Picking and choosing
Time was when a pension fund looked to its custodian bank just to hold securities and cash on its behalf and possibly settle is transactions, while it employed other organisations to provide services such as performance measurement, compliance monitoring and securities lending. Nowadays, however, custodians are offering an increasing number of these services themselves, arguing that there are many advantages in receiving theses functions bundled together. There is a widespread take-up of the services, suggesting that pension funds agree - but only up to a point.
Netherlands-based Kas Bank offers nearly 20 services over and above basic custody. These include performance measurement and attribution, risk analysis, passive currency overlay, global derivatives clearing, transaction cost analysis and defined contribution administration. Among the chief advantages to a fund taking these services from the bank along with custody is that all the data is retrieved from one source and therefore there is consistency in pricing and valuation of securities, says Ben Kramer, head of sales, institutional investors, at Kas Bank, which has 400 institutional custody clients – mainly pension funds – and around E245bn under custody,. “There are no intermediaries between the raw data and the end-product,” he says.
Richard Humes, head of global custody at Switzerland-based custodian Pictet, agrees. With the custodian performing the analytical services the pension fund doesn’t have a third party taking the data and trying to interface to their systems, “with all the potential for errors and problems that presents,” says Humes.
Pictet has around 60 pension fund clients and $100 bn under custody. It too now offers a wide range of additional services, although Humes suggests that some functions - such as securities lending and cash management and reclamation - that were once considered optional extras are now so common as to be considered part of the basic package.
These days Pictet is experiencing a high demand for all services surrounding the analysis of investment and execution, says Humes. Pension funds want to know if their asset managers are getting the best prices when they trade; they want an analysis of brokerage commissions, or even an analysis on a trade-by-trade basis to see if there are patterns of commissions with certain brokers or in certain markets and why. “It is all part of the current concern with controlling costs,” says Humes.
Performance measurement and attribution – analysing where performance has come from and if this is consistent with the pension fund’s expectations of its managers – is also in demand. Also popular, says Humes, is post-trade investment compliance monitoring, where the fund gives the custodian the investment guidelines for each manager and the custodian checks to see whether the managers are following them, and provides exception reports where they are not.
Bedrijfspensioenfonds voor de Agrarische en Voedselvoorzieningshandel (AVH), the pension fund for agricultural and food production workers in The Netherlands, takes performance measurement, currency overlay and tax restitution services from Kas Bank in addition to basic custody, and makes use of its portfolio browser facility to keep up-to-date with its holdings. This bundling of services has the advantage of it being “easy to deal with one organisation for several services,” says Erik Martens, director of AVH. “The custodian has all the information from my asset managers.”
Like AVH, Sweden’s Trejde AP-Fonden (AP3), which manages part of the buffer fund capital in the Swedish public pension system, takes additional services – securities lending, performance measurement and asset manager limits and control monitoring – from its custodian Northern Trust “because all the information is there with the_custodian,” says Sven Askenberger, chief operating officer of AP3. “For securities lending, for example, it makes it much easier for control purposes to have this done by the custodian because if we decide we want to sell some stocks, the custodian can easily check if they are out on loan and get them back.”
On the other hand, AP3 prefers to get its global clearing and execution services from other providers. “We don’t want to put all our eggs in the same basket,” says Askenberger. Similarly, AVH is wary of concentrating too much activity with one supplier, and choosing its offering by default. “We have to prevent the custodian from becoming the preferred supplier”, says Martens.
AP3, likewise, insists that any additional services it does take from its custodian, such as securities lending, is done on merit. “We compare the services offered by various different suppliers and choose the best,” says Askenberger. “If the custodian shows itself to be the top performer in a particular service, then there is no disadvantage in getting the service from the custodian.”
Kramer believes that custodians are winning business on merit. “Custodians nowadays offer a better and more client specific product compared with the specialist services_suppliers – custodians have become the specialists,” he says.
Humes suggests that pension funds are looking more and more to their custodians because of the enormous amounts of data they have to deal with and try to interpret, and because of the pressure to have more timely information. “Many pension funds have given us mandates to interpret the information on their_trades right through to the strategic investment allocation decisions,” he says. Also, when pension funds restructure their portfolios, the transition needs to be managed and custodians can help with this process, advising on the best way to make the transition and the risk factors along the way,” says Humes. This is starting to border on consulting or even asset management. “Custodians are building expertise around the whole investment business,” he says.
Neither Bpf AVH nor AP3 have put a limit on the number of services they will take from their custodians. AVH is looking to use the global proxy voting service of Kas Bank in the future, while AP3 is currently looking to see whether its custodian could offer it an integrated matching utility for equities, fixed income and foreign exchange. While there are several matching engines for one or two asset classes in the market, such as the Omgeo engine for equities and fixed income operated by Thomson Financial and the Depository Trust & Clearing Corporation in the US, “we would like to see one supplier that could offer matching across equities, fixed income and foreign exchange because that would mean we had to set up only one interface for all the trades,” says Askenberger.
There is still further to go in terms of what custodians might offer pension fund clients. “The role of the custodian is changing rapidly and it is now considered to be the back and middle office of investment managers or institutional investors,” says Kramer. Because they are an independent party in the investment process, and because they hold the data of pension fund investments, custodians are “best placed to provide objective services,” he claims.
Humes says that in the end it is about efficiency. Getting added services from a custodian means still only having to deal with one counterparty and one contract. “And the pension fund gets the information [it wants from the added_services] quickly, because the analytics are just bolted on to the custodian’s systems,” he says.
But Humes admits that getting extra services from a custodian means giving up a degree of independence. “And if you have just one provider, then the functionality is limited to what they can offer,” he says. So it is important to pick the right custodian in the first place.