The Board of the International Organization of Securities Commissions (IOSCO) today published its final report on Standards for the Custody of Collective Investment Schemes’ Assets (CIS Assets).
The report seeks to clarify, modernize and further develop international guidance for the custody of CIS assets consistent with IOSCO’s core Objectives and Principles of Securities Regulation, June 2010 (IOSCO Principles).
It sets out eight standards divided into two sections aimed at identifying the core issues that should be kept under review by the regulatory framework to ensure investors’ assets are effectively protected. The first section focuses on key aspects relating to the custody function. It reaffirms the importance for the regulatory framework to provide for suitable custodial arrangements to be in place, clear segregation requirements and appropriate independence. The second part of the report is dedicated to standards relating more specifically to the appointment and ongoing monitoring of custodians.
The report identifies some of the key risks associated with the custody of CIS assets, such as operational risk, misuse of CIS assets, risk of fraud or theft, and information technology risk.
A number of market developments in recent years prompted IOSCO to revisit its paper on Guidance on Custody Arrangements for Collective Investment Schemes, published in 1996. These developments include:
- Events like the Lehman Brother and MF Global insolvencies or the Madoff fraud, which focused attention on CIS asset regimes.
- A tendency by CIS managers to invest more in complex instruments today than they did in the 1990s.
- The widespread use of electronic book entry to register and keep track of ownership changes in securities, which has led to a major change in market practices and processes, creating new challenges and risks.
- Evidence that CIS managers are also becoming more active in making CIS assets “work” for their clients.
- An increase in the diversification and internationalization of CIS portfolios since 1996, which has given rise to new cross-border challenges.
Standards for the Custody of Collective Investment Scheme Assets
Standard 1: The regulatory regime should make appropriate provision for the custodial arrangements of the CIS.
Standard 2: CIS assets should be segregated from:
- the assets of the responsible entity and its related entities;
- the assets of the custodian / sub-custodian throughout the custody chain; and
- the assets of other schemes and other clients of the custodian throughout the custody chain (unless CIS assets are held in a permissible omnibus account).
Standard 3: CIS assets should be entrusted to a third party custodian that is functionally independent from the responsible entity.
Standard 4: The responsible entity should seek to ensure that the custody arrangements in place are disclosed appropriately to investors in the CIS offering documents or otherwise made transparent to investors.
Standard 5: The responsible entity should use appropriate care, skill and diligence when appointing a custodian.
Standard 6: The responsible entity should at a minimum, consider a custodian's legal / regulatory status, financial resources and organisational capabilities during the due diligence process.
Standard 7: The responsible entity should formally document its relationship with the custodian and the agreement should seek to include provisions about the scope of the custodian's responsibility and liability.
Standard 8: Custody arrangements should be monitored on an ongoing basis for compliance with the terms of the custody agreement.