(February-2003) 10 ways custodians earn their keep

When we think of “custody”, all sorts of images spring to mind. Huge vaults, safes filled with share certificates, or maybe something to do with the justice system.

Historically, custody was about the safekeeping of assets and collection of income. These days, master custodians perform these core functions, but in an electronic environment. And more importantly, they support their clients with sophisticated reporting, Internet access and value-added services. Custodians are perhaps the “quiet achievers” of the institutional investment service providers.

Clearly, there are benefits to using a custodian, because this segment has grown phenomenally over the last 15 years. Put simply, the master custodian ensures that funds receive the commercial peace of mind and business support that they need as fiduciaries.

The custodian’s client base is the institutional market — large superannuation funds with sophisticated investment policies and multiple investment managers.

Custody is, in fact, a core and strategically important activity for any large superannuation fund. The master custodian provides additional security through separation of duties, brings efficiency to the investment process and provides important reporting services and risk controls.

Member investment choice solutions, like unit pricing and registry, are also important services that are increasingly being delivered by the master custodian.

Interestingly, the choice of a master custodian is a decision which is made relatively infrequently — perhaps every five years, or even longer. Given the magnitude of such a decision, it is essential to understand both the dynamics and the benefits of this unique service. So, what are the 10 top areas in which a master custodian can add value?

1. Independence. The custodian has no vested interest in investment decisions, or investment manager selection. This ensures complete independence from managing the actual investments. Also, objective measurement of compliance with investment mandates is assured.

2. Risk control. Use of a custodian facilitates legislative compliance under the SIS legislation and Financial Services Reform Act. The master custodian also provides a key separation of duties between the fund’s investment managers and administrator.

3. Administrative ease. The custodian is the single point of contact so that investment information is centralised. Without a custodian, individual contact must be made with multiple investment managers, asset consultants and other service providers, in order to assess overall investment status.

4. Specialist skills. The custodian performs the specialist task of safekeeping, settlement, collection of income and monitoring cash movement. Accordingly, other service providers can focus on their roles without being distracted by the need to perform these functions.

5. Cost savings. In a number of ways, the specialist skills of the custodian translate directly into cost savings for the fund. Having the custodian holding assets makes it easy to transition investment managers at little cost (assets may not have to be liquidated). Also, reporting services (accounting, tax, performance) are very cost effective.

6. Revenue opportunities. The custodian can provide efficient cash handling. This eliminates the client’s need to monitor, recall, administer and manage the cash position. Other revenue generating opportunities can also include securities lending, directed brokerage and directed foreign exchange.

7. Consistency. The custodian provides consistent valuation, accounting, tax and performance measurement methodology. This allows easy comparison across all investment managers and assets. Without this consistency, comparison of results becomes meaningless.

8. Consolidation. Consolidated accounting and tax reporting is provided. The custodian’s auditor provides half-yearly audit confirmation, covering all assets. This is preferable to receiving multiple letters, from the auditors of various individual investment managers (all with differing comfort levels).

9. Partnership in adding value. The custodian adds value to the relationship — such as suggestions regarding member investment choice solutions, interpretation of accounting, tax and performance measurement standards, and securities market information.

10. Future growth. Because of the depth and breadth of services and products offered, the custodian provides solutions to call on as the client grows. In addition, funds do not need to continue to invest in sophisticated IT systems and specialist staff, resulting in potential ‘fast-tracking’ of future product opportunities.

So, what are the differentiators in deciding on which master custodian? For a start, look at the business focus of the custodian — is it more interested in providing back office services for investment managers, rather than the range of services required by large super funds?

Importantly, the custodian should demonstrate a major commitment to ongoing investment in the business. This is critical because it provides the client with access to technology (including Internet delivery), industry best-practice, as well as high levels of investment in new products.

Finally, the custodian should have a demonstrated commitment to the superannuation segment, as well as a strong Australian presence.

— Robert J Brown is the executive manager of Commonwealth Custodial Services.