Key trends that will determine the future of depositaries in Luxembourg

Depositaries play a key role in safeguarding investors’ interests through obligations imposed to them by the UCITS and the AIFMD law.

The efficiency and effectiveness with which these players conduct their operations is therefore key for protecting the trust into the Luxembourg investment fund sector. Within this article we will explore some key trends that Executives of depositary organizations have to address, not only to ensure ongoing compliance with their obligations, but also to maintain their competitive position.

Coping with increased regulatory expectations

While depositaries have already been confessed the duties of asset safekeeping and performing certain oversight obligations under the UCITS and AIFMD law, expectations by the regulators with regards to the scope and extent of these procedures have recently increased. ESMA in their Supervisory Briefing from 31 May 2022 stated that depositaries have to include all ESG related investment restrictions in the monitoring of compliance of investment instructions coming from the investment manager. This required depositaries to adapt the scope of their related work accordingly. In addition to that the CSSF remarked in their feedback to ESMA’s Common Supervisory Action on Valuation that the oversight procedures performed by depositaries, especially with regards to AIFs investing into illiquid assets AIFs, were not sufficient due to a general lack of involvement in the verification of the valuation framework. Depositaries are therefore required to enhance the respective skills of their workforce.

Opportunities and threats that come with the retailisation of Private Asset Funds (ELTIF 2.0)

While traditional closed-ended AIF investing into Private Assets, which are market to professional investors, can be serviced by Luxembourg PSFs holding a “Professional Depositaries of Assets other than Financial Instruments” (PDOAFI), retails AIFs, such as the upcoming ELTIFs 2.0, require the appointment of a depositary holding a MiFID firm or Banking license. Asset servicing players operating only under the status of a PDOAFI therefore must carefully assess the impact on their business of not being able to offer “one-stop-shop” services to retail AIFs. A response to this challenge could consist in forming strategic alliances with fully licensed depositary banks that do not offer fund administration services.

Increasing efficiency through smart automation and the use of artificial intelligence

Many depositaries in recent years have increased their efficiency through smart automation, such as robotics facilitating reconciliations or cash-flow monitoring. However, the adoption of artificial intelligence solutions is still in its infancy within most organizations. Possible use cases for depositary banks consist of the extraction of investment rules from prospectuses through OCR technology, or optimization of treasury operations in a fund structure through automated balance sweeping.

Focus on fund costs puts pressure on delivery models and expansion into value-add services

Core depositary services, such as safekeeping and transaction processing, are perceived as commodity services by Fund Managers, which puts significant pressure on depositaries for optimizing their delivery model, e.g. through off-/nearshoring of their operations, IT outsourcing, or business process outsourcing. However, Luxembourg regulatory requirements not only demand from depositaries to maintain sufficient substance, but also to provide for strong oversight and governance when outsourcing their operations. Another trend that can be observed is the expansion of depositary banks into higher value services, such as fund finance or treasury operations.

The CEOs of depositaries must carefully consider these trends’ individual and collective impact on their business. How they will respond to them can have a significant impact on the viability of their organizations within the coming years.