Clients actively involved with their custodians know their provider does not just offer custody and settlement services. All custodians these days are leveraging the existing relationships they have with their custody clients. They are keen to add to the list of ‘value added services’ used by their clients. Many believe they must provide the broadest array of products and solutions just to survive. The latest offerings include transaction cost analysis, transition management and commission recapture services, all of which are being marketed actively by custodians.
The positive news for the client is that with this increasing array of services it is possible to obtain centralised delivery of multiple services from a ‘one-stop-shop’ provider. Naturally, this approach is the one that most custodians are hoping clients will choose, and that they will end up being used for an increasing range of services.
But clients need to be aware that as technology improvements continue to simplify the movement of data around the market, there are fewer benefits in centralising services such as trade confirmation, custody, securities lending, investment accounting and performance measurement with a single provider. Given some of the exits from the business in recent years, some clients are wary of putting all their eggs in one basket. In addition, some see this concentration of services with their custodian as reducing their ability to select a new provider for individual services in the future. Using a single provider for many services offers synergies, but may also blur the line between different services, either from a service delivery point of view or with respect to fees.
Custodians ultimately want to secure new clients and sell more products to existing clients. However, clients know that cutting edge new products will not compensate for weak delivery of the core services currently being used. Clients want their custodians to put sufficient resources into retaining existing relationships. A reason commonly cited by clients who change their custody arrangements is underlying dissatisfaction with how the incumbent custodian handled the relationship. This could include weak relationship management, not being proactive in introducing new service offerings or not being able to demonstrate that their service levels meet best market practise. At the most basic level, a custodian needs to retain each client. Winning new clients and setting up new relationships is a costly activity.
Regardless of whether a custodian is providing basic custody or a full suite of value added services, keeping clients happy is essential. One key to ensuring happy clients is strong relationship management. Does the custodian understand your needs and areas where improvements can be made? Equally important is having a mechanism, not just for measuring whether the custodian meets the your expectations, but also how the custodian’s performance compares to the custodian’s peers. By being able to demonstrate that a custodian’s service delivery is competitive, a client will feel more comfortable retaining the custodian and using the custodian for more services.
Selecting ‘best-of-breed’ providers and using a custodian for an increasing array of services need not be mutually exclusive, provided the delivery of each service is measurable and fees are unbundled. With the increasing focus on transparency, many asset owners are wary of receiving bundled services, particularly if a bundled fee proposal is offered, and place a priority on using best-of-breed providers. It will be essential for clients to demonstrate that their custodian can offer best of breed for each service provided to the client, particularly if they want to consider the custodian as a provider of additional products and services. Generally, there is very little monitoring of custodian service levels and custody arrangements. Objective, measurable criteria need to be considered.
The demands of institutions for more transparency in the market for global custody services have given rise to rating and operational benchmarking products for custodians. Our Private Ratings and Operational Benchmarking (Probe) provides clients with measurable criteria, which demonstrates how the custodian is performing relative to the client’s expectations and as compared with other custodians.
Probe aims to establish a formal view of each custodian (rating) and supports that with an objective assessment (benchmark) based upon a client’s operational experience with that custodian and the experience of custody clients in our universe of data.
The private custody rating takes into account major components, such as each custodian’s:
q credentials, which is the custodian’s experience in, and commitment to, deliver custody services together with their management of the business;
q internal operations, which includes an evaluation of the custodian’s IT and communications systems, its operational reporting, as well as its client relationship management capabilities and network management; and
q risk, which assesses the custodian’s position on financial, asset safety, asset servicing and operational (procedures and controls) risks.
Core services, as revealed by the breadth and quality of the nine core services offered and as appropriate, additional value added services (see Table 1), as well as the custodian’s technical ability to deliver the services to a high standard, while minimising risk to the client in providing the service;
The data to support the private custody rating for Probe reporting is derived from ongoing and client-specific research, knowledge of custodian banks based on requests for proposals, general profile data maintained by the banks, bank presentations and interviews.
The private global custody rating focuses on the key areas of asset safety and risk minimisation. The overall custody rating, and the rating of each service, is provided on the familiar ratings scale, which runs from AAA (extremely strong), through BBB (adequate) to C (unable to deliver at even a minimally acceptable level).
The operational benchmarking component is derived from data supplied by the custodian in respect of its clients’ participation in the Probe programme (see Table 2). Operational benchmarking provides a fund with a quantitative assessment of its custodian’s service based on monthly client specific data provided to us by the custodian bank. The output measures results over time to identify trends. Performance is measured against the spectrum of core operational services.
The custodian’s performance is assessed against the commitments made to the client in the request for proposal, service level agreements and/or custody contract between the two parties. The performance of the custodian will ultimately determine whether the rating by category – settlements, income collection – is amended, and collectively, whether the performance overall means that the private custody rating is confirmed as stable, placed on watch or upgraded/downgraded.
Just as custodians need to focus more on client management, asset owners need to pay more attention to how they monitor the ongoing relationship and ensure the continued appropriateness of the arrangements. The UK Financial Services Authority’s conduct of business rules require that, among other things, a regulated firm “is expected to establish and maintain a system for assessing the appropriateness of its selection of the custodian and to assess the continued appointment of that custodian”. The rules are not prescriptive, but this regulatory directive supports the commercial rationale that asset owners need to take an active role in reviewing the ongoing appropriateness of their custody arrangements, which logically includes quantitative and qualitative assessments. This brings an increased focus on risk assessments of custodians and also the quality of the delivery of services. Trustees will have to know that their arrangements are appropriate.
There will always be clients who, despite regulatory and market pressures, will continue to take a hands off approach to their custody arrangements. However others, those who are mindful of the risks associated with custody and the changes in the market and service offerings, will be increasingly looking at their custody arrangements. Incumbent custodians that can demonstrate that they are meeting their commitments, as defined in the service level agreement and compared to the rest of the market, will be in a position to shine.
Joanne Parker is a director of consultants Thomas Murray, based in London