The role of a global custodian has changed in recent years, with pension funds tending to use a wider range of services than before. And in a competitive industry where clients have their eye firmly trained on value and cost, the big players are keener than ever to stand out from the crowd.
Some custodians see their role as broader than simply providing services to individual pension funds. Benjie Fraser, director acting for pension funds at the Bank of New York BNY), says it is the bank’s commitment to the pension fund industry as a whole that helps distinguish it as a custodian. This is particularly important now in what are challenging times for pension funds, he says.
As well as this, the BNY specialises in providing services which are specific to the sector, he says.
“We hold ourselves out to be a leader in the pensions space as a whole,” he says. “We are actually rolling up our sleeves and being very active in the market.” The bank has been involved in conferences and seminars on the theme of risk, he says. “We are doing a lot about provoking discussion about tomorrow and being a forum for pension funds,” he says.
What is increasingly important for pension funds, he says, is the quantity of reporting that is required. “Our role as safe guardian of assets defines custody,” says Fraser. While that role does not go away, the role of record keeper is now an important function too.
“They want to have good reporting. If money is managed externally, then they want the Bank of New York to do it.” Risk budgets are also a major concern for pension funds, and Fraser says BNY has teamed up with Wilshire to offer tools to aid risk budgeting.
“Value-added is coming up the adviser chain,” he says. Custodians are moving in to the whole area of managing data, and adding the ability to provide pension payments, while it does not get into the space of pensions administrators. “We do a lot of things behind the scenes,” he says.
Interest in securities lending is increasing among pension funds, he says, as they look for new sources of income, though there are still hurdles for some funds.
“Information on securities lending is at an all time high,” he says. “Many pension funds want to know about improvements there have been in the service, but many have to overcome policies trustees have made in the past.”
JPMorgan Worldwide Securities stands out in the custodian marketplace because of quality of service, says Ann Doherty, regional head of European client management.
“I believe our ability to provide excellent service and solutions to the business needs of both pension funds and their fund managers distinguishes us,” she says. The firm’s integrated product capability as well as its best in class risk management, disaster recovery and a “fortress balance sheet” gives pension funds the assurance they need in trusting it with their custody and administration, she says.
In terms of add-on services, Doherty says integration and automation of all processes are of paramount importance to pension funds. “The ability of our clients to manage their portfolios with a limited number of staff and internal infrastructure is a defining aspect of the pension fund industry,” she says.
Transition management, futures and options clearing, trade cost analysis and currency overlay are just a few of the additional services JP Morgan Worldwide Securities can offer clients, and “in a seamless fashion,” she says.
“These allow for transparency for our clients with excellent execution and management information tools.”
Securities lending, says Doherty, is now the norm and not the exception for all pension funds in Europe. “The majority of our work with our clients in securities lending is developing the link between risk and return -- amending guidelines as clients are more comfortable with the risk parameters around lending.
“The only clients for whom lending does not work are those who have invested heavily in funds, as funds are not a lendable asset,” she says.
Doherty finds it quite right that pension fund clients review their arrangements periodically, including their choice of custodian. “We have a process in place with all clients for this to be done formally every quarter. However, many funds will perform a formal market comparison every five years or so.
“We retain our clients by doing a good job for them every day, providing market competitive fees as well as constant product and service innovation.”
At State Street Investor Services, Alasdair Reid, head of asset owners, says his is the only service provider which can provide a comprehensive, fully scalable “one-stop shop” for an integrated range of investment services.
“The partnerships we form with our clients are extensive,” he says. State Street Investor Services’ top 100 global clients have an average of 12.2 “product relationships” with State Street, he says, and 70% of its revenue is derived from existing clients.
“Our scale indicates we can cope with the biggest and most complex mandates anywhere in the industry – globally, we have $9.5trn (e7.8trn) in assets under custody and $1.4trn in assets under management, and we operate in 25 countries and over 100 markets,” he says. Data was collected at the end of March 2005.
Technology, says Reid, is driving the custody business. “Which is why we commit 20% to 25% of our annual operating expenses to technology spending,” he says. State Street has a track record for innovation, introducing new products to the market like ‘virtual pooling’, and has proved that it can respond quickly to new regulatory requirements.
Reid says that as the self-awareness of pension funds has increased in recent years, their need for and usage of custody services has evolved. “The need to keep up with regulatory pressures and maximise efficiency amidst increasing media coverage and public awareness of pension issues has helped to blur the distinctions between “core” and “value-added” services,” he says.
And as the financial services industry has consolidated, with more and more providers dropping out of the market, pension funds are much quicker to see the point of having just one global custodian that provides a whole range of services.
“For example, not all that long ago core custody encompassed simply safekeeping and settlement,” says Reid. “As master record-keeping has become more advanced, however, the list of common servicing requirements now includes income collection, tax reclaims, corporate actions and proxy voting.
“Cost and technological considerations have led investment accounting to be considered part of the “core” custody offering as well – global custodians are now more likely to provide investment accounting than specialist third parties.”
Securities lending and commission recapture have become part of a global custodian’s core offering, because it so obviously more efficient to have one large program rather than several small ones.
Northern Trust boasts a long history as a custodian. “Having provided custody services for over 100 years we are familiar with the needs and expectations of that client base,” says Jemma Broadgate, vice president UK business development. Most of the clients are pension funds.
“This means we understand our clients’ operational needs, as well as their business objectives, and ensure that we are providing and designing a range of products and services that will meet their developing expectations.”
It is important for pension funds to have a secure environment for holding assets, she says. “As well as offering financial strength and a prudent and conservative culture, Northern Trust is able to offer clients some of the highest levels of sub-custodian indemnification, insurance and liability protection,” she says.
Risk management is also high on the agenda for pension funds. Northern Trust, says Broadgate, also helps its pension fund clients by monitoring and controlling, in-house, a number of different elements of risk.
“Our on-line communication system, Passport, can be used by clients to get full daily information about their portfolios; from on-line valuations; to investment accounting information; to transaction and settlement activity – ie, detailed information for someone involved in the day to day running of the fund,” she says.
The system is flexible enough so that summary information and reports can be created that are the right sort of level for trustees and investment committee meetings, she says.
“We have a client servicing team that is dedicated to supporting pension funds and is familiar with the issues pension funds are facing – and the appropriate resolutions.”
With investment returns becoming harder to get from traditional sources, Broadgate agrees with others that add-on services are becoming increasingly important for pension funds. “They are having to look for other means to make their assets work harder and grow the value of their funds,” she says.
But it is not only revenue generating activities like securities lending and commission recapture that are attracting more interest, but also services which help pension funds make sure they are getting the best rates for their cash and foreign exchange, for example.
“Transparency is now all important as pension funds look to compare what they are getting against the market,” she says.
Broadgate says there is a lot more interest in Northern Trust’s Investment Risk and Analytical Services. These let pension fund clients measure the risk in their portfolios, see how this would be affected by various events, and also monitor their fund managers’ investment activity against their mandates and across the fund at a consolidated level, she says.
It is not just from existing clients that securities lending is increasingly in demand, says Broadgate, but also from prospective clients, who intend to join the securities lending programme as soon as they appoint the firm custodian.
“This demand is being largely driven by the need to maximise investment returns, but also by a better understanding of how we carefully manage the risks involved and the level of indemnity we are able to provide,” she says. “So long as there are enough assets, which are attractive to the borrowers in segregated portfolios, there is no reason why a pension fund should not consider securities lending.”
Like other custodians, Northern Trust is working hard to keep the clients it has. “We know that we need to get the basics “right first time” so that our clients can concentrate on their own daily activities, and we have tough operational controls and procedures in place to help us achieve that,” says Broadgate.
Pension funds say it is important that a custodian handles any disputes that may arise properly. Broadgate says that in the main, disputes arise between custodians and their clients when the clients become unhappy with an aspect of service and communication and resolution are not effective.
“We do our utmost to avoid this kind of situation and therefore recognise the importance maintaining a regular dialogue with our clients, listening to them and positioning our business so that we continue to meet their needs.”
Alain Limauge, head of pension fund products at BNP Paribas, also says pension funds are not only looking solely at the custody product any more.
“They are much more interested in looking for an environment that suits their business, one that protects their assets and gives them independence vis-à-vis their asset manager,” he says.
The main thing BNP Paribas has to offer pension clients is its position as a big European custodian. “We are very aware of the features of the local market,” he says. For multinationals choosing a custodian, it makes sense for them to opt for one that operates in different places within Europe, and one that can provide the same service in each place.
“Instead of having to sub-deposit their assets, we can keep them all on our books,” says Limauge. In this way, BNP Paribas can be the global custodian, but also the local custodian, he says.
Custody tends to be a plain vanilla product, but BNP Paribas is very good at the value-added services, says Limauge, such as performance measurement. Performance measurement is a particularly important service for pension fund clients, he says.
“We are able to consolidate different portfolios, and provide a benchmark for the performance measurement,” he says. “We can really track and analyse in detail the source of the outperformance or underperformance, and do real analysis on the portfolio.”
Broker fees are monitored too. “We can analyse broker commissions and make sure that the pension fund is not being overcharged for the difference services it receives,” he says. In this way, the custodian is acting as a safeguard in the interests of the pension fund, he says.
Tax efficiency is another key factor, he says. “The fact that we’re reclaiming tax on dividends is very important to clients.”
Securities lending is an important service available through custodians. But Limauge says that
BNP Paribas does not see a huge increase in demand for securities lending among pension funds, with many remaining relatively cautious about it.
Securities lending is mostly used by pension funds in the more mature pension fund markets of the UK and the Netherlands, where pension funds are more capitalised, he says.
BNP Paribas is able to act as principal or agent in securities lending, he says. Which role it is required to take depends on the pension fund, and the region. “For example, in the Netherlands, a pension fund will ask us to act as principal, whereas in the UK, they ask us to act as agent,” he says. As principal, the institution is rated AA+, he says.
Limauge says the biggest concern pension funds have about their custodian is the rating of the bank and the long-term quality of the institution. “At the moment, we are doing very well on this,” he says.
As a custodian, Limauge says it is very important to support the pension fund and remain client focused. No dispute should not be allowed to arise, he says; a compromise would always be found.