegation of safe-keeping duties by the appointed depository of an alternative investment fund (AIF).

The consultation is open until January 30, 2015 and Esma aims to finalise the guidelines and publish a final report in Q2 2015.

The depository provisions – and, in particular, those on asset segregation – are a key aspect of the AIFMD framework and are aimed at improving investor protection.

The paper states that questions have arisen in relation to the practical application of the required segregation at the level of the delegated third party or sub-delegate.

Esma considers that the account where the AIF's assets are to be kept at the level of the delegated third party can only comprise assets of the AIF for which the safe-keeping has been delegated to the third party and assets of other AIFs. Non-AIF assets cannot be included in such an account.

The delegated third party can, therefore, hold an account for multiple AIFs, but questions have arisen as to whether the assets which can be held in such an account are only those coming from the same delegating depository or, alternatively, whether the omnibus account can hold assets for AIF clients coming from different delegating depositories.

Article 99(1) of the Level 2 Regulation states that third parties shall keep "such records and accounts as are necessary to enable it at any time and without delay to distinguish assets of the depository's AIF clients from its own assets, assets of its other clients, assets held by the depository for its own account and assets held for clients of the depository which are not AIFs".

Two options are foreseen in the prosed guidelines on this point.

Under the first option, the account on which the AIF's assets are to be kept by the delegated third party may only comprise assets of the AIF and assets of other AIFs of the same delegating depository. Assets of AIFs of other depositories would be considered as assets of the third party's "other clients".

Under the second option, a delegated third party holding assets for multiple depository clients would not be required to have separate accounts for the AIF assets of each of the delegating depositories.

Following a cost benefit analysis, Esma discarded three other options:
• AIF and non-AIF assets could be commingled in the account on which the AIF's assets are to be kept at the level of the delegate. However, the delegate could not commingle assets coming from different depositories in this account.
• AIF and non-AIF assets could be commingled in the account on which the AIF's assets are to be kept at the level of the delegate. The delegate could commingle assets coming from different depository clients in this account.
• AIF assets should be segregated on an AIF-by-AIF basis at the level of the delegate.

The first two options were discarded as they would have provided a clearly lower level of investor protection given that they would have allowed a higher level of commingling of the assets of AIFs which might frustrate the recovery of assets in the event of a bankruptcy of a depository or sub-depository.

The last option was discarded as the marginal benefit of the additional level of segregation in terms of an expeditious return of assets in the event of the bankruptcy of a depository or sub-depository does not seem likely to exceed the marginal cost of this level of segregation.

The prime brokerage industry expects it will have to increase pricing to clients if strict segregation requirements restricts its ability to hypothecate the assets posted as collateral by hedge funds and held on their behalf.

Grant Lee, asset management director at PwC, says: "The issue in the UK is where these assets are held by prime brokers, or delegates of the prime broker, in the depo-lite model where assets of AIFs are not kept separate to non-AIF assets of other clients but they are held separately to the assets of the prime broker, or firm assets. Systems at the moment are simply not set up for making the distinction between AIF and non-AIF assets. The consultation paper presents two options but both options maintain the separation between AIF and non-AIF, the distinction between the two being that there is a further separation between assets attributable to different prime brokers where the underlying delegate is the same.

"In the UK in the client assets and client money rules regime this added level of separation between AIF and non-AIF assets may add extra cost to the charges by prime brokers without any noticeable benefit to investors, as investors have the separation between firm and client assets. The big question is the impact on financing where prime brokers do not currently track the AIF / non-AIF split in rehypothecated assets."

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