Lobbying by global custodians has succeeded in adding a clause on force majeure to the draft European Union directive on alternative investment fund managers (AIFM).
This means custodians and sub-custodians will not be liable for clients' assets in events beyond their control like political problems, such as the collapse of a country's government or an unforeseeable change in currency.
"We have managed to carve out an exception, and that has been extremely helpful," says one regulatory affairs specialist in London, whose company would not allow him to be named.
But the latest changes still fall well short of an ideal outcome, say custodian firms.
Global custodians are worried that they will be liable for clients' assets under the draft AIFM law, as noted in April by Tony Lewis, Hong Kong-based head of global custody for HSBC Securities Services. This has been the cause of much debate behind the scenes, and some custodians fear that the rules could be extended to Ucits-compliant funds and then further worldwide.
The latest revisions to the directive were passed on May 17 by the Economic and Monetary Affairs Committee of the European Parliament and a separate draft was approved by the European Council on May 18. It is now going through a trialogue process designed to find a compromise between the European Council, Commission and Parliament. If an agreement is reached, the directive is in line to be passed through the Parliament on July 6.
Another amendment is that depositories or custodians can delegate tasks to a sub-custodian.
However, custodians still face wholesale changes to the way they do business. "Until the final draft is issued, there are still major concerns within the industry about how the politically motivated AIFM directive may negatively impact investors within Europe," says David Aldrich, London-based managing director of global client management at BNY Mellon.
"Although the European Council has offered a less damaging version for investors compared to the European Parliament," he adds, "the most likely compromise text appears to be harmful to the interests of, among others, institutional clients, pension fund investors and their members."
Aldrich says there are still three main areas of concern. One is depositary liability -- that is, the possibility that the custodian may be held liable for losses outside its direct control.
Another is leverage -- specifically, the explicit regulation of levels of leverage within a fund without clear definitions of how leverage is measured within different strategies and with no apparent understanding of how it relates to the risk of particular strategies.
The third concern is over the 'third-country' provisions. Measures have been proposed that would create a 'fortress Europe', which may mean expert, institutional investors cannot access funds that offer the strategies and risk/return profiles they need to meet their liabilities.
It is believed that the addition of force majeure to the directive, which has been under discussion for more than a year, comes as a result of lobbying efforts by all the major custodian firms, including BNY Mellon, Brown Brothers Harriman, JP Morgan and HSBC.
Sources report that recent meetings between custodians and EU officials have been polite but tense. Some say the proposed regulatory changes to the custody business in Europe are the biggest they have ever known.
Under the current proposals, if things go wrong, custodians will have to prove they didn't do anything illegal, rather than the other way around, says the expert source, who has been close to negotiations. It is a reverse of the burden of proof, he adds.
If passed, the law is likely to force custodians to re-evaluate their current fee structures.
The European Parliament released a statement on May 18 that includes updates to the directive. Regarding liability, it says a depository will be able to avoid liability for any loss of financial instruments if it is a result of force majeure or it can be proven that the cause of the loss was an unforeseeable external event.
One of the arguments against some of the changes proposed is they may inadvertently encourage the growth of weaker custodians, which could profit by undercutting established players. There is a worry that smaller custodians without the genuine capability to do the job may offer services, potentially resulting in instability down the track.