The International Organization of Securities Commissions (IOSCO) today published a consultation report on Principles regarding the Custody of Collective Investment Schemes’ Assets. The report is aimed at gathering the views of investment managers, custodians, institutional investors and other interested parties on the development of a set of principles for the custody of Collective Investment Schemes’ (CIS) Assets.
Custodians play a key role in the safekeeping of CIS assets as recognised in IOSCO Principle n°25[1] which states that “the regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets”.
To prepare this consultation document, IOSCO built on previous IOSCO papers on the subject[2] and survey responses from twenty-seven jurisdictions. The survey sought information about the legal, regulatory and operational landscape for CIS asset safekeeping in each of those jurisdictions.
A number of market developments have occurred since publication in 1996 of the IOSCO paper on the Guidance on Custody Arrangements for Collective Investment Schemes, leading IOSCO to revisit its published guidance. Events like the Lehman Brothers and MF Global insolvencies or the Madoff fraud have focused attention on CIS asset protection regimes.
CIS managers tend to invest more in complex instruments today than they did in the 1990s. The wider array of eligible investment instruments raises questions about the scope of the custodian´s safekeeping role and duties. In addition, the growing and now widespread use of electronic book entry to register and track ownership changes in securities is transforming market practices and processes, creating new challenges and risks.
Since 1996, CIS have taken important steps to diversify and internationalise their portfolios. Growing foreign investments have increased the need for CIS to appoint sub-custodians in foreign jurisdictions. This trend may have implications, especially regarding the delegation of safe-keeping functions, as custody chains tend to be longer and more complex, involving many foreign jurisdictions.
Taking into account these recent market developments, the consultation paper explores the key risks associated with the custody function.
The Proposed Principles
While acknowledging that the regulatory regimes for the safekeeping of CIS assets are diverse, and the responsibilities and regulatory status of the entities that provide safekeeping services are also varied, the report published today proposes nine principles divided into two sections aimed at identifying the core issues that should be kept under review by the regulatory framework. While the first section focuses on general aspects relating to the custody function, the second part of the report is dedicated to principles relating more specifically to the appointment and ongoing engagement of custodians.
Principle 1: The regulatory regime should make appropriate provisions for the custodial arrangements of the CIS.
Principle 2: CIS assets should be segregated from:
- the assets of the responsible entity, its related entities and other schemes;
- the assets of the custodian / sub-custodian throughout the custody chain; and
- the assets of other clients of the custodian throughout the custody chain (unless CIS assets are held in a permissible omnibus account).
Principle 3: CIS assets should be entrusted to a third party custodian. In limited circumstances where the regulatory regime permits self-custody of CIS assets, additional safeguards should be put in place to ensure proper segregation and protection of CIS assets.
Principle 4: The custodian should be functionally independent from the responsible entity.
Principle 5: The responsible entity should seek to ensure that the custody arrangements in place are disclosed appropriately to investors in the CIS offering documents or otherwise made transparent to investors.
Principle 6: The responsible entity should use appropriate care, skill and diligence when appointing a custodian to safe keep CIS assets.
Principle 7: The responsible entity should, at a minimum, consider a custodian's legal / regulatory status, financial resources and organisational capabilities during the due diligence process.
Principle 8: The responsible entity should formally document its relationship with the custodian and the agreement should seek to include provisions about the scope of the custodian's responsibility and liability.
Principle 9: Custody arrangements should be monitored on an ongoing basis for compliance with the terms of the custody agreement.
IOSCO welcomes the comments on this consultation report in order to be able to better inform the formulation of a final report with adopted principles.
Comments should be submitted on or before Wednesday 10 December 2014.
[1] Principles for Collective Investment Schemes in IOSCO Objectives and Principles of Securities Regulation, June 2010, page 10. Available at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD323.pdf
2 IOSCO Discussion Paper on the "Guidance on Custody Arrangements for Collective Investment Schemes" published in 1996 and IOSCO's Final Report on “Recommendations Regarding the Protection of Client Assets”, Report of the IOSCO Board, January 2014, available at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD436.pdf.