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

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February 2007

Evaluating, Selecting And Monitoring Global Custodians

By: Ross Whitehill

In the UK and European markets, the task of evaluating, selecting, and monitoring global custodians and related service providers is increasingly being enshrined in legislation and best market practice guidelines. Portfolio sizes and the focus on the individualʼs interest as a beneficial owner in the portfolio are also providing the momentum for better practice around reviews.

While the Canadian market does not have legislation similar to the UK and European markets, there are guidelines being introduced by the various regulatory and industry associations in regards to business process outsourcing. The Office of the Superintendent of Financial Institutions introduced the B10 – Business Process Outsourcing Guideline for Insurance Companies, the Ontario Securities Commission is working with its international counterpart and the Canadian Association of Pension Supervisory Authorities (CAPSA) to introduce guidelines that are in line with the Financial Services Act in the UK. The underlying principles are focussed on best market practice, benchmarking, and monitoring.

monitoring global custodians

Experience in the last 12 to 18 months reveals that institutional investors are concerning themselves more and more with the business of ensuring that their current arrangements are in line with best market practices. The stimulation for this has come from publicity surrounding many high profile changes of custodian and the service, risk minimization, and financial benefits that have accrued to the investor or fund as a result of the review.

The industry is being drawn to three distinct levels of provider evaluation and this reflects the importance of the various stages in the life cycle of a relationship with a provider.

These reviews of the current arrangements take the form of a clear ʻhealth checkʼ that examines three critical elements of a relationship with a provider:

Service Level Agreement

The first step is to look at the service level agreement (SLA) in order to understand what services are being provided by the custodian. Typically, the SLA is not very well constructed and takes the form of a high level description of what services are available, but does not address the commitments that are required of both parties. Increasingly, investors are requiring that their SLA addresses all aspects of the service, from consistency of relationship management staff through to disaster recovery plans.

Custody & Related Services Agreement(s)

Next, the main agreement gives a full picture as to the asset safety and risk minimization provisions in the relationship and the extent to which the custodian bank/service provider will take responsibility for losses and protect the client from risks in the markets. Often the contracts that have been signed present a variety of risk evasive clauses and many agreements have protections in favour of the service provider. When challenged, the providers will generally say that there is never likely to be a situation in which such clauses would be invoked and, therefore, there is no cause for concern. Investors can form their own conclusions.

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