Country and Financial Market Infrastructure Risk Monitoring

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1 Country and Financial Market Infrastructure Risk Monitoring Jim Micklethwaite Director, Capital Markets 3 rd September 2014 Thomas Murray Data Services

2 Country and Financial Market Infrastructure Risk Monitoring AIFMD and UCITS V Requirements! AIFMD Depositary liability - Only if an event (resulting in a loss) is external, beyond reasonable control and the consequences would have been unavoidable can the depositary discharge its liability. The depositary retains liability for instances of fraud or insolvency within the sub custody network. However, the third party (sub-custodian) can be held liable for the loss if, under the contract between the depositary (global custodian) and the third party, the depositary can prove that it has duly performed its due diligence duties and that the specific contractual requirements for the delegation of responsibility are met.! Transfer of Liability from the depository/global custodian to the sub custodian! Contractual indemnity - sub custodian to the global custodian/depository! Contractual discharge under AIFMD! UCITS V Depositary liability - Strengthened, making the depositary liable for any loss of UCITS assets held in custody, whether at sub-custodian or CSD. UCITS investors have right of redress directly against the depositary. Delegation of depositary liability is not permitted. Thomas Murray Data Services

3 Country and Financial Market Infrastructure Risk Monitoring Key Components AIFMD & UCITS V! Country Risk external events that may result in loss of principal! Acts of God natural disasters that may impact physical holdings, or electronic record keeping due to breakdown of operations of intermediaries or FMIs.! Acts of Man breakdown in rule of law or civil unrest that may impact the operations of intermediaries or FMIs! Capital Market Infrastructure Risk loss of principal through failure of a CSD or CCP, inadequate segregation or asset safety protections (including physical holdings)! Sovereign Risk sovereign risk ratings, key economic indicators, trends! Sub-Custodian Asset Safety Risk market practice for asset segregation and reconciliation amongst sub-custodian banks Thomas Murray Data Services

4 Country and Financial Market Infrastructure Risk Monitoring! Natural disasters: TM AIFMD Profiles Country Risk! Hydrological disasters events caused by deviation of normal weather cycle (floods, storms surge, etc);! Meteorological disasters events caused by short-lived/small to medium scale atmospheric events (storms, hurricanes, tornados, strong heat waves/cold spells);! Climatological disasters events caused by long-lived/medium to large scale processes (prolonged rise in sea levels, El Nino, etc)! Geophysical disasters events derived from solid earth (volcano eruptions, earthquakes, etc).! Acts of man:! Wars, internal conflicts, civil unrest, coup d etats, declaration of state of emergency, curfews or martial law. Thomas Murray Data Services

5 Country and Financial Market Infrastructure Risk Monitoring TM AIFMD Profiles Capital Market Infrastructure! Counterparty Risk the risk of a counterparty not being able to settle its obligation;! Asset Safety Risk the risk that the assets held by the CSD may be lost of misappropriated (omission, error, misuse, breakdown of controls, etc);! Asset Servicing Risk - The risk of a loss arising from missed or inaccurate information provided by the depository, or from incorrectly executed instructions, in respect of corporate actions;! Financial Risk the risk of the CSD not being able to operate due financial issues;! Operational Risk the risk that deficiencies in information systems and controls, human error or management failures will result in losses. Thomas Murray Data Services

6 Country and Financial Market Infrastructure Risk Monitoring TM AIFMD Profiles Sovereign Risk! Measures long-term credit worthiness of the country s sovereign debt;! Based on long-term sovereign rating of major credit risk agencies:! S&P! Moody s! Fitch Thomas Murray Data Services

7 Country and Financial Market Infrastructure Risk Monitoring TM AIFMD Profiles Custodian Asset Safety Risk Risk that assets held by local custodian may be lost of misappropriated.! Securities Risk - the risk that if a local custodian defaults, the client securities are treated as being part of the assets of the defaulting bank.! Account structures and naming conventions;! Level of asset segregation;! Record keeping within the books of the custodian and;! Frequency of reconciliation.! Assets Risk - the risk that, in case of default by the custodian, clients are exposed to losses of cash placed with the bank.! Record keeping;! Reconciliation;! Accounting structure and segregation. Thomas Murray Data Services

8 Country and Financial Market Infrastructure Risk Monitoring Risk View Through the Custody Chain Risk View Through the Counterparty Chain Market & Depositories Tracking the post trade environment surrounding protection of client assets of all invested markets (100+ markets/ CSDs tracked) Transfer Agents Monitoring Questionnaire and automated risk report developed as part of an industry initiative Prime Brokers Risk Assessments Global Custodians Assessing and monitoring the risk and operational capabilities of your global custodian(s) Cash Correspondents Monitoring Questionnaire Sub-Custodians As above, including on-site operational reviews of all direct or indirect agents Other Counterparties Fully auditable technology providing evidence of actions Thomas Murray Data Services

9 Sub Custodian Monitoring Marie Ellis Senior Bank Analyst, Agent Bank Monitoring 3 rd September 2014 Thomas Murray Data Services

10 Sub Custodian Monitoring! Areas covered within on-site Due Diligence Visits:! Relevant internal controls over key business processes (may be covered by SSAE 3402, internal audit letter or similar) a formal controls discussion! Organisation management structure, division of duties, policies and procedures etc.! Contingency plans/business recovery/disaster recovery/testing and insurance arrangements! Material exceptions highlighted/steps taken to address! Discussion with management, compliance/legal, internal audit, risk management to assess quality of internal control, risk mitigation measures.! Verification and validation that regulatory requirements met (for example segregation of assets under AIFMD)! Naming convention of accounts/account structure! Recoverability of assets! Market Information Delivery Mandatory requirement under AIFMD Thomas Murray Data Services

11 Sub Custodian Monitoring! External Audits under AIFMD the sub-custodian must be a reputable entity with adequate supervision, structure and expertise to carry out its role, and be subject to effective prudential regulation (including minimum capital requirements) and supervision including periodic external audit! Increasing pressure towards a standardised approach across all sub-custodians i.e. SOC1/ SSAE 16/ ISAE3402 report! Revision in contract arrangements - Tightening of language/responsibilities between the depositary and the sub-custodian to reduce ambiguity/lack of clarity, to incorporate specific AIFMD requirements i.e. segregation of AIF assets, specifying account structures and account naming conventions! Formulation of Service level agreements - if not already in place tightened up where already existing to reduce uncertainty about performance standards, such as reconciliation frequency, detail on deliverables, reporting requirements and standards Thomas Murray Data Services

12 Panellists Marie Ellis, Senior Bank Analyst, Thomas Murray Data Services Marie joined the Agent Bank Monitoring team at Thomas Murray in January this year and has over 13 years experience in the custody industry. Prior to Thomas Murray, Marie worked at Brown Brothers Harriman (BBH) for 11 years, where she headed the Network Management team in London and held various relationship management and client service roles during this time. Marie was also involved in various relationship management and client service roles at HSBC Securities Services prior to BBH. Miles Reucroft, Editor, Thomas Murray Data Services Miles Reucroft is the editor of the Thomas Murray Data Services website. He has been with the company since February 2013 and covers a range of areas, including AIFMD and UCITS V. Thomas Murray Data Services

13 Panellists Koen Vanderheyden, Partner, DLA Piper Koen advises on financial law, particularly banking and financial service regulatory work, investment management, collective investment schemes, clearing and settlement, capital market transactions, cash management and treasury, institutional capacity building and transactional banking. He has frequently acted as a liquidator for major companies and financial institutions and he is recognised by the Commercial Court and the Banking and Finance Commission. He is an independent director for several financial institutions. Tim Reucroft, Director of Research, Thomas Murray Investor Data Services. Tim joined Thomas Murray in January 2001 conducting research and risk analysis into the European securities markets. This developed into an Overseas Advisory service for capital markets where he helps countries modernise their infrastructures such as in Qatar, Russia, Ukraine and South Africa. He now heads up TM s CCP Risk Assessment programme, as well as providing specialist input on derivatives and prime brokerage for many of Thomas Murray s engagements. Previously, Tim worked for Capco and KPMG as a consultant, Salomon Brothers as Head of Derivative Operations in London and at LIFFE where he was Head of Compliance. Tim is regular speaker at conferences. He has degrees in Natural Sciences from Cambridge and Philosophy from London, as well as being a qualified accountant. Thomas Murray Data Services

14 Panellists Jim Micklethwaite, Director Capital Markets, Thomas Murray Data Services Jim Micklethwaite manages the Capital Markets Infrastructure division. His responsibilities include running the team that tracks market practice in over 100 markets, assess risks in over 140 CSDs and is in the process of analysing risks in around 75 CCPs worldwide. Previously, Jim was a senior analyst within TM Network Management evaluating and selecting local and global custodians for clients as well as supporting a variety of consultancy engagements. Prior to joining Thomas Murray he was at Taylor Nelson AGB as Senior Researcher in their Financial division. Thomas Murray Data Services