Depositary banking: Luxembourg seeks to preserve its safeguards while preparing for a more digital market

For Luxembourg’s depositary banks, innovation does not necessarily mean rewriting the rules from scratch. It can also mean making an established model more efficient, more interoperable and better equipped for digital assets, while preserving the legal and supervisory foundations that have underpinned the country’s fund industry.

That tension ran through the discussions at DepoBank Day on 1 October, where representatives of the ABBL, ALFI and LPEA examined some of the issues currently shaping Luxembourg’s depositary and asset-servicing industry, from the future of the European depositary framework to securities law and tokenisation.

For Brenda Bol, Chair of the ABBL Depositary Banking Cluster and Member of the ABBL Board of Directors, the direction of travel is clear: greater integration and innovation should strengthen the existing model rather than dilute the protections it provides.

By Marilyn Rinck, Head of Banking Regulation, Financial Markets and ESG, ABBL, and Andrey Martovoy, Senior Adviser – Innovation & Digital, ABBL

A European debate, and a Luxembourg red line

The prospect of a more integrated European cross-border depositary regime has resurfaced as part of the broader debate on the integration of EU financial markets.

The ABBL does not oppose greater market access or operational flexibility. But it considers that these objectives should remain subordinate to three principles: investor protection, legal certainty and effective supervision.

In its view, the current framework under UCITS and the recently revised AIFMD already provides an appropriate balance. The targeted derogation introduced under AIFMD II offers a way of addressing genuine capacity constraints without fundamentally changing the architecture of the depositary function.

A broader cross-border depositary regime would, by contrast, raise questions that go beyond market integration.

The ABBL warns that reopening the framework could increase market concentration and weaken the proximity between the fund, its depositary and the authority responsible for supervising them. It could also introduce additional operational and systemic risks.

The association therefore favours another route: greater supervisory convergence and stronger practical cooperation between national authorities.

The argument is essentially one of proportionality. Luxembourg’s existing model has developed around a direct relationship between the fund, its depositary and its home supervisor. For the ABBL, that proximity continues to offer strong safeguards for investor assets, clear liability arrangements and robust oversight.

Clarifying what happens along the custody chain

The same concern for legal certainty lies behind another issue currently being examined in Luxembourg: Draft Bill No. 8797, which would amend the law of 1 August 2001 on the circulation of securities.

The proposal is technical, but its practical implications are significant.

It seeks to clarify that an investor’s proprietary rights are linked to securities that have actually been deposited or held within the custody chain. Where a custodian itself uses another Luxembourg or foreign custodian, the rights passed on to the client cannot exceed those held further up the chain.

The draft legislation would also allow a custodian to reverse an erroneous book entry where securities had been credited to a client account even though they were never in fact received further up the custody chain.

That clarification does not eliminate client protection. If the failure is attributable to the custodian, contractual liability may still arise.

For the ABBL, the distinction is important. It separates the proprietary right to securities that actually exist in the chain from the potential liability of a custodian for its own failure, while making cross-border custody arrangements more predictable.

In a sector whose business model depends heavily on trust and legal certainty, such technical clarifications can have consequences for competitiveness as well as for investor protection.

Tokenisation moves closer to the market

If the debate over the depositary framework is largely about preserving safeguards, tokenisation raises a different question: how quickly can Luxembourg move from experimentation to industrial-scale use?

The ABBL sees the digitalisation of financial assets as increasingly relevant for Luxembourg precisely because the activities most likely to be affected, including investment funds, custody, asset servicing, securities settlement and banking, are already at the heart of the country’s financial ecosystem.

Luxembourg has progressively developed a legal framework for distributed ledger technology through four blockchain laws, to which the ABBL says it has contributed with the aim of ensuring that regulated financial institutions can make practical use of the technology.

The association’s current focus is therefore less on individual products than on the conditions required for tokenised securities, funds and other financial assets to develop safely and at scale.

Its Working Group on Tokenisation and DLT brings together around 130 representatives from banks, service providers, law and consulting firms and market infrastructures, feeding industry experience into national and European discussions.

Behind that ambition lie several unresolved issues.

From pilot projects to institutional scale

The first concerns the European regulatory framework.

The ABBL supports the DLT Pilot Regime as a means of improving post-trade efficiency and enabling tokenisation. But it argues that the framework must become sufficiently scalable for institutional use, with fewer artificial barriers, a clear path towards a more permanent regime and rules based on risks rather than on the technology itself.

The principle is particularly relevant for investment funds and ETFs: using DLT to issue or transfer an existing financial instrument should not, in the ABBL’s view, create a wholly new regulatory category simply because the underlying technology has changed.

The second issue is settlement.

Tokenising the asset without modernising the cash leg would leave part of the existing fragmentation untouched. The ABBL therefore supports central bank money as the anchor where it is available, while also recognising a complementary role for regulated commercial bank money under appropriate safeguards.

That discussion has already moved beyond theory. The Eurosystem launched Pontes on 21 September, enabling wholesale tokenised transactions to settle in central bank money. The ABBL has also contributed to the ECB’s longer-term Appia initiative, arguing in favour of interoperability between eligible public and private infrastructures rather than reliance on a single technology or network.

Legal certainty remains as important as technology

Technology alone, however, will not determine whether institutions adopt tokenised finance.

Questions around ownership, transfer, custody, collateral, insolvency and the legal effect of transactions recorded on DLT remain central.

The ABBL is therefore calling for a coherent European framework that avoids unnecessary overlaps between the rules applying to crypto-assets, tokenised financial instruments, tokenised deposits and DLT infrastructures.

For banks, custodians and depositaries, this is particularly important because their obligations extend across the full lifecycle of an asset. The same economic activity, the ABBL argues, should be treated consistently irrespective of the technology used.

There are also more prosaic obstacles: interoperability between DLT networks and traditional systems, common messaging and data standards, identity and access management, fragmented liquidity, and the cost of operating conventional and tokenised infrastructure in parallel.

These issues underline one of the broader messages emerging from the sector: regulation alone will not create a functioning digital market.

Standards, infrastructure and market practices will need to develop alongside the legal framework.