BNP Paribas has completed its segregation of client assets for compliance with the UCITS V directive—what were the major challenges in this?
The ultimate goal was to separate the UCITS assets from: (i) the proprietary assets of the depository, (ii) the assets from the non-UCITS funds—the so-called alternative investment funds, and (iii) from other clients’ assets. In essence, we had to create a fourth bucket along the custody chain, in the same way that we did for the Alternative Investment Fund Managers Directive (AIFMD) implementation project.
In practice, it was similar to a custody migration. We had to create new UCITS accounts on behalf of our eight EU depository branches, and create new standing settlement instructions, which we then had to communicate to our clients before we migrated all the assets from their old accounts in to new UCITS delegated accounts.
It was a massive exercise that took place over a period of four months. We started the first migration of actual slots in December 2015, and finished at the end of March 2016, in time for the effective start of the UCITS V regime. Work was mostly done over the weekend, in full coordination with our clients’ middle-office teams.
The main challenge was completing this on top of all the normal business activity—ours and that of our clients. We’re talking about tens of thousands of positions that had to be moved in a quality manner, with minimum impact to our clients and their trading counterparties. We had to be disciplined in the communication so as not to confuse clients’ brokers, and we had to be aware of trade settlement dates. But, it’s a core skill of a custodian to manage large-scale migrations like this while maintaining business-as-usual, and we handled a fairly similar process, with the same kind of segregation rules, when AIFMD came in to force in 2014.
How do the UCITS V segregation requirements differ to those under AIFMD?
To be frank, with regards to segregation, there is no technical difference. AIFMD requirements applied to the whole of the custody delegation chain, right through to the level before the central securities depository (CSD). Segregation applies also to assets held in international CSDs (ICSDs) when they’re acting in an investor CSD capacity.
When ICSDs are not acting in an issuer capacity they are delegates, and therefore we have to segregate at their level and at their sub-delegates’, if any. As far as we’re concerned, this was already the case under AIFMD, so there was no real difference there. Operationally, as far as the actual segregation is concerned, it’s a repeat of what we did before.
There are nuances, however, in the broader question of asset safekeeping. First, there is a new requirement in the UCITS V directive for the depository to provide fund managers with periodic assets-in-safekeeping reporting. That means reporting on the inventory of all the assets that a depository is safekeeping.
Of course, this is nothing new as far as transferable securities are concerned—as custodians, we would already provide daily reports to our clients. But, under UCITS V, the scope of the reporting is extended to all assets under safekeeping, including non-custodisable assets such as derivatives, foreign-exchange forwards and money market instruments. That kind of depository consolidated asset reporting is an explicit new obligation that has no equivalent under AIFMD.
Does segregating client assets have any advantages, aside from regulatory compliance?
I would argue that there are some further operational benefits. The overriding objective was regulatory, with the intention to facilitate the recovery of assets, but there is additional value and further benefits there. Although custodians do handle omnibus accounts, or non-segregated accounts, in a very effective way, for certain types of safekeeping structures there are benefits to segregation. It is beneficial for assets held as collateral to be duly segregated, and not comingled in omnibus accounts. From a reconciliation perspective, it is especially beneficial for the fund administrators, and to allow for the depository to be able to perform controls on the collateral.
With that in mind, might this segregation have come about without regulatory prompting?
No, because if there is no official standard, there are conflicting objectives between stakeholders in the industry. You end up with a trade-off between ease of identification of the asset and operational efficiency. Some have an interest in assets being as co-mingled as possible, in order to facilitate financing transactions and other operations, to reduce the burden of reconciliation, or to reduce the cost of maintaining large accounts. On the other hand, the depositories may have opposite requirements. If the directives had not clarified the rules, the depositories alone might not have obtained the account structure they required to do their job effectively.
For custodians, will the benefits of UCITS V ultimately outweigh the costs of compliance?
I think the jury is still out on this, and I think the answer will be different for every depository custodian. The cost of compliance is considerable. It takes investment in tools and controls to operate at the standards required of AIFMD and UCITS V, and the same standards apply equally to large and small depositories. Large depositories can easily deploy new processes over hundreds of billion of dollars in assets and across thousands of funds, but it’s a lot more effort for smaller depositories both to comply and to remain compliant, and the cost cannot be passed on to the fund managers or the investors.
It is our anticipation, and I think it is happening, that this will contribute to the continued consolidation in the market. It’s a scale industry that is operating under raised standards, with raised costs of meeting those standards. And it’s indiscriminate.
What is still left to do in preparation for UCITS V?
There are a few more tasks to complete. We have yet to get all the data feeds that we require from some of our clients, and they are needed before we can start our controls and properly start operating comprehensive safekeeping. We also have to sign updated service level agreements and depository contracts with some of our clients.
There is more to be done to complete the upgrades to our internal sourcebooks, or our books of procedures, to ensure that they reflect the new standards of depository duties.
So, there is still a tailing of unfinished projects, which, again, is similar to what we experienced in the AIFMD implementation. But we have no doubt that we will have completed those tasks before level two of UCITS V becomes effective in October.
It helps that our clients have also had a lot of regulatory change to deal with—it is in everybody’s interest to implement the new pieces of regulation on time so that we can move on to the next stage of the roadmap. Most of our clients also manage alternative investment funds, and so dealt with AIFMD as well. They had run their own complementary projects and were very experienced in the kind of work we were doing.
It’s also worth bearing in mind that the fund managers have a lot of changes to implement under UCITS V themselves, and the bulk of their work—in particular the changes to prospectus and to investor information documents, adopting the new remuneration rules—is still in front of them.
We are trying to help them by making sure that we have dealt with what is under our control, in order to help them comply as early as possible, too.
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