In safe hands

Changing regulation has led to an increase in depositary services throughout Europe, and the Channel Islands are looking to score their piece of the action, as Dave Waller explains

These days it seems managing wealth is only half the job when it comes to financial services. The other half is in satisfying the regulators. And nowhere is this more apparent than in the rise of depositary services. In April, Gentoo became the first firm to launch a dedicated depositary service for non-financial assets in Guernsey. Before them, Ipes, Heritage and Ogier were among those making similar moves in the UK, EU and Jersey.

But what exactly is a depositary, and why is there a sudden increase in the number of firms offering this service? In simplest terms, a depositary is the "playground monitor" of the alternative funds world. Its task is to cast an independent eye over alternative funds, ensuring fund managers are playing fairly - investing where they say they are, owning the assets they say they own, and following the rules. The depositary will also safeguard the fund"s assets - a pretty important job when the "playground" is worth billions of dollars.

Despite the increase in depositary services, it"s far from being a new offering. “The actual functions now coming under the depositary banner - asset verification, safekeeping and cash-flow monitoring - we"ve been doing for decades in our Guernsey business,” explains Mark Huntley, Managing Director at Heritage Group, a fund administrator that has recently set up a separate depositary services wing. “It"s the appliance of a science we already have.”

What"s new is the formalisation of these functions. From a regulatory point of view, such custodial roles have long been necessary for open-ended funds operating in Europe, as dictated by the EU"s UCITS directive. In the world of alternative funds, such as private equity and real estate, these rules didn"t apply. Yet under the EU"s Alternative Investment Fund Managers Directive (AIFMD), depositary requirements now apply in this sphere too (see box on page 32). The Directive has also opened the market of provision beyond the traditional large custodian banks, the likes of JP Morgan or BNP Paribas, to include smaller providers with expertise in the alternative funds space.

And this is all due to regulation. “You can absolutely guarantee this is something that fund managers wouldn"t want to put in place but that is being forced upon them,” explains Neil Townson, Managing Director at Ogier Fiduciary Services, UK. “The regulations have created a particular type of depositary with private equity, real estate and alternative funds in mind. It"s also given more choice of provider. As a fund administrator, Ogier has traditionally focused on private equity and real estate, so it"s appealing for us to provide depositary services in this area, where our expertise is.”

Expanding the offering

Ogier isn"t alone in making this transition. In fact the majority of companies moving into the depositaries space are existing fund administrators. There"s no huge barrier to entry, and as they"re already experts in these asset classes, it serves as just another bolt-on service. But there"s another key driver - if a fund administrator doesn"t offer depositary services, they may soon see their clients walking off with rivals who do.

“For now, fund managers are sticking with the provider they know,” says Kirsty Mackay, Executive Director in advisory and assurance business services at EY. “Hence you have all these businesses setting themselves up as a one-stop shop, offering depositary services too, in order to keep hold of those clients. There"s an assumption among many businesses that they"ll be able to keep their client base, but are they being complacent? Newer players may well take them instead.”

Indeed, given that it"s required by regulation, a depositary service may provide a lure to clients for an administrator"s other services. “Lots of fund managers were doing administration in-house,” says David Crosland, a Partner at Carey Olsen in Guernsey. “But now along comes a directive saying "you must go out and find an independent service provider as a depositary". So for the fund administrator it provides a hook to start selling other administration services to them, like tax information exchange services, accounting services or "know your customer" checks [see page 44].”

At the moment, depositary providers are being chosen by fund managers primarily on price and how easy it is to make the transition. And as a company needs a certain critical mass in terms of clients to get scale and meet the regulatory requirements, there"s heavy cost involved in starting from scratch. Entirely new entrants are thin on the ground. In terms of market share, it"s the existing specialist fund administrators who are moving in and cleaning up.

“Private equity is all about relationships and reputation,” says Justin Partington, Commercial Director at Ipes. “So to provide these depositary services well you have to have a credible offering - you can"t just set up and expect business to come in.”

Outside looking in

So what does this mean for Guernsey and Jersey? There"s a flurry of activity in depositaries across the EU - indeed, Vistra recently expanded its AIFMD depositary offering in the Netherlands - but the Channel Islands, while launching services, are in a rather different position.

The AIFMD only applies to EU-based funds, or those marketing into the EU, while its private placement provisions allow individual EU states to apply their own interpretation of the rules. From July, states like Germany, France and Denmark require non-EU funds to have AIFMD-equivalent standards, therefore a depositary. Most others don"t. To date, depositary services, while gaining traction, appear to be less pressing for those in the Channel Islands.

“We have 22 clients now,” says Partington at Ipes, which was quick to launch its depositary service in early 2013. “Two of those clients are looking at the Channel Islands; 20 are looking at the UK.” Similarly, while Huntley reports a great deal of activity in Heritage"s Malta office, he says of Guernsey that people “aren"t knocking the door down to get a formalised depositary function”.

That said, the ink"s still drying on AIFMD, and the regulatory landscape is always evolving. The Channel Islands" regulators have been quick to move to establish equivalents to AIFMD - in place since the start of 2014. This dual regulatory regime allows fund managers to "opt in" to the rules to show they"re compliant with the requirements of AIFMD. This will be crucial for business if the EU throws the door to the Europe-wide passport system open to the Channel Islands, as it"s expected to.

“I don"t think anyone else has a fully AIFMD-compliant equivalence regime,” says Crosland. “I doubt Cayman has even thought about it yet. Looking at investment managers here, they"re already making themselves ready for a full compliance regime, even though it"s not yet needed.”

Indeed, the consensus is that it"s best to be ready. Huntley says Heritage will probably move to have a Channel Islands" depositary offering “in the next two or three months”. Ogier is taking a similar approach - ready to build a Channel Islands model around their UK and EU depositary model “when the need arises”. Partington says he expects demand for depositary services in the Channel Islands to “pick up in the second half of this year”.

“By July next year, 20 per cent of the UK"s private equity fund managers will be regulated with AIFMD, and that figure will only grow over time,” Partington continues. “The big US players are now waking up to the EU regulation and their implications. This could mean a lot of business for Channel Island administrators and depositary services. The US guys are waking up to it. And there will be more over the next year.”