Malta is a thriving base for alternative investment funds, however risks exist to this market in the form of the Alternative Investment Fund Managers Directive [AIFMD]. As of 2012 there were 566 funds (including sub-funds)managing €8.3bn of funds. This EU directive, which entered into force on the 22nd of July 2013, was drafted in response to the global financial crisis, and was intended to regulate more tightly hedge funds and private equity funds, and their investment managers.  Malta was actually the first member state of the EU to transpose the requirements of the AIFMD into national law, on the 27th of June 2013.

One of the requirements of this directive is that alternative investment funds [AIFs] based in a particular jurisdiction use a locally licenced depositary institution to act as the custodian of their funds. (For example, a hedge fund may have $100 million of investors’ funds which it will hold with the custodian bank.) However Malta has a limited number (less than 10) of suitably licenced banks providing custody services, and due to the lack both of the quantity and the size of such banks the Maltese government negotiated a derogation from the AIFMD’s requirement for Maltese AIF’s to use Maltese custodians, until 2017. However from 2017 all Maltese AIFs will need to repatriate their funds to a local custodian.

As it stands the limited number of licenced depository institutions in Malta could at best throttle the further development of the sector, or at worst threaten Malta with systemic risk. A potential concern is that failure of one hedge fund might put at risk the viability of its depository bank, and then the viability of all the other hedge funds that also hold their funds with that particular bank.The government might then become involved either directly if it has a shareholding in that bank, or indirectly through an obligation to support any failing financial institutions.

Until 2017 Malta faces limited risk from this threat, however Malta needs to plan how it will mitigate this risk beyond that date. Firstly it can try to attract more large banks to offer custody services in Malta in readiness for 2017. Alternatively it can negotiate a continued derogation, beyond 2017, from the AIFMD’s prohibition on using foreign custodian banks. A third alternative might be a significant rewriting of the AIFMD to permit non-local custodians generally. However other financial centres in the EU, with more locally based licenced custody service providers, might not support either a continuation of the derogation beyond 2017, or a redrafting of the AIFMD to protect and enhance their own finance sectors.

A key EU financial regulatory institution in this field is the European Securities and Markets Authority which was set up within the European System of Financial Supervisors on the 1st of January 2011. While the meeting may have been routine, and may not have discussed this particular issue, it is interesting to note that The Minister for Finance, Professor Edward Scicluna, “received a courtesy call from the Chairman of the European Securities and Markets Authority (ESMA) Mr Steven Maijoor, in the last week of June 2014” and discussed inter alia “the manner in which Malta could further develop its financial services sector while also exploring broader economic diversification into other sectors”.

Also, if Malta is actively looking for large banks to establish operations in Malta it is interesting to note that in 2014 the world’s largest bank by assets (and three of the top ten largest) is Chinese and that Malta recently signed an MoU with China, covering, among other areas, cooperation in financial services. Therefore custody banking might be an area where Malta and China can work together to develop opportunities.