The Effects of AIFMD on Tri-party Collateral Management

The Effects of AIFMD on Tri-party Collateral Management

August 2015


The rules for asset segregation under the Alternative Investment Fund Managers Directive (AIFMD) may have an adverse impact on tri-party collateral management.

The European Securities and Markets Authority (ESMA) is planning to issue guidelines setting out requirements for the segregation of alternative investment fund (AIF) assets. If these guidelines include the segregation of AIF assets from other client assets in the sub-custodian’s books, we believe this will increase operational costs, potentially add systemic risk, and have an adverse impact on tri-party collateral management.


The main AIFMD legislative text was published in the Official Journal of the European Union in July 2011. It was supplemented by a more detailed Delegated Regulation that was published in March 2013. With the public policy objective of improving investor protection, AIFMD requires depositaries for AIFs to segregate in their own books AIF assets from non-AIF assets.

Controversies around AIFMD and asset segregation relate to the degree to which the segregation requirements placed on the depositary have to be replicated down the custody chain to the sub-custodian level. This is an important point as the final set of AIFMD segregation requirements may also apply to UCITS (Undertakings for the Collective Investment in Transferable Securities) under the UCITS V Directive.

These questions arose via the consultation paper published by ESMA in December 2014 (ESMA/2014/1326, “Guidelines on asset segregation under the AIFMD”). ESMA will determine what any future guidelines might say in this respect. The industry is waiting for final guidelines as to whether the segregation by AIF requirement would be mandated throughout multiple layers of the sub-custody chain.

While ESMA contemplated five options in their consultation paper, they have, as of the paper’s publication date, broadly discounted Options 3, 4 and 5. Public response to the paper demonstrates the broad industry consensus that Option 4 should be permitted, but that overall, the industry requires flexibility to utilise all five options as necessary to achieve investor protection.

Final guidance from ESMA is expected in Sep/Oct 2015. Until then, the standard and accepted industry practice of utilizing client omnibus accounts at lower levels in the sub-custody chain will remain.

The Effect of Segregation Along the Custody Chain

With asset segregation throughout the sub-custody chain, the tri-party collateralization process will change significantly. Currently, tri-party collateral management uses a combination of client omnibus accounts and books and records segregation (vs. external movements) which allow for the internalization of settlement. Books and records segregation identifies which assets belong to the collateral provider (unallocated) and which belong to the collateral receiver (allocated). Internalising the movement of collateral at the tri-party agent gives the agent the flexibility to:

  • handle substitutions (recalls or record date events) on a real-time basis and
  • continue to move collateral between counterparties without being constrained by external deadlines.

If AIFMD asset segregation rules require that AIF assets and non-AIF assets be held in different accounts at a sub-custodian, then this would prevent internalization of settlement, and tri-party agents would have to send individual settlement instructions to the sub-custodian for every collateral allocation to an AIF client. These settlement instructions would need to be processed not only in the tri-party agent’s system but also throughout the sub-custodian chain, exposing the business to external movements and external deadlines.

We are raising this systemically important issue not just from a financial service provider’s perspective, but more importantly, as an issue for the real economy and market participants (notably pension funds, asset managers and other providers of savings vehicles) who would be adversely affected by these proposals and who would not receive any clear identifiable benefit.

Our view is that the proposal for asset segregation throughout the custody chain is predicated on the following premises.

  1. Asset segregation at the sub-custodian between AIF client assets and non-AIF client assets provides increased investor protection.
  2. In the event of a custodian insolvency, an administrator would be better able to promptly return client assets from a segregated account than they would from an omnibus account.

We believe that both of these premises are misleading.

We believe that segregation in established books and records can achieve investor protection, and that segregation in accounts throughout the sub-custody chain introduces additional operational and settlement risks to the investor. Segregation would also introduce settlement delays, increase counterparty exposure and significantly impede the collateral substitution, optimisation and movement process.

In addition, segregation at the sub-custodian level would have a number of unintended negative consequences, including the following:

  • In our view, no tri-party collateral management agent would be able to perform tri-party collateral management services for AIFs if all collateral transfers also needed to occur at the sub-custodian level. This is due to the delay that would result from the necessary movements at the sub-custodian level. It would mean that intraday books and records movements of collateral, on which the market relies, could not occur. The non-AIF market would continue to operate under a tri-party collateral management model.
  • The AIF and their counterparties would be forced to move to a bilateral collateral management world in which counterparty, credit, settlement and operational risk would be increased.
  • Groups who need to source eligible collateral to post as margin to satisfy European Market Infrastructure Regulation (EMIR) obligations would not be able to efficiently and cost-effectively source inventory as a consequence of the required collateral being held in multiple segregated accounts.
  • Many thousands of accounts within T2S would be required to be opened in order to support the segregated structure at the domestic CSD, which would be exported on to T2S. We understand that the T2S platform was not designed to support many thousands of additional accounts, given that the development of T2S assumed that omnibus account structures would continue to be widely used.

If you would like more information on AIFMD and tri-party collateral management, please contact your Relationship Manager.

« Back to Focus on Regulation Readiness

BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may be used as a generic term to reference the corporation as a whole and/or its various subsidiaries generally. This material and any products and services may be issued or provided under various brand names in various countries by duly authorised and regulated subsidiaries, affiliates, and joint ventures of BNY Mellon, which may include any of the following. The Bank of New York Mellon, at 225 Liberty St, NY, NY 10286 USA, a banking corporation organised pursuant to the laws of the State of New York, and operating in England through its branch at One Canada Square, London E14 5AL, registered in England and Wales with numbers FC005522 and BR000818. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the US Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon, London Branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request.  The Bank of New York Mellon SA/NV, a Belgian public limited liability company, with company number 0806.743.159, whose registered office is at 46 Rue Montoyerstraat, B-1000 Brussels, authorised and regulated as a significant credit institution by the European Central Bank (ECB), under the prudential supervision of the National Bank of Belgium (NBB) and under the supervision of the Belgian Financial Services and Markets Authority (FSMA) for conduct of business rules, a subsidiary of The Bank of New York Mellon, and operating in England through its branch at 160 Queen Victoria Street, London EC4V 4LA, registered in England and Wales with numbers FC029379 and BR014361. The Bank of New York Mellon SA/NV (London Branch) is authorised by the ECB, NBB and the FSMA and subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority. Details about the extent of our regulation by the Financial Conduct Authority and Prudential Regulation Authority are available from us on request. The Bank of New York Mellon, Singapore Branch, subject to regulation by the Monetary Authority of Singapore. The Bank of New York Mellon, Hong Kong Branch, subject to regulation by the Hong Kong Monetary Authority and the Securities & Futures Commission of Hong Kong. The Bank of New York Mellon Securities Company Japan Ltd, which acts as intermediary for The Bank of New York Mellon. Not all products and services are offered in all countries.  

The information contained in this material is intended for use by wholesale/professional clients or the equivalent only and is not intended for use by retail clients. If distributed in the UK, this material is a financial promotion.

This material, which may be considered advertising, is for general information purposes only and is not intended to provide legal, tax, accounting, investment, financial or other professional advice on any matter. This material does not constitute a recommendation by BNY Mellon of any kind. Use of our products and services is subject to various regulations and regulatory oversight. You should discuss this material with appropriate advisors in the context of your circumstances before acting in any manner on this material or agreeing to use any of the referenced products or services and make your own independent assessment (based on such advice) as to whether the referenced products or services are appropriate or suitable for you. This material may not be comprehensive or up to date and there is no undertaking as to the accuracy, timeliness, completeness or fitness for a particular purpose of information given. BNY Mellon will not be responsible for updating any information contained within this material and opinions and information contained herein are subject to change without notice. BNY Mellon assumes no direct or consequential liability for any errors in or reliance upon this material.

This material may not be distributed or used for the purpose of providing any referenced products or services or making any offers or solicitations in any jurisdiction or in any circumstances in which such products, services, offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements.

All references to dollars are in US dollars unless specified otherwise.

This material may not be reproduced or disseminated in any form without the prior written permission of BNY Mellon. Trademarks, logos and other intellectual property marks belong to their respective owners.

© 2015 The Bank of New York Mellon Corporation. All rights reserved.