Under the mattress, something stirs
The argument over whether to employ an independent custodian seems to have been won with the overwhelmingly majority of pension funds. And the advantages of a single global custodian appear to be accepted by many. Once established, the relationship tends to be a durable one, although there are a few dissatisfied customers
Custody is traditionally classed as the perennial underside of the mattress, the time-consuming commodity that everyone has to think about but very few pension funds take pleasure in arranging.
However, with the range of securities services now being offered by custodians, and the cost savings that can be achieved in consolidating corporate pension assets in one location, pension funds are looking twice at the role of the oft-maligned custodian.
For this month’s Off The Record we asked pension funds a question that increasing numbers of funds and institutional investors are asking themselves – whether to have a custodian independent of their investment managers or even to move to employing a global custodian. And if so, why?
One thing is for sure – if the person handling your money is not doing what you want, interest in custody becomes paramount – Barings is not so distant a memory in some fund managers’ minds.
Consequently, it seems that the argument over whether to employ an independent custodian or not has already been won, with 92% of respondents confirming this as their current set-up.
And the custodian is being selected by the funds themselves for the most part. Only 16% say they leave the decision to their investment manager, although the number rises to around a third of funds which say their custody is arranged as part of a mutual funds package.
One reply noted a potential problem allied to investment managers selecting the depository bank: “For the first two years we had a cut-off problem between the year-end closing, pending settlements and the exchange rate difference between the investment manager and ourselves.”
Some funds still take a two-tier approach to the security of their assets, with one noting that they keep the money internally in the UK, for example, but use external arrangements overseas. Another fund has been caught in the global act: “We are currently moving to a global custodian where practical.”
The overriding message, though, seems to be to keep custody simple. Just under three-quarters of the respondents say they use a single custodian, although one fund appears to take the opposite tack, employing a roster of six to hold its assets. Over cautious and a bit costly, perhaps?
Or, possibly, very sensible if you believe that spreading your assets around means you take less of a hit in the event of a crisis.
Indeed a number of funds advocate a multi-custody strategy, claiming “better service” or the desire to avoid “monopolistic structures”.
Another seems keen on extricating itself from its custody web: “For our different funds in different countries with different committees it is difficult to get a single custodian in place. But we’d love to consolidate things!”
Pension fund/custodian relationships to all intents and purposes hold together fairly well, according to responses. A third of funds note they have been with the same custodian for five years or more. Only a couple had stayed entwined for more than 10 years – although some might have to dust off the contracts to see when they were signed, with several funds answering “years ago”.
In the majority of cases the reasons given for selecting an independent custodian were independence, security, administration and cost control.
However, a few respondents noted legal obligations to separate the assets from the fund, while another pointed out the business obligations: “It is a necessity for a US mandate.”
And without a doubt, when the majority of pension funds employ custodians they want them to be global. Sixty-eight per cent of funds say their custodian has world-wide operations.
Reasons put forward for going global focus on simplicity. “One-stop-shop” and “one contract and focal point” crop up regularly as responses. This accompanies the practical: “we operate on a global basis, so we want a custodian that does”.
Another respondent points to the possible benefits: “A global custodian can aggregate the total portfolio and enhance risk control.”
However, a dissenting voice notes that it recently reviewed a global custodian arrangement against that of a domestic operator in terms of performance and switched to the local player.
One manager, though, points out what could be the end-game scenario in custody: “The global custodians are the only ones in a position to provide all the value added services that we require to run the fund more effectively, as well as providing all the revenue generating services.”
The figures for managers employed by funds bear out the trend that global would appear to be great. Twenty per cent of Off The Record respondents employ State Street and Bank of New York as custodian, closely followed by Citibank and ABN-Mellon with 16% each. Chase, Northern Trust , Deutsche, MeesPierson and Pictet all have just under 10% of respondents’ business, with other selected custodians mentioned including Unibank, Dresdner, UBS, HSBC and SEB.
Reasons for selecting a particular custodian against the competition, perhaps unsurprisingly, produced little variety – “expertise, quality and service” all appearing repeatedly in responses. For other pension funds the standard issues of “cost” and “best offer” came out on top.
However, a number of replies point to reputation on the international stage as a crucial factor in their choice, with one manager lavishing praise on their custodian: “They have the best systems and network of sub-custodians in the market.”
Certainly the process for choosing a custody partner is not looked upon lightly by pension funds. Seventy-two per cent say they undertake a full selection process and beauty parade to identify which firm will be handling their assets. And by and large funds are doing this off their own backs, with only a quarter seeking input from a consultancy firm on their custody choice.
A significant proportion of respondents (72%) use their custodian to look after any foreign exchange requirements. And 44% say they ask for both investment accounting services and cash management as an add-on service, with one fund noting the practicalities: “We will shortly begin using our custodian’s offshore cash balance fund to get cash off the balance sheet here.” Stock lending and performance monitoring and attribution come in around the 30% mark of fund usage for custodians, with portfolio analytics, compliance monitoring and risk management used by around 20%.
Custodians can take heart from the fact that four out of every five funds say they are generally satisfied with their custodian relationship. Unfortunately there are a few funds with ‘issues’ right now. One notes: “We are not completely happy and there are some present problems.” No names though I’m afraid….
A further comment suggests areas for custodian improvement: “We have some difficulties for cash reversals, timing and overdraft interest in more exotic countries.” One manager comment, however, encapsulates the level of competition in the field and its possible detrimental effect on service: “Teams now seem stretched and things take a long time to get done.”
Nevertheless, another manager notes though that breaking up a custody affair can be hard to do: “The move from our previous custodian has been harder than anticipated.”
This could be one reason why only 16% of managers say they have previously terminated a custody agreement and only slightly over one in 10 believe they might switch in the future. One manager answers the question with an emphatic: “Hopefully not!”