AIFMD depositary services: banks vs. boutiques

The AIFM directive, made effective on 22 July this year, requires alternative fund managers, among many other things, to appoint an independent depositary. The reasoning behind the move to an external provider is aimed at protecting investors by monitoring cash, ensuring the fund owns what it says it owns and does what is says it is going to do.

Beginner's guide to depositary services

On the most basic level, depositary services look after three areas

1. Cash management: making sure money moving in and out of the account is monitored, to make sure it goes to and from as it is meant to.

Bank or boutique? unquote" explores the pros and cons of each provider

2. 'Good title' / 'retention of title': to verify that the assets are owned by the fund, and where to document the assets to.

3. Corporate oversight: that the fund has the right procedures in place, and that the fund operates to its mandate.

For those private equity houses to which the directive applies to, the new regulation is forcing a service upon them. What's more, there has never before been a depositary service for the private equity industry. These two factors have made the new market for service providers heated and competitive.

There are two types of organisations with sufficient skin in the private equity fund administration game to be adequate depositary providers. First are the independent boutique fund administration businesses, including Aztec Group, Ipes and Langham Hall. By already performing the back office function for a wealth of private equity firms, this set of players is well-versed in the intricacies of the asset class.

Second are the custodian banks, as a number already offer depositaries for other forms of investment, and some may also be administering the accounts of institutional investors exposed to private equity. Most visible in the space so far have been BNY Mellon and BNP Paribas.

Both boutiques and banks approach private equity depositaries at very different ends of the spectrum and so, for fund managers struggling to select the best one, there are several factors to take into account when making a choice.

Here's a quick overview of the pros and cons of each provider:

Banks

For

• Big balance sheet – can take the hit if something goes wrong
• Global reach
• May already be providing services for LPs

Against

• Less specialist experience of private equity
• Concern over heavy-handedness

Boutiques

For

• Understanding of industry
• Able to offer tailored / bespoke service
• May already be providing fund administration to GPs
• Can seamlessly implement depositary behind the scenes

Against

• Little experience with depositaries
• Needs independence from main fund administration business – requires robust Chinese walls

 

Of course, as a forced service, cost will be one of the main deciding factors. For the boutiques, with this offering being entirely new, several options have been put on the table. For example, Ipes offers three models: click rate by transaction; a fixed rate; or a hybrid model based on activity levels.

Peter Craft, head of BNY Mellon's asset servicing's pan-European trustee & depositary business, acknowledges cost as a concern: "For investment trusts it's primarily about costs – a well-regulated, conservative industry that considers itself a forced buyer of services. For private equity there are different asset classes with different considerations so cost is an element but substance is also important." It is understood that banks are focusing on basis points models.

The argument voiced most loudly from the banks is that their vast balance sheets could comfortably take the hit if anything went wrong. There's no denying that banks could happily cover liability if an asset were lost, however, as James Duffield, head of business development at Aztec points out: "The depositary must take the hit if a business is lost, but how likely is this to happen?"

Justin Partington, commercial director at Ipes, also notes that private equity assets are unlikely to 'get lost'. It would indeed be curious if all 335 Bridgepoint-owned Pret a Manger shops somehow disappeared within the loss definition of the Directive.

However, the financial instruments held by private equity funds, such as stocks or bonds, are liable to 'fat-fingered errors': they are subject to loss through back office mistakes. Despite concerns from the banks that boutiques would not be able to insure, or even afford to insure themselves against these sorts of losses, Ipes has been permitted by its insurers to utilise the fund administrator's existing policy. However, the business is in the process of securing a new policy to ensure complete separation of the depositary from the administration business. And, according to Partington, the new policy pricing is about 50% more than their standard administration cover.

After costs, GPs will also be concerned about receiving the least disruptive service. With many firms currently handling fund administration in-house, it is important that the move to a third-party provider is done seamlessly, with very little disturbance to everyday operations. "The average private equity CFO has a vast amount of pressure on them," says Duffield. "They know they need a depositary service but it is vital that it is made as easy as possible." 

Cost and level of service are key factors but the heart of the battle between boutiques and banks concerns experience of the industry as opposed to experience of depositaries. Here is where each party feels they have the advantage. For Craft, it is BNY's expertise in depositaries that will see the mandates rolling in: "Independents may know the clients but they don't know depositary. It's a high-entry-cost business that demands new people and resources to do it. The regulator wants independent insight. This means the independents must have solid Chinese walls – essentially they will need to set up a new business."

This is, of course, exactly what the boutiques have done – set up new divisions, even with their own insurance policies to unequivocally ensure an independent service. And, a quick glance at the FCA's register of authorised depositary providers shows the regulator seems comfortable enough with their levels of separation. Indeed, of the six registered and authorised UK transitional depositary firms so far, four are independent.

The ultimate victors in this contest will of course be decided by who private equity houses award their mandates to. But as the competition reaches boiling point, for those still on the side lines, it should at least be an entertaining one to watch.

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• Topics
• Regulation
• AIFM Directive
• IPES
• Aztec Group
• BNP Paribas