Depositary Bank

A depositary bank is a regulated institution, usually a bank, appointed by an investment fund to keep the fund's assets safe and to watch over how the fund is managed on behalf of its investors. Under the European Union's UCITS and Alternative Investment Fund Managers (AIFMD) rules, every fund must have one, and it is legally liable to investors if assets in its custody are lost.

The term has two meanings. In European and offshore fund law, the depositary is a fund's independent guardian, close to the trustee of a UK unit trust. In US equity markets, a depositary bank is the institution that issues American depositary receipts (ADRs), certificates that let US investors trade foreign companies' shares. Both differ from a plain custodian, which holds assets under contract but has no oversight duty, and from a US depository institution, the legal term for a deposit-taking bank.

Imagine a school trip fund. The teacher decides how the money is spent, but the money itself sits with the school office. The office pays bills only when the paperwork is in order, checks that the teacher is sticking to the agreed budget, and has to make good any money that goes missing while in its care. Parents trust the arrangement because the person spending and the person holding are different.

A depositary bank is the school office for an investment fund. The manager chooses what to buy and sell, but the assets are held by the depositary, which keeps track of every share and every cash movement. If the manager breaks the fund's rules, the depositary is expected to notice and raise the alarm.

EU law gives the depositary three groups of tasks:

• Safekeeping. Holding financial instruments such as shares and bonds in segregated custody accounts, and verifying ownership of other assets, such as property or private equity stakes, that cannot be held in custody.
• Cash-flow monitoring. Making sure all investor subscriptions and fund cash are booked to accounts in the fund's name, and checking for unexplained movements, a safeguard against money laundering and theft.
• Oversight. Checking that share issues and redemptions, valuations and net asset value calculations follow the law and the fund's rules, that income is applied correctly, and that the manager's instructions comply with investment limits.

The depositary must act independently of the fund manager, may delegate safekeeping only under strict conditions, and in most cases must be located in the fund's home member state. For loss of a financial instrument held in custody, it must return an identical instrument or the corresponding amount without undue delay, unless the loss came from an external event beyond its reasonable control.

The modern depositary regime grew out of the 2008 crisis. After Bernard Madoff's Ponzi scheme was exposed in December 2008, investors in several Luxembourg funds, notably LuxAlpha, learned that their depositaries had delegated custody to Madoff's own firm. At the same time, the collapse of Lehman Brothers during the 2008 financial crisis left fund assets held by its prime brokerage arm frozen. AIFMD, adopted in 2011 and applied from July 2013, introduced detailed depositary duties for alternative funds, and the UCITS V directive of 2014, applied from March 2016, brought retail funds into line. Supervisors such as Luxembourg's CSSF enforce the rules locally. Offshore centres take a lighter approach: Cayman private funds supervised by CIMA must arrange for safekeeping and cash monitoring, but not necessarily through a single EU-style depositary.

In the US sense, a depositary bank buys or receives a foreign company's shares in its home market, holds them through a local custodian, and issues ADRs that trade in US dollars on US exchanges or over the counter. The bank pays dividends to holders in dollars, passes on voting rights and charges fees for issuing, cancelling and servicing the receipts. The first ADR was created in 1927 for shares of the British retailer Selfridges. The main ADR depositaries today are large banks such as BNY, Citibank, JPMorgan and Deutsche Bank. This role is mainly about converting foreign shares into a convenient US dollar instrument and handling settlement, not about supervising a fund manager.

Depositary work is concentrated in a few international financial centres, where the same banks often provide fund administration as well, which regulators require to be kept functionally separate. Depositary fees are usually charged as a small percentage of the fund's assets, paid by the fund itself, so investors bear the cost of the protection it provides.

• Directive 2014/91/EU (UCITS V)
• Directive 2011/61/EU (AIFMD)