35 Custody coverTSASPnf:Layout 1 28/8/09 13:51 Page 35 funds europe GLOBAL CUSTODY SURVEY 2009 36-38 custody1TSASPnf:Layout 1 28/8/09 13:52 Page 36 CUSTODY: CONTRACTS 36 36-38 custody1TSASPnf:Layout 1 28/8/09 13:52 Page 37 Contract killers Asset managers are forging more rigorous contracts with their custodians. Nick Fitzpatrick says the changes, which could affect prices, are revolutionary for an industry that’s three decades in the making Global custody is witnessing possibly its For the AMF, the French regulator, it can now biggest shake up in the 30 years since the boast a higher level of regulatory protection for business first gained a footprint in the ‘Pre-crisis, it did not fund shareholders. institutional investment sector. matter so much to Speaking about the broader market, Three decades after custody banks began to Margaret Harwood-Jones, head of institutional persuade pension funds and asset management clients of a global investors at BNP Paribas Securities Services, businesses that their assets would be safer and custodian which sub- says: “I can see some contractual agreements in more efficiently administered if custodians the industry changing and new examples of looked after them, the Lehman Brothers custody banks they used. best practices emerging.” collapse of September 2008 and the more But network She says that another subject of contractual recent Bernard Madoff scandal have put these scrutiny, which also plays to the fears about claims to the test. management is far more counterparty failures that Lehman produced, is Largely, the industry has proved itself, yet important to clients now’ the extent to which custodians check the custody is nevertheless changing. integrity of their sub-custodian network. Apart from regulatory-led initiatives (see “Pre-crisis, it did not matter so much to separate article, p40-42), clients are recasting clients of a global custodian which sub-custody contractual agreements themselves. Investors banks they used. But network management is who were shaken by the impact of sub-prime- far more important to clients now,” says related chaos are much more rigorous about Harwood-Jones. their custodians’ duties and obligations when it One topic is whether or not custodians As an example, she says that clients want to comes to keeping assets secure, custody should return assets – at their own expense – if know if a sub-custodian commingles client executives report. a broker fails while those assets are in transit. assets with its own assets, which could leave And a further change that some anticipate There is no consistency in European law clients at risk if the custodian turns insolvent. is that more onerous duties for custodians about this, but France has firmly dealt with the “Global custodians have to demonstrate that could increase the price of custody- issue – and not in favour of custody banks. our sub-custodians have segregated third-party related services. Following a 2009 legal case involving assets on a client-by-client basis and that there custodians RBC Dexia Investors Services and is no commingling,” Harwood-Jones says. Contract killing Société Générale Securities Services, together Another area of focus is the level of The outcome for costs is still uncertain and not with asset managers Lafitte Capital, Delta compensation offered by custodians. everyone sees an upward price move as Alternative Management and Day Trade Asset Göran Fors, global head of custody at Nordic inevitable. But what does appear certain is that Management, a French court determined that banking group SEB, says: “Clients want to see clients are not waiting for regulators to tighten a custodian must return all assets immediately exactly how they will be indemnified. We see up the scope of a custodian’s responsibility. – a so-called ‘absolute obligation’ – even if the changes in the way institutions are evaluating Instead they are taking steps themselves to assets are then only partially returned to the new providers and the level of indemnification make contracts watertight. There is a move by custodian when insolvency proceedings against is a part of that criteria.” investors to try and contractually capture every the intermediary are finished. main eventuality that the financial crisis The case was complicated and centred on Greatly appreciated has taught them about and to determine assets used by prime brokers for collateral and But it could also be that the increased scrutiny how liable their custodians are when things go rehypothecation. The ruling is a comfort for of custodians is leading to a greater badly wrong. asset managers, but a problem for custodians. appreciation of the custodian’s job. 37 36-38 custody1TSASPnf:Layout 1 28/8/09 13:52 Page 38 CUSTODY: CONTRACTS Daron Pearce, head of relationship “There are credit risk-related elements that leverage to offer a long list of custody- management, Emea, at BNY Mellon Asset exist within the custody product where we related functions, the shrinking menu Servicing, says: “The custody market has been advance money to clients. The cost of capital to may open up the market to niche players to fundamentally shaken and it has brought all banks is much higher than it was before the fill the gaps where other custodians pull out home the fact that there is risk in custody.” financial crisis so all finance activity is or can’t compete. An example, and again related to experiencing significantly higher costs. If levels Pearce, At BNY Mellon, says that in commingling, is that when investors retreated stay where they are, it’s easy to see that in some Q2 this year, activity in custody and from equities into cash as markets began to cases this may have to be shared with the client.” related asset servicing picked up as shake, they realised that their cash was held on A greater awareness of risk and the asset managers returned to focus on the custodian’s balance sheet and not contractual measures used to deal with it have operational issues, such as outsourcing back- segregated in the way their equities generally consequences for clients beyond cost, though. office functions. were. Therefore clients might favour a bank Fors, at SEB, says that some custodians Custody has long-since matured and it is with a strong credit rating to reduce risk in simply might not risk entering certain markets now rare to find a pension fund or asset their cash holdings. where financial instability is high due to manager that does not outsource its own But they may also appreciate that stable substandard financial infrastructure – for custody operations. custodians can charge a premium related to But over the past ten years custody banks this stability, too. If the risks associated with have sought to boost revenues and custody and the manner in which custodians differentiate themselves by rolling out value- can control these risks are understood better, it added services such as fund administration, may well give custodians a chance to revisit the ‘People thought custody fund accounting and performance risk-reward discussion without feeling too measurement. More recently custodians uncomfortable about it. was just a commodity. have competed fiercely to provide services At least, this is the kind of argument Now they recognise that related to the newly popular alternative custodians are edging towards. There is a lot investments industry, such as the pricing, of talk in the industry at present about the investment in settlement and accounting for esoteric repricing services in order to wean revenues technology we make, instruments and complex strategies. off basis-point charges related to assets, and to These services are offered on a best-of- reprice in accordance with risk. stability, and balance breed, or component, basis, or they are Asked about this, Pearce says: “When we sheet strength are all bundled together with traditional custody. look at our own pricing there is more realism Pearce says asset managers continue to on behalf of buyers now. People accept important and consider both options. custodians have to price for risk.” differentiating factors’ Bundling has been criticised in the past for He adds: “People thought custody was just a fuzzy pricing. But if custodians do price for commodity. Now they recognise that the risk, or offer more concentrated services in investment in technology we make, stability, competition with specialist providers, it and balance sheet strength are all important could be expected that pricing will become and differentiating factors.” less opaque. example, lacking a strong central French revolution counterparty, or where laws around sub- Revolutionary change Given the court ruling in France, there is little custody do not require funds to be segregated. A combination of regulatory change, client wonder that the cost of French custody may “It will be difficult for custodians to take on scrutiny and custodian realism is threatening increase. This was a view indicated in Funds all the risks that exist in specific markets,” to force up custody costs. Custodians hope Europe (May 2009) by François Marion, says Fors. clients will be philosophical about this chairman of Caceis Group, a French banking Similarly, Bruno Prigent, deputy head of if it happens. firm that operates custody services. Société Générale Securities Services, says: At least custodians have, by and large, “France is the European market where prices “The Lehman Brothers and Madoff episodes demonstrated their value. Speaking of BNY for custody, depositary and fund services are helped us identify clearly the different risks Mellon, Nadine Chakar, head of Emea at the lowest. Therefore, if it appears that the that we have when we provide depositary BNY Mellon Asset Servicing, told Funds French market charges the lowest price but services or fund administration services. Now Europe last October: “This episode bears the higher risk, then an adjustment will we have to address these different risks by [Lehman Brothers] tested us and it tested be necessary,” he said at the time.