Seeking safe hands quietly
Pension funds say their relationship with their global custodian should be one of quiet trust. After all, it is not some peripheral investment area that they are putting in the bank’s hands – it is usually the entire asset pot. The stakes are high.
Colin Hunter, chief financial officer of the Universities Superannuation Scheme in the UK, says it’s important to have a close relationship with your custodians. You have to be able to place trust in them. “Mistakes happen from time to time,” he says, “and we look to our custodians to admit when they have been at fault and to compensate us for losses incurred without our having to involve the lawyers. We are happy with both firms of custodians that we use.”
The USS has a capital value of around E33bn, and uses custodians to hold all its securities assets. Custody, says Hunter, is an ideal operation for outsourcing.
“While it is possible to carry out the function in-house,” he says, “by using an external organisation which specialises in custody, operational risk is reduced and security is also increased, slightly, since the assets are held independently of the administrator or manager.”
The custodians USS uses at the moment – JP Morgan Investor Services and State Street – have been in place for about 10 years. “They were selected after we issued an RFP to about ten banks,” says Hunter.
The main selection criteria that the fund used were the financial standing of the bank, market coverage, the extent to which the bank will stand behind its sub-custodian network, system capabilities - including existence of data links to the fund’s managers and investment accountants which were not universal at the time - and cost.
“We did not use a consultant for that exercise but are likely to do so the next time we issue an RFP,” he says. This will probably happen in 2005.
As well as the standard services they offer, such as dividend and tax collection, USS uses its custodians for stock lending, although it also uses a third party lender for part of the assets. Hunter says the fund is considering using the custodians for a commission recapture programme too.
If you’re looking for a new custodian, he says, it’s important to review their standard contractual terms. You should try to strengthen these terms in your favour before actually appointing a custodian, he says.
The London Pension Funds Authority has recently reappointed JPMorgan Investor Services as custodian for three more years. Specialist custody consultant Thomas Murray helped with the appointment. Amanda Walker, head of finance and investments at the LPFA, says the authority uses a global custodian for a number of reasons. “The pace of change in global markets - ie, investing globally - the demands of multiple investment manager structures, difficulties in recruiting and retaining staff in-house as we’re based on the city fringes, high levels of IT infrastructure are just some of the reasons for fully out-sourcing this function,” she says.
Using the custodian for value-added services such as securities lending has worked well, says Walker.
The authority has been very pleased with JPMorgan as custodian. “I have consistently experienced high levels of service and not found it necessary to complain in over six years working with the custodian,” she says. But it’s vital to do your research properly before appointing a custodian. “Market testing has allowed us to benchmark quality and price competitiveness.”
The European Patent Organisation used a tender procedure to find a custodian, says Silvio Vecchi, administrator of the reserve funds at the EPO in Munich. It also used the services of a consultant to help with the appointment.
Funds are managed internally, he says, and the securities held are in custody with the institution, State Street Bank. All the assets are in custody, except for parts of investment funds, he says. Apart from custody, the EPO also uses State Street’s securities lending services.
The Bayerisde Versorjungs Kamner (BVK) in Munich appointed a custodian in order to have all depositary bank services in one place, says Daniel Just of the fund. “Before this we had several depositary banks.” The fund simply used the parent banking organisation of the relevant asset manager as the depositary bank for that part of the portfolio.
But this meant there was a lack of transparency in the overall fee structure, he says. “Now, by making a strict division between the tasks of asset management and those of a depositary bank, in each case the service we pay for is the one we have engaged them to do. So there are no more dirty fees.”
On top of that, it was important for the fund to have reporting coming from one place and with one standard, he says. This is the only way to achieve an integrated risk which encompasses all funds, he says. “The custodian is our partner when it comes to reporting for all the funds.”
At the moment, the BVK carries out all its funds business through the custodian. “Taking this one stage further, before the end of this year, the direct business will be completed for reporting purposes in the form of a virtual fund at the BNP Paribas,” says Just.
“Later on we plan to include our property business within this reporting form. But for this, BNP Paribas still has to put the necessary structures in place.”
All in all, the fund is very pleased with the first steps it has taken with BNP as its custodian. However, reporting will have to be developed further within the framework of the fund’s increasing needs.
Daniel Dubach, chief investment officer at Avadis Vorsorge in Switzerland, agrees that the practice of using a custodian bank that is linked to the investment management organisation is problematic. In fact there are rules within Avadis’ organisation that prevent this from happening. “Whoever is the custodian cannot be the asset manager at the same time,” he says. Avadis runs pension funds for a number of corporate clients, including the ABB fund.
Within its fund platform, Avadis uses Dexia as its custodian, and has done for two years. Because it is in a fund set up, the custodian calculates NAVs for the fund product. It also undertakes the sub-custody duties including handling securities around the world, settlement, cash transactions and bookkeeping for the fund products, says Dubach.
A custodian is indispensable for big organisation like Avadis which has 17 different funds, he says. “We couldn’t think of doing it all without a custodian,” he says. The organisation has had a custodian arrangement since the mid-1990s, and as such is one of the earliest users of these services.
“What we learned was this was an excellent step,” he says. “You have transparency, you know where your assets are, and they can help in added value services.” Dubach would always recommend that larger pension funds use a custodian.
“If I were a board member I would push for the fund to use a custodian. I’m interested in getting an overview – without a custodian it is difficult, and you could have conflicts of interest,” he says.