Since the introduction of the European Alternative Investment Fund Manager Directive (AIFMD), the role of the depositary bank has significantly expanded in terms of duties and obligations. The implementation of the Undertakings for Collective Investment in Transferable Securities Directive V (UCITS V) in 2013 aligned the regulatory framework between AIFM and UCITS funds, transforming the depositary from a mere custodian of assets into a true watchdog. This article explores the deep role of the depositary bank, from the fundamentals of a custodian bank to his strong oversight mission.
The Fundamentals of the Depositary Bank
The main target of the custodian bank is to safeguard (or record keep) the assets and to verify the ownership verification:
- Safekeeping/recordkeeping of assets: ensuring segregation between the bank’s own assets and those of the fund to mitigate loss risk for the asset held in custody in plus of safeguard them. For the other assets (e.g. not held in custody), recordkeeping of those positions.
- Ownership verification: confirming that the fund’s assets are properly registered and owned by the fund, not by third parties.
The Five core duties
From an assets safeguardian, the custodian becomes a true oversight function with those regulatory. Indeed, UCITS V and AIMFD implemented new core duties as well as other oversight processes to ensure the investor’s trust and to reinforce the strenght of the Depositary Bank. Fives pillars are the main road for the Depositary:
- Control of Management Company / Investment Manager instructions: the Depositary Bank must ensure that all instructions of the Management Company or Investment Manager are compliant with applicable laws and rules of the prospectus. It passes by the Investment Restrictions Monitoring.
- Control of subscriptions and redemptions: verifying that unit prices align with the published net asset value (NAV), reinforcing investor confidence.
- NAV verification: protecting investors against wrong evaluation by checking the accuracy of the fund’s net asset value calculations.
- Control of income: the income must be allocated following the rules in place, basically the prospectus.
- Timely settlement: all transactions made by the fund must be settled in a timely manner. It means that any break should be investigated and resolved as soon as possible.
Additional Oversight responsibilities
In plus of these core duties, AIFMD and UCITS V also define strict requirements for cash flow monitoring, due diligence and escalation processes.
- Cash flow monitoring: tracking all cash movements to detect unusual or significant transactions and ensure proper justification.
- Due Diligence and Escalation Process : These mechanisms ensure that third-party service providers are properly monitored and that any irregularities are escalated to relevant stakeholders. This reinforces the Depositary Bank’s role as a key risk mitigator.
A strategic role to protect the investor interests
The Depositary Bank maintains a comprehensive view of all fund activities and, as consequence, holds the critical information required to protect investors’ interests. Its responsibilities extend beyond custody to continuous oversight, with cash flow monitoring playing a central role. Through rigorous controls and verification processes, the Depositary Bank reinforces investor confidence by ensuring ongoing supervision of core custody functions as well as related services such as fund administration and transfer agency.
Challenges and future trends
The transformation of the Depositary Bank from a custodian to an oversight function introduces several strategic and operational challenges that will shape its future.
First, the coexistence of AIFMD and UCITS frameworks creates overlapping obligations that vary across jurisdictions. National regulators can interpret rules differently, creating fragmented compliance requirements. For instance, the Commission de Surveillance du Secteur Financier (CSSF, Luxembourg Supervisory Authority) has issued a circular stipulating that the indemnification of any material NAV error is mandatory, as set forth in Circular 02/77 (which has since been replaced by Circular 24/856).
Then, as funds increasingly outsource services such as fund administration, transfer agency or investment restriction monitoring, Depositaries face higher operational risk. Effective oversight requires robust controls plan, due diligence frameworks, continuous monitoring of service providers, and well-defined escalation processes to address irregularities promptly.
Digitalization is also restructuring fund operations. Depositaries must adopt advanced technologies to maintain efficiency and accuracy, for example: AI tools to detect irregular cash flows or valuations errors.
Finally, enhanced regulatory obligations and technology investments increase operational costs. Depositaries must balance compliance with profitability, often through automation, process optimization, and strategic partnerships.
Conclusion
The Depositary Bank has evolved from a simple custodian to a key oversight function, ensuring transparency, compliance, and investor protection. Faced with regulatory complexity and technological evolution, its future depends on adaptability and innovation. By adopting digital tools and strengthening governance, the Depositary will remain a pillar of trust in an increasingly complex financial environment.
References:
6.-The-new-depositary-regime-under-the-luxembourg-law-of-12-may-2016-.pdf
The evolution of a core financial service – Custodian & Depositary Banks