Custody of investment company assets with a foreign securities depository
Rule 17f-7 requires US mutual fund managers, whenever they make an investment decision, to take into consideration the local market depositories and the safety of underlying assets during the settlement process and in ongoing safe custody.
Eligible Securities Depository
Under the rule, funds and their custodians may maintain their assets with a foreign securities depository only if it is an “Eligible Securities Depository.”
An eligible securities depository must act as or operate a system for the central handling of securities that is regulated by a foreign financial regulatory authority.
An eligible securities depository must:
- Acts as or operates a system for the central handling of securities or equivalent book-entries in the country where it is incorporated, or a transnational system for the central handling of securities or equivalent book-entries;
- Regulated by a foreign financial regulatory authority
- Holds assets for the custodian that participates in the system on behalf of the Fund under safekeeping conditions no less favourable than the conditions that apply to other participants;
- Maintains records that identify the assets of each participant and segregate the system’s own assets from the assets of participants;
- Provides periodic reports to its participants with respect to its safekeeping of assets, including notices of transfers to or from any participant’s account; and
- Is subject to periodic examination by regulatory authorities or independent accountants.
Risk Analysis
Rule 17f-7 requires that a fund’s primary custodian furnish the fund or its investment adviser an analysis of the custody risks of using an eligible securities depository before the fund places its assets with the depository.
Although Rule 17f-7 does not prescribe specific factors to assess risk, the adopting release provides that, generally, this analysis should cover:
- A depository’s expertise and market reputation;
- The quality of its services;
- Its financial strength;
- Any insurance or indemnification arrangements;
- The extent and quality of regulation, and independent examination of the depository, its standing in published ratings, its internal controls, and other procedures for safeguarding investments; and
- Any related legal protections
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