Custody today is a commodity – or so the line goes. And with the number of providers in the market steadily diminishing and technology levelling the playing field, who’s going to argue?
Talk to Europe’s pension funds, however, and the debate on the role of custodians becomes less clear-cut.
How pension funds select and deal with custodians is still far from uniform across Europe. From multinational organisations to straight domestic company plans, there remain a number of scheme/jurisdiction-specific considerations to take into account.
Angela Docherty, corporate investment consultant at Anglo/Dutch multinational Unilever, explains that the selection of custodians for the group’s numerous pension plans is based on a ‘preferred provider’ list of players for which she, at the ‘corporate centre’, is responsible. Local plans then use the list to select the firm that meets their specific needs.
Docherty notes that such a complex arrangement led Unilever to seek consultant advice in its custody hiring. “What happened was that when we set up our preferred provider list we used Towers Perrin’s custody operation. We outlined the criteria we were looking for and they did all the initial research and we met the short- listed firms. It is important to recognise that core custody service has become a commodity. Therefore you need firms who distinguish themselves in other areas. The criteria included commitment to the business – demonstrated by their investment in technology, such that they are visibly leading edge with a clear commitment to being a global player and a structure that indicates that custody is an important business area. They also have to provide value added services such as securities lending, performance measurement and cash management.”
She notes that the key deciding factor was the custodian’s ability to manage global relationships and understand the needs of multinationals.
Docherty says the centre last carried out full-scale reviews in 1997/98, which led a number of the larger Unilever schemes worldwide to change their custodian. “One of our ongoing plans at the moment is to undergo a thorough review of the preferred providers. You have to make sure you keep up to date with what is happening.” Such an in-depth review of the preferred providers will take place approximately every five years, although she notes that there is a constant overview of the relationship between funds and their chosen custodian.
“Northern Trust is the custodian of our large UK fund and we have regular debates with them on their systems and value adding services. Also, I’ll go over to Chicago and look at the tools that they are developing and see where they could add value for us as a multinational.
“We also meet with them regularly over here to push the line on the reconciliation work they do for us, as we need to ensure it remains leading edge. We work with them a lot to make sure we are on top of how they are developing because, as a result of the local fund selection process, Northern Trust is the biggest custodian for Unilever’s funds, with about 60% of our assets.”
Docherty notes that Northern simultaneously looks after the firm’s North American, Irish, South African, Canadian and UK expatriates pension funds and says they were picked as a preferred provider independently by each country because of their capabilities. Some of the other large Unilever funds are the responsibility of the other preferred providers – Bank of New York, JP Morgan Chase and Deutsche Bank.
“You need to look at other markets pragmatically. For example, Australia is never going to be a big market for the preferred providers because the tax laws are complicated, so it is best to have a local provider.”
Jean-Pierre Steiner, corporate pensions manager at Swiss multinational, Nestlé, says the fund changed its custodian last year for similar reasons.
“It was not that the previous service run by Pictet & Cie in Geneva was not very satisfactory, but we wanted to have full-blown consolidation of all Nestlé group pension funds with a couple of global custodians. Pictet could just not play that role as a matter of company policy, so we moved to Northern Trust.”
However, Steiner notes that the transition has been rather painful for a number of reasons. “Some of this can be attributed to us, because we were in a hurry to respect a certain deadline for tax reasons. Thankfully now things are working much better.”
The criteria for selecting the new custodian, he comments, was this international scope and the ability to serve pension funds in different jurisdictions: “We also wanted the possibility of a group to act as a master custodian for all Nestlé corporates.
“In the end we retained three custodians because we don’t believe that one group can do this world-wide. The two others are JP Morgan Chase and State Street.
“We use them in different markets – Northern is not present everywhere and it was difficult for us to force all our pension funds to move into one arrangement because they made a choice depending on local relationships.”
Steiner says the shift in provider could significantly alter the way the company monitors its custody relationship. “This didn’t happen very often in the past and was formerly done on a market-by-market basis. We’ll probably do it much more regularly now – maybe every three to four years – unless there are any issues that force us to do it more regularly.”
For Steiner, the key to good custody is quality of service and product development, particularly in terms of risk management and accounting, areas where he believes custodians could still do a bit more than they do today.
“In terms of standard products there is not much difference between the players, but on the quality of the service there are issues of personal relationship and willingness to help and understand the requirements of a given sponsor, so there are differences between custodians.
“Northern Trust, despite the difficulties of this transition, has been very helpful in the delegation of teams week after week to help us to solve the issues. They also do special reporting for us, particular to the needs of the Swiss pension plan and have helped us set up investment trusts in Dublin where they have a presence.”
Steiner points out that a recent change in Swiss law was the ‘trigger’ that forced Nestlé to look at its custody relationship.
“We didn’t just change though for tax purposes but more for pooling reasons and to offer our other group pension funds the possibility of putting their assets in a larger fund.”
In terms of how much this might save the group, he comments: “We do have figures on the potential savings and it is a meaningful amount. The money side is the first thing you think about, but there is also the quality. Rather than having a smaller pension fund in a market picking a local manager, they all now want to have access to the best in class, so in terms of monitoring, etc, we have certainly improved the way in which the middle size and smaller funds in the Nestlé group work.”
Bruno Dambermont, head of treasury and finance at the e100m pension funds of Belgian brewing corporation Interbrew, notes that the firm’s two Belgian pension funds are invested in Sicavs for fiscal reasons under Belgian law. As a result, Dambermont says that the fund’s investment managers also act as custodians to the assets.
“We use two large banks, Banque de Groof and ING/BBL, both well known on the Belgian and European markets. The size of these outfits means that we are confident about the quality and suppleness of the reporting that we receive.”
The fund, he explains, has looked at the option of taking on a global custodian, but declined, failing to see where value could be added compared to the work involved in transferring its custody: “We have asked ourselves this question because of the trend towards pension funds employing a global custodian. However, we don’t consider that we have a big enough fund to invest in this type of structure. We also haven’t heard a convincing enough argument to move us away from the system that we have in place at present.”
All in all he says the fund is happy with the custody relationship it has and with the quality of the reporting. “We look at this issue maybe two or three times a year and we haven’t had any problems yet.”
Other countries have their own idiosyncrasies that influence a fund’s choice of depositary bank, as Santiago Fernandez Valbuena, chief executive of the e3.8bn Fonditel pension funds in Spain, explains.
“Spanish regulation requires that a fund has only one custodian and that it has to be Spanish-domiciled. In essence, this means that Spanish trustees tend to make one custody appointment decision in a lifetime.
“This does not mean that we are not extremely happy with the custodian that we have – BBVA. They are a large bank with correspondents everywhere, so things flow well. And given the price we get with them the arrangement is pretty hard to beat!”
However, Fernandez says that the fund did spend a considerable time in looking around at custodians and identifies two main issues that he believes are imperative to any selection.
“Custody is a very commoditised business and what pension fund managers like us will demand on top of the basics are two or three things. One is faultless tax dividend reclaim. Now that portfolios are so international this tends to be a major headache. You have to fill in forms for the Italian, Portuguese or Dutch authorities in the local language and sometimes you tend to procrastinate on these things because the amounts are so small. Nevertheless, over the long haul these amounts do add up to something quite significant so you want speed of operation there and not everyone does this in a seamless way.”
He adds that the number two ‘definite’ is performance evaluation. “The custodians have all the data and we are bound by law to have one custodian, so it would make sense for them to do the numbers rather than have us pick their electronic brains, so to speak, and massage the numbers ourselves. This should be a very automatic business once you provide the software and there are a number of custodians that do this already.”
Richard den Bult, pension fund controller at the e4.5bn pension fund of Dutch steel group Hoogovens, says that with around 12 external managers running the scheme assets at any given time, the choice of custodian was vital. “What we need from a custodian is strong core custody work and some added value in administration and fund accounting.”
Den Bult recounts the story of how he came to appoint Citibank as custodian to the fund. “I started looking in magazines for information about the big custodians about four or five years ago, when I arrived here.”
Despite initial discussions with external consultants, he says Hoogovens finally decided to carry out the request for proposals in-house. “In effect, for custody the short-lists are very short! We couldn’t see the added value of using a consultant.”
Having whittled down the number of potential providers, Den Bult says he then had the chance to start asking more pertinent questions – looking at the systems in place, the people and then negotiating on the price. “One of the main questions for us was whether custody was a strategic issue for the company. You have to know that the bank will invest in its services for the future, such as IT investments.” He believes, though, that there are few notable differences between custodians today: “I think that at this moment the difference between the custody firms is not so big. There is a move towards internet-based technology and converting data to information. Most of them are moving towards web-based solutions and better quality information.”
Den Bult says the custody relationship in place is working well and notes that the fund has back office staff doing monthly evaluations of the custodian and looking at operational issues.
In terms of specific products, Hoogovens uses its custodian for securities lending, fund accounting, reconciliation and compliance services. “For a fund like us with many investment managers, fund accounting is important in case there are any differences with what the managers themselves are accounting. Compliance is also important and the custodian monitors this for us.”
Summing up, Den Bult compares the custody arena to a luxury car showroom. “You build up a relationship with a particular custodian and decide whether you are happy with this, because the differences in prices are not very big, nor are the differences in systems.
“It is comparable with cars. You have the BMW, the Jaguar and the Mercedes – they are all quality cars, so which do you choose. It’s a personal choice at the end of the day.”