1. © 2015 Dechert LLP Continuing Professional Development Course for Directors of Investment Companies and Investment Funds: Custody/Depositary and Prime Brokerage Peter Astleford, Dechert LLP 16 February 2015

2. Custody: High Level Legal/Commercial Considerations  Single provider or multi-custodian model?  Market coverage under branch and sub-custody network.  Creditworthiness/reputation (credit rating or availability of a guarantee).  Responsibility taken for sub-custody network.  Costs (Direct and Indirect).  Service offering.  What assets are “custodiable”? 16 February 2015 2 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

3. Prime Brokerage Services  A package of services including stock and cash financing.  “Custody” services offered as an “add on” to maximise the prime broker’s access to the fund’s collateral.  The custody service may be real (i.e. under a trust arrangement or similar) or based upon a simple contractual promise (bankruptcy risk) 16 February 2015 3 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

4. Prime Brokerage Services (cont.)  Services provided “at will”.  Financing re-payable on demand.  Margin terms can generally be changed on short notice.  Rehypothecation (loss of proprietary right of ownership).  Rehypothecation cap (and impact on pricing).  Availability of bankruptcy remote custody solutions. 16 February 2015 4 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

5. Prime Brokerage Services (cont.)  Client money protection.  Reporting.  Availability of other services (e.g. research, cap intro).  For a multi-prime broker model: –appoint providers with complementary strengths. –may provide extra insolvency protection. 16 February 2015 5 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

6. Depositary Arrangements: What does AIFMD require?  EU AIFMs must appoint a single depositary for EU AIFs.  EU AIFMs must appoint one or more entities to carry out “depositary lite” for non-EU AIFs marketed in the EEA (oversight services only).  Non-EU AIFMs and EU AIFMs not marketing in the EEA need not have any depositary services at present. 16 February 2015 6 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

7. Depositary Arrangements: What does AIFMD require? (cont.)  Post 2015, if passport extended to non-EU AIFs, AIFMs of non-EU AIFs will need to appoint a single full depositary if marketed in the EEA on the basis of a passport.  Post 2018, if private placement abolished, AIFMs of non-EU AIFs may need to appoint a full depositary if marketed at all in the EEA. 16 February 2015Continuing Professional Development Course for Directors of Investment Companies and Investment Funds 7

8. Depositary Arrangements: What does AIFMD require? (cont.) Offshore AIFM/Onshore AIFM with no EEA marketing Out of Scope 16 February 2015 8 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds Depositary/Prime Broker Structures

9. Depositary liability under AIFMD  Once the fund proves “loss”, a full depositary is liable unless it can prove external event beyond its reasonable control.  Even then, the depositary must prove that the consequences of the external event “would have been unavoidable despite all reasonable efforts to the contrary”.  So a depositary may be liable for loss following sub-custodian’s insolvency, fraud or error or even a foreseeable nationalisation. 16 February 2015 9 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

10. Discharge of depositary liability under AIFMD  A depositary can discharge itself of (i.e. avoid) liability for loss of assets by: –having a sub-custodian agree to accept liability directly to the fund; and –having the fund agree to this discharge of liability.  There must be an “objective reason” for the discharge (usually agreed under the contract).  The depositary still has a regulatory obligation to perform oversight and control (contractual position to be negotiated). 16 February 2015 10 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

11. Discharge of depositary liability under AIFMD (cont.)  Apportionment of risk will then be a commercial negotiation between the prime broker and the depositary.  Contractual discharge vs indemnity (no restrictions).  Impact on fund launch timetable. 16 February 2015 11 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

12. UCITS V requirements  UCITS V (scheduled for implementation by 18 March 2016) aligns UCITS depositary rules with AIFMD.  The liability standard will be the same as under AIFMD, but there is no contractual discharge of liability permitted.  Commission’s view: UCITS investors would not understand the consequences of such a discharge.  So there is no means at all for UCITS depositaries to achieve contractual avoidance of liability, even where they must appoint a local custodian... unless they refuse to service a particular market or country. 16 February 2015 12 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

13. Implications of the Depositary Liability Regime under AIFMD and UCITS V  Concentration risk.  Increased costs and a new pricing framework for depositaries.  Greater due diligence on the sub-custody network.  Benefits for custodians using group companies leading to further concentration risk.  Development of new operating models.  Risk premia/blackout for emerging/frontier markets? 16 February 2015 13 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds

14. AIFMD and Asset Segregation at Sub- Custody Level  ESMA’s consultation on Box 1 closed on 30 th January 2015.  The results are expected in Q2 2015 16 February 2015 Continuing Professional Development Course for Directors of Investment Companies and Investment Funds 14 Depositary Sub-Custodian Depositary’s own assets Assets of the clients of other depositaries Assets of the depositary’s non-AIF clients Assets of the depositary’s AIF clients Sub- Custodian’s own assets Box 1

15. Key points for directors to consider on and during their appointment 1.What are the imposed custody/depositary regulatory rules applicable to that fund? 2.What do the directors consider a safe way for assets to be held? 3.What particular risks does the fund’s investment policy give rise to in terms of safe custody? 4.Safety/reputation/capitalisation/insurance arrangements of the depositary/prime broker/sub- custodian network. 16 February 2015Continuing Professional Development Course for Directors of Investment Companies and Investment Funds 15

16. Key points for Directors to consider on and during their appointment (cont.) 5.Robustness and integrity of the legal documentation including impact of transfer of title/rehypothecation, client money protection, legal charges etc. 6.Disclosure of the arrangements to investors. 7.Initial ongoing due diligence (get warranties?) and periodic re-appraisal of 1-6. 8.Above all, don’t ignore common sense and the smell test. There will be inevitable reliance upon others for the multiplicity of parties and legal regimes that will probably apply. 16 February 2015Continuing Professional Development Course for Directors of Investment Companies and Investment Funds 16

17. For further information, visit our website at dechert.com. Dechert practices as a limited liability partnership or limited liability company other than in Dublin and Hong Kong. 21300469.doc Any questions?