Establishing an EU internal market for depositaries

Publication Date08 May 2020
Date08 May 2020
AuthorChristopher Buttigieg,Joseph Agius,Sandra Saliba
SubjectAccounting & Finance,Financial risk/company failure,Financial compliance/regulation
Establishing an EU internal
market for depositaries
Christopher Buttigieg,Joseph Agius and Sandra Saliba
Malta Financial Services Authority, Birkirkara, Malta
Purpose This paper aims to examine the rationale for the establishmentof a depositary passport as the
next logicalstep in building an internal market for investmentfunds in the European Union (EU). It makes the
point that the de facto prohibition of depositary passporting poses risks to nancial stability and has an
adverse impact on investor protection in EU member states, which do not have a fully developed funds
Design/methodology/approach This paper analyses both the arguments in favour and againstthe
adoption of a depositarypassport. Moreover, it examines this proposal in the context of differentapproaches
to fosteringthe internal market such as mutual recognition, harmonisationof regulation, reexive governance
of nancialsupervision and centralised supervision.
Findings Based on the review of the currentEU legal framework, this paper, subsequently, putsforward
possible solutions for theestablishment of an internal market for depositary business,which solutions have
been discussedwith various experts in the eld to assess theirfeasibility in practice.
Originality/value The paper contributes to the debate on the EU internal market in the eld of asset
management, which is topical in view of the upcoming review of the EUs Alternative Investment Fund
Keywords Depositary passporting, Investor protection, AIFMD, UCITS, Harmonisation,
Mutual recognition, Domicile, Credit institutions, Investment rms, Investment funds
Paper type Research paper
1. Introduction
The freedom of movement of services, being one of four fundamental freedoms of the
European Single Market (European Commission, 2019a,2019b,2019c;TFEU, 2012),
underpinned achievements in building the Capital Market Union (European Commission,
2019a,2019b,2019c). The passporting regime which brings along the right to provide
nancial services in other European Union (EU) and/or European Economic Area (EEA)
member states without the need of establishing a registered ofce or a branch therein, has
proven to be benecial for both asset managers andthe underlying investors of investment
funds. With regard to the asset management industry, the primary legislation governing
investment funds and relevant service providers are the UCITS Directives[1], in particular
Directive 2009/65/EC (UCITS IV, 2009) as amended and Directive 2011/61/EU (AIFMD,
2011). While both legislativeacts ensure a smooth cross-border operation of assetmanagers,
they remain consistent in prohibiting depositaries from beneting,from the internal market
through a framework for passporting. Paradoxically, while credit institutions and
investment rms are allowedto offer custody and depositary services under a number of EU
Directives, i.e. Directive 2014/65/EU (MIFID II, 2014), Directive 2013/36/EU (CRDIV, 2013),
Alternative Investment Fund Managers Directive (AIFMD) and Directive 2014/91/EU
(UCITS V, 2014) and Directive (EU) 2016/2341 (IORP II, 2016), the legislation is misaligned
in terms of allowing for an internal market passport for depositaries servicing investment
funds (Hooghiemstra,2018), as the latter is prohibited.
EU internal
market for
Received17 October 2019
Revised23 January 2020
25March 2020
8April 2020
9April 2020
Accepted9 April 2020
Journalof Financial Regulation
Vol.28 No. 4, 2020
pp. 587-603
© Emerald Publishing Limited
DOI 10.1108/JFRC-10-2019-0130
The current issue and full text archive of this journal is available on Emerald Insight at:
Both directives provide that the depositary of EU domiciled investment funds shall be
established in the home member state where the investment fund is established. While,
undoubtedly, depositaries are instrumental in terms of ensuring investor protection and
oversight of the investment funds operations (Moloney, 2016), within the internal market
there are no restrictions with regard to the nationality of the underlying investors of an
investment fund or the asset manager. Indeed, in terms of the UCITS Directive and the
AIFMD, investment funds can passport into other member states and offer their units to
investors in these jurisdictions.As will be argued in this paper, it, therefore,follows that the
current state of affairs whereby the depositary has to be in the same member state of
the investment fund to ensure proper investor protection, does not appear to reect the
dynamics underpinningthe establishment of the internal market.
The research questions which this paper aimsat addressing are as follows:What are the
existing barriers to the establishmentof an effective internal market for depositaries? What
are the required additional regulatory and supervisory policy actions, which need to be
taken to provide for the adoptionof a depositarypassport?
The authors bring the benets of depositary passporting into sharp focus, especially in
the context of the upcoming review of the AIFMD. In this regard, the 2019 European
Commissions Report on the Operation of the AIFMD Directive 2011/61/EU (European
Commission, 2019a,2019b,2019c) states that more than one-third of the respondents
representing a mixtureof fund domiciliation noted that transitional provision,allowing the
depositary to be in a different domicileto the fund, should be extended. It is crucial to stress
that the AIFMD has initially allowed a derogation from the applicable restriction and
introduced a de facto depositarypassport.
Article 61(5) of AIFMD providedthat the competent authorities of:
[...] the home Member State of an Alternative Investment Fund Manager (AIFM) may allow
relevant credit institutions and investment rms established in another Member State to be
appointed as a depositary until 22 July 2017 (AIFMD, 2011).
The rationale behind the subsequent prohibition of depositary passporting is unclear. The
transitional provisions allowedtemporary functioning of de facto passporting of depositary
functions and this arrangement operated seamlessly across all EU member states during
this transitional period. A question should be asked as to why the depository passporting
was not seen as a threat to investor protection withinthe transitional period, but it is seen as
one ever since July 2017.
The central argument of this paper is that the relevant provisionsof the AIFMD and the
UCITS Directive, as complemented by the existing EU prudential regulation of credit
institutions and investment rms, providethe extent of harmonisation necessary to allow a
framework for mutual recognition betweenmember states to operate effectively in the eld
of depositary services. The authors argue that the domicile restriction applicable to
depositaries translates into barriers to competition within the internal market, which in the
case of smaller member states is likelyto result in inefciencies and higher charges applied
by the local depositary business. The restriction on the free movement of depositaries also
adversely impacts the development and growth of the funds industry in the affected
member states. To this end, while the main argument against the establishment of an
internal market passport for depositaries is based on investor protection concerns, the
authors argue that to the contrary, in some member states, such threatis posed by the lack
of an effective depositarypassport.
The authors claim that the establishment of a depositary passporting regime can be
achieved througheffective mutual recognition based on:

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT