The case for the introduction of an EU Depositary passport

The passporting regime brings along the right to provide financial services in other EU and/or EEA Member States without the need of establishing a registered office or a branch therein. The freedom of movement of services, being one of the four fundamental freedoms of the European Single Market, underpinned the achievements in building the Capital Market Union.

The passporting regime has proven to be beneficial for both asset managers as well as the underlying investors of investment funds. Whilst the primary legislation governing investment funds and relevant service providers ensures a smooth cross-border operation of asset managers, it remains consistent in prohibiting depositaries from benefiting from the internal market through a framework for passporting.

Paradoxically, whilst credit institutions and investment firms are allowed to offer custody and depositary services under several EU Directives, the legislation is misaligned in terms of allowing for an internal market passport for depositaries servicing investment funds, as the latter is prohibited.

In view of the political-economic achievements within the EU asset management industry, the introduction of depositary passporting is seen as a logical step to achieve a complete internal market for the asset management industry. To achieve this result, the solution is not one where an even higher degree of harmonisation (the single rulebook mechanism) is required.

Rather, it lies in reflexive governance of financial supervision combined with a framework for the strengthening of mutual trust between national financial supervisors or, alternatively, a centralised approach to supervision by extending the remit of the single supervisory mechanism.

From a financial stability point of view, the establishment of the depositary passporting regime would fairly limit the concentration and the systemic risks at a domestic level. Indeed, the issue of concentration risk is seen in small jurisdictions where problems of scale make it less attractive for new and notably large depositaries to operate in these countries.

This, in turn, leads to concentration risk where the domestic depositaries become dominant by virtue of their size and accordingly, they would become a threat to financial stability.  Against this backdrop, based on assets under depositary (“AuD”) figures as at 31 December 2018 in Malta, a significant percentage of total AIF/UCITs AuD is concentrated with three depositaries and this high concentration of AuD is understandably a cause for regulatory concern.

From an investment fund and investor viewpoint, the depositary passport will bring more competition in the depositary field and more choice of service providers for investment funds and investors possibly leading to a reduction in counterparty risks as well as lower depositary costs.

Depositary passporting would ensure that the internal market could become more integrated and competitive vis-à-vis global competitors. Bearing in mind the need to safeguard investors’ protection and financial stability, there is a case for the passport to be given exclusively to credit institutions and investment firms which may act as depositaries of investment funds.

Ultimately, both the credit institutions as well as investment firms, are already subject to relevant passporting regimes under other EU legislation. The current prohibition of depositary passporting does not relate to the lack of regulatory assurance in the case of provision of services on a cross-border basis, but rather the lack of mutual trust between the jurisdictions hindering the internal market and the overall establishment of the Capital Markets Union.

Read more on this topic in an academic paper, titled “Establishing an EU internal market for depositaries”, written by MFSA Chief Officer Supervision, Christopher P. Buttigieg, Head of Financial Stability, Joseph Agius, and Senior Analyst within the Supervisory ICT Risk and Cybersecurity function, Sandra Saliba which was published in The Journal of Financial Regulation and Compliance.