Actions for depositaries following Central Bank of Ireland review

The Central Bank of Ireland (Central Bank) carried out a thematic review of how depositaries apply oversight procedures to assess the risks associated with the funds and with the organisation of managers (FMC) that depositaries represent.

In a letter to industry dated 11 May, the Central Bank sets out the findings of its review. Although the Central Bank identified examples of good practice, it also highlighted certain deficiencies, which should be evaluated by depositaries. Below, we consider the findings in more detail and examine the practical implications for depositaries and FMCs.

Understanding a fund’s model

A central theme of the letter is that risk assessment is a foundational element of a depositary’s oversight framework. The Central Bank highlighted that a depositary’s inadequate understanding of a fund’s model or the organisational structure of an FMC can result in acceptance of business outside the depositary’s expertise or capacity, leading to ineffective oversight procedures and, ultimately, negative outcomes for investors including inadequate valuation oversight or failure in the detection of investment breaches.

The Central Bank’s review focused on three core areas of depositary activity:

• client acceptance and onboarding;
• due diligence processes; and
• depositary independence and management of conflicts of interest.

These areas represent the lifecycle of a depositary’s engagement, from pre-appointment, to ongoing monitoring, and governance.

The Central Bank observed examples of deficiencies in depositaries’ controls, particularly in relation to the robustness of risk assessment frameworks and regarding the effective identification and management of conflicts of interest. The findings indicate a requirement for improvement to ensure consistent practices across the sector.

Main findings

Client acceptance and onboarding

An important takeaway is the expectation that onboarding should be carried out by depositaries according to a structured risk assessment methodology. Observed good practice include:

• documented methodologies linking a fund, its FMC and characteristics of the fund to a depositary’s risk ratings;
• tailoring oversight procedures to the specific risk profile of the fund in question – rejecting a “one-size-fits-all” approach; and
• for the acceptance of new business, there is a clear linkage between a depositary’s risk appetite and the results of the depositary’s risk assessment.

Notably, the Central Bank expects depositaries will only accept mandates that are aligned with the depositary’s risk profile, which is an important point where commercial pressures have a risk of influencing onboarding decisions. There is also a strong emphasis on governance, including the observation of best practices. These include the documentation of the involvement of relevant committees or at board level, and the formal input and challenge by the compliance function, or second line of defence, in relation to new business opportunities.

Ongoing due diligence

The Central Bank clarified that risk assessment is not a one-off exercise and good practice includes a regular refresh of risk assessments, with the frequency determined by the nature, scale and complexity of the fund and the organisation of an FMC; use of operational data, such as around breaches or errors, to inform risk reassessment; and formalised due diligence processes with clear roles, timelines and escalation mechanisms.

The emphasis on using BAU issues – like trends in operational errors – is notable, which reflects the importance of data-driven supervision, where depositaries are expected to analyse the outputs of their oversight rather than simply record them. The Central Bank also highlighted the importance of complete follow-up on due diligence findings before sign-off; and structured governance around depositary reporting to unitholders.

Importance regarding the management of conflicts of interest

The review findings place strong emphasis on depositary independence, which remains a cornerstone of the UCITS and AIFMD frameworks. The Central Bank identified as good practice the formal consideration of actual or potential conflicts of interest during the onboarding process and the adoption of comprehensive policies and procedures. It also highlighted practices such as the use of onboarding checklists, maintenance of risk registers, the ongoing review and reporting of conflicts to a relevant committee or the board as examples of good practices.

Implications for FMCs

While the Central Bank’s letter is addressed to depositaries, FMCs should not view this as a purely depositary issue. The increased focus on due diligence, including diligence of the organisational structure of the FMC, the focus on information flows, and oversight interaction, means that FMCs should expect more detailed requests and scrutiny from depositaries. FMCs should expect a more formalised engagement process and increased challenge in areas such as valuation and delegation.

Practical implications

The Central Bank requires that its findings be brought to the attention of the board or management body of a depositary. In practical terms, depositaries should expect that risk assessment frameworks will be assessed during inspections, evidence of input or challenge, especially at committee level, is recommended, and inconsistencies across funds or client types will be scrutinised.

This thematic review reflects a broader theme from compliance to demonstrable effectiveness. For depositaries, the priority is to embed structured and documented risk assessments, ensure alignment between risk appetite and client acceptance, and strengthen governance and evidence of challenge.