Depositary, Custodian, Trustee: Their Respective Roles Towards Investment Funds
If it is pretty clear what the role of the manager of an investment fund consists of, things become slightly more disorientating when other entities involved in fund structures are considered. One may ask what are the respective roles assumed by a Depositary, a Custodian and a Trustee, and what are the possible relations between them.
The same word may correspond to several types of functions and activities, depending on which jurisdiction and type of investment funds we are talking about. This post reflects my experience in handling Luxembourg, French, Irish, BVI, Cayman and Hong Kong funds’ work: my comments may therefore not be relevant to US funds (clarifications thereof are welcome!):
1. Depositary / Custodian
In a nutshell, the Depositary is a “Super-Custodian”, or more accurately a “Central Custodian”. A Depositary could choose to assume all the functions of a Custodian, although in practice it makes sense to delegate some functions to Sub-Custodians (see below). On the opposite, a Custodian may not assume all of a Depositary’s functions.
A Depositary generally has three functions:
(1) the preservation of the assets of the fund (the depositary holds the title of the assets when they are transferable instruments such as equities, or operates as a mere book-keeper complementing a Prime-Broker’s job when it comes to derivatives);
(2) the day-to-day administration of the assets of the fund (the depositary receives the income produced by the assets);
(3) the control of the funds’s operation (compliance with investment policies, notably proper creation/redemption/cancellation of the units/shares issued to the investors)
So what is the difference between a custodian and a Depositary? Well, a Depositary is a regulated bank holding a licence allowing it to operate as a Depositary, which may choose to delegate part of its functions to a Sub-Custodian.
A Depositary holds the title of the assets of the funds (unlike a Sub-Custodian), national laws may require that a fund appoints a Depositary (e.g. UCITS funds and most of continental Europe’s non-regulated funds such as Luxembourg’s SIFs shall appoint a Depositary located in their own jurisdiction, although this may change with UCITS IV introducing a passport for Depositaries) which is held liable, together with the manager, for the supervision of the fund’s business, and potentially vicariously liable for the functions it has delegated to a Sub-Custodian.
Such delegation to a Sub-Custodian often occurs when the manager wants to invest in markets where the Depositary does not operate or operates under a separate entity (this is “Global Custody”). There are of course rules to be observed when structuring a delegation, which notably implies the performance of due diligence and ongoing monitoring by the Depositary. As Sub-Custodians are governed by their national laws, the rules on asset segregation and re-hypothecation may vary widely.
2. Trustee / Custodian
Trustees only exist in jurisdictions where Trust Law applies, that means English common law jurisdictions. There are no Trustees involved in continental Europe’s funds.
The Trustee is the legal owner of the fund’s assets and owes a fiduciary duty to the investors i.e. the beneficial owners of the fund’s assets. Its role is very similar to the control function assumed by a Depositary: there is no Depositary when there is a Trustee, but there is a Custodian. The Trustee’s roles consist of:
(1) holding control over the asset of the fund that were entrusted to him by the investors ;
(2) making sure that the investment policies provided in the Trust Deed and the laws governing the fund are observed by the investment manager ; and
(3) ensuring that the assets are segregated from the manager’s assets.
The Custodian exercises a direct control over the assets of the scheme and has the main mission to hold, safeguard and operate them in accordance with the managers’ investment decisions.
Although the respective roles of Trustee and Custodian shall be clearly distinguished, in some jurisdictions the Law authorises one single entity to assume both roles, such entity being thus referred to as the “Trustee/Custodian”.
Summary:
Trustee = control only
Custodian = custody only
Depositary = custody (frequent delegation) + control
