Depositary-Lite: It’s more expensive to be single

Following the introduction of the Alternative Investment Fund Managers Directive (AIFMD), UK and other EU hedge fund managers who wish to market their non-EU, offshore hedge funds to EU investor through private placement will need to comply with the so-called Depositary-Lite regime.  This requires managers to ensure one or more firms are appointed to perform the depositary duties of safe keeping of assets, cash flow monitoring and oversight.  Two fundamentally different depositary-lite models have emerged: single or multiple firm. 

“We see clear advantages to a multiple-firm model over the single model and believe most managers will have a strong preference for the multiple model,” said Bill Prew, CEO of Indos in a recent discussion paper.  “While there are obvious benefits to depositaries offering the single model – including consistency of operations and higher potential returns [to the depositary], by far the majority of managers will have a strong preference for the multiple-firm model.”

“At Indos we have met over 40 London-based hedge fund managers, from large to small, over the past six weeks and we have yet to meet a firm which prefers the single model,” Bill Prew added.

The discussion paper points out key differences between the two depositary-lite models:

Many existing depositaries are proposing a ‘one stop’ solution whereby they will perform all three depositary-lite duties, which explains that the second model is where the duties are performed by a combination of existing prime brokers and custodians (safe keeping of instruments), existing administrators (cash flow monitoring and record keeping of other fund assets such as derivatives) and an oversight provider performing the oversight duties.

Depositary-lite compliance should largely be a pragmatic, flexible and cost-effective ‘plug and play’ solution. The main action for managers is to identify an appropriate firm to perform the oversight duties.

“The issue of cost-effectiveness is key,” said Bill Prew.  “In the multiple-firm model, funds really ought only to be paying for the oversight function.  This should start at 2 basis points reducing as assets grow and there are strong arguments that fees should be capped at a certain level depending on the complexity of the strategy, fund structure and terms.”

“The single model is naturally going to cost more since the depositary is taking responsibility for safe keeping and daily cash flow monitoring, Bill Prew added.  “Some reports suggest the costs for a single model could start as high as 5 basis points – if true, this will be a significant drag on fund performance and high relative to fees already paid for administration.” 

“Several managers have commented they view these fee levels as an attempt to use AIFMD to increase margin and reverse the fee compression seen in the administration industry over recent years.  That’s why it’s going to be more expensive to remain single,” Bill Prew concluded. 

To obtain a copy of the Indos Financial Limited Discussion paper please complete the form below.

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