What does a UCITS depositary do, and when can it delegate, resign or be replaced?

Each common fund and each VCIC has a single depositary, appointed by a written contract that sets out the information flows the depositary needs. It must be either a credit institution or another legal entity authorised to act as depositary, which meets capital requirements and is prudentially regulated and continuously supervised. Either way, its registered office is in Cyprus, or in another Member State with a branch in Cyprus. Since 22 April 2016, when Law 52(I)/2016 deleted an earlier exemption, every VCIC must entrust its assets to a depositary.

No company may be both management company and depositary, or both VCIC and depositary. Each must act honestly, fairly, professionally and independently, and only in the interest of the fund and its unitholders. A depositary may carry on other business that could create conflicts only if it separates that business functionally and hierarchically and identifies, manages, monitors and discloses the conflicts.

First, oversight. The depositary checks that units are sold, issued, repurchased, redeemed and cancelled lawfully and that they are valued correctly. It carries out the management company's or VCIC's instructions unless they breach the law or the fund rules, checks that payment for the fund's deals arrives within the usual time limits, and checks that income is applied correctly.

Second, cash monitoring. All the fund's cash must be booked in accounts opened, at an eligible institution, in the name of the UCITS, of its management company or of the depositary acting for it. An account in the depositary's name may not also hold money belonging to the depositary or to the institution keeping it.

Third, safekeeping of all the fund's assets. Instruments that can be held in custody sit in segregated accounts in the name of the UCITS or its management company; for other assets the depositary verifies ownership and keeps an up-to-date record, and it regularly sends a full inventory. Assets in custody are shielded from the creditors of an insolvent depositary or EU delegate. The parallel rules for investment firms are in How must an investment firm safeguard client money and financial instruments?

Oversight and cash monitoring can never be delegated. Safekeeping can, if the aim is not to avoid the Law, there is an objective reason, and the depositary uses due skill, care and diligence in choosing, reviewing and monitoring the delegate. The delegate must always have adequate structures and expertise, be prudentially supervised and externally audited, segregate the client assets it holds for the depositary from both its own assets and the depositary's, and protect them if it becomes insolvent. Sub-delegation follows the same rules. Where a third country requires local custody and no local entity meets these tests, a local entity may be used only if investors were told beforehand why and with what risks, and the management company or VCIC instructed it.

The exam material also repeats the 2012 rules: delegation where the fund rules allow it, custody of listed instruments by an authorised foreign depositary, and revocation at any time. Since 22 April 2016, Law 52(I)/2016 has replaced them with the tests above.

Custody assets may not be reused for the depositary's or a delegate's own account. Reuse is allowed only if it is for the account of the UCITS, on the management company's instructions, for the benefit of the fund and its unitholders, and covered by high-quality liquid collateral received under a title transfer arrangement, worth at all times at least the reused assets' market value plus a premium. The exam material lists these as four circumstances. The Law requires all four together, and has done so since the reuse rule was introduced on 22 April 2016.

A depositary that wants to resign gives the management company, or a self-managed UCITS, written notice at least 3 months ahead. The management company or UCITS tells CySEC immediately and proposes a successor; if that is unjustifiably delayed, the resigning depositary makes the proposal. CySEC approves the choice or asks for another. The outgoing depositary keeps working until its successor has fully taken over. The change also means amending the fund rules or instruments of incorporation. CySEC may itself require a replacement for serious breaches, or where the depositary is not acting in the interest of all unitholders. The management company or a VCIC's board may also apply, proposing a successor.

Liability works at two levels. If a custody instrument is lost, by the depositary or a delegate, it must return an instrument of the same type, or the corresponding amount, without undue delay, unless it proves an external event beyond its reasonable control whose consequences were unavoidable. For other losses it answers for negligent or intentional failure. The exam material describes only the second standard; the return duty has applied since 22 April 2016. Delegation does not reduce liability, it cannot be excluded by contract, and unitholders may claim directly or through the management company or VCIC.