The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

Back Issues

Annual Report On Global Custody Global Powerhouses Rule

By: Stuart Plummer

It seems the Canadian custody industry has hit its stride over the past couple of years. With domestic consolidation being replaced with a feeling of general stability, custodians are focusing on more long-term strategic planning and product development. Investment in technology to handle core services of trade settlement and reporting has presented new opportunities for custodians and shifted the view many have had of the custody industry to that of a strategic partnership. Indeed, this view of the Canadian custody industry has expanded to a world view. While local issues have a lot of influence, they tend to fall into broader, worldwide categories.

So where do custodians stand today? What is their focus and what solutions are they delivering? What should their clients be asking?

Canadian purchasers of custody have realized that their suppliers are no longer bound by our national borders. Looking at the top custody banks in the world it is easy to identify several names from our local market. Assets are very concentrated in the hands of a few. The world’s top 15 custody banks oversee US$41 trillion while the next 22 have less than US$5 trillion. So what does this mean to a Canadian plan sponsor? It shows that the consolidation we have experienced here is not unique. These global powerhouses have had to make significant technology investments to deal with the massive transaction volumes and risk controls that must be in place to satisfy clients, shareholders, and regulators. Therefore, commitment to the business at this level is a given. Furthermore, the experience and expertise gained through operations in many markets then improves the quality and depth of products available here at home.

A prime example of the benefit of a global operation is the development of settlement points around the world. The increasing demands for geographic investment diversification by clients into developing markets have focused custodial efforts on their global custody networks. Investment managers must be able to rely on the custodian as a resource for critical information about settlement practices around the world. The number of markets in a global network is a balancing act between ensuring clients are not kept out of a country they have determined should now be a part of their strategy and opening too many unneeded markets, driving up the overall costs of maintaining the infrastructure. A prudent network management team regularly assesses the strength and viability of the local agent banks in each market, benchmarking them to financial and service standards. Local market practice guidelines and depository risk analysis should be made available to clients and their investment managers to assist them with their due diligence. Further, the network manager must have a contingency plan to replace a local supplier on a timely basis if they suspect that credit quality or service standards could be impaired. The safety and security of client assets is paramount. This level of research and oversight is mandatory given the volatility of foreign markets that are in different stages of development.

Multi-national plan sponsors are increasingly taking advantage of a custodian’s presence in different countries. Utilizing a single technology platform allows a plan sponsor to realize economies of scale and receive the consolidated reporting necessary for oversight while leveraging local service and expertise within each country. The alternative, choosing separate suppliers in each country, makes the governance process more complicated, expensive, and less timely.

New product development takes place in each market to satisfy the needs of local clients. Since there is often so much in common among similar clients in different countries, a regular review of developments within a global custodian’s operations will often find that an analogous offering exists in another location. Leveraging the efforts and experiences of others within the organization can significantly speed up the implementation time for a new product. Equally important is the opportunity to have an experienced operations group outside our borders provide their support. Such centres of operational excellence offer efficient, risk-controlled support that might not be possible on a smaller scale.

Custodians often tout their investment in technology to their clients, sometimes forgetting that technology is just an enabler. It’s the enabling part that has had such an impact in the last few years. Browser-based Internet portals have made their appearance, and have proven to be a significant improvement over dial-up lines that relied heavily on proprietary software. Anywhere, anytime access is a reality. Finally, clients and their investment managers can get real time access to portfolio information. Even more impressive is the capability to deliver customized, prescheduled reports, global market trading alerts, economic commentary, risk analysis, or to even hold online meetings via the portal. The possibilities are endless and as long as speed of access and security can be maintained, custodians will continue to be creative in terms of adding useful content and improving client satisfaction.

The combination of technology and the vast amount of data has transformed custodians into data warehouses. Examining that data for information that can improve the investment process presents one of the current opportunities. For example, measuring the flow of funds across thousands of portfolios as managers increase or reduce their investment in different capital markets provides key information about changing market weights. Such timely information might reinforce a manager’s opinion of a market or highlight an opportunity that would benefit from further research. The challenge with this much data on hand is not accessing it but sifting through it to assess what is useful.

How are custodians using this information to benefit their clients? A good case in point is the current industry initiative to improve straight-through processing (STP) rates for trade settlements. Even without the transition to settlement on trade date plus one day (T+1), the securities industries in both the U.S. and Canada have set goals to raise STP rates to at least 95 per cent. ACap Gemini Ernst and Young study commissioned for the Canadian Capital Markets Association identified potential savings of $140 million directly linked to STP. Custodians are able to measure STP rates at a client or investment manager level and identify processing breaks that act as barriers to STP. As a result, custodians are now working with clients and their investment managers to streamline the settlement process to realize real cost savings and improve efficiencies.

Expertise is also available from custodians when clients change investment managers or make changes to their investment strategy. Custodians have moved beyond the consultative role they previously played when such changes were made – controlling the movement of securities, cash, and tracking income while reporting the results.

Directly, or through affiliated money management firms, custodians are now introducing transition management services. Transition management is a specialized form of trading that can reduce costs and control risks when trading out of one portfolio of securities and into another. Transitions can be relatively straightforward or very complex, such as when it involves multi-country, multi-currency moves across both time zones and asset classes. A global custodian can draw on the breadth and depth of its organization to support these types of changes.

While transition management is an evolutionary product, investment manager outsourcing represents a revolutionary strategic direction for custodians. Outsourcing processes are a common occurrence in many industries, including custody, so some explanation of how it is different is in order. Investment manager outsourcing refers to a custodian taking over the mid- or back-office functions of an investment management operation. As investment managers identify their core competencies as managing money and servicing their clients, many are coming to the conclusion that outsourcing operations, technology, and even personnel presents an opportunity to contain costs and sharpen their strategic focus. Custodians, with their scaleable systems and capital resources, are one of the outsourcing possibilities that investment managers are considering. Among the many new functions that an outsourcing custodian might offer are replacing legacy technology systems with their own, re-engineering processes, providing trade instructions, and reconciling security positions with other custodians and preparing accounting and performance measurement reports on behalf of the investment manager. Investment manager outsourcing is much more than taking over a set of processes. It is a partnership between two organizations that must consider both the operational and reputation risks before proceeding. This is truly a quantum difference from the custodian’s original functions of trade settlement and income collection.

Has the Canadian custody industry truly hit its stride? Whether consolidations are finished or not doesn’t seem to matter so much any more. The focus has shifted to strategies that have a longer view and often include global considerations. Leveraging a sizable investment in technology and worldwide experience has paid dividends in terms of product development and the added value custodians have been able to offer to their clients.

Stuart Plummer is director, product management, sales and marketing, for CIBC Mellon Global Securities Services Company.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Subscribe to Daily News Alerts

Subscribe now to receive industry news delivered to your inbox every business day.

Interactive issue now onlineSubscribe to our magazinePrivate Wealth Online