Benefits and Pensions Monitor
Annual Report And Directory Of Global Custodians -
Custodians Learn To Deal With Alternatives
Things have changed for custodians in Canada.
There was a time when their primary jobs were to settle trades and send out statements at the end of each month showing their clients their holdings.
However, three to 3½ years ago, says David Linds, senior vice-president, business development and client relationship management, at CIBC Mellon Global Securities Services, “we started to see a very distinctive trend” towards the use of more alternative investments.
At that time, institutional investors were still restricted in the amount of foreign investment (30 per cent) that they could hold. Many had no other choice than to use derivatives to enhance investments within the limits of the foreign property rule.
Plus, Defined Benefit pension plan funds were looking for ways to increase their returns and offset growing pension plan liabilities. Again, alternatives attracted them.
Linds says the big plans started the trend to invest in over-the-counter investments, alternative investments, hedge funds, and private placements as well as direct investments in real estate, timber, and private equity.
As well, institutional firms were creating sophisticated instruments such as variance swaps and binary options. Custodians started to see a very distinctive trend away from the standard kinds of investments to “more alternatives, more esoteric hedges, more privates,” he says.
Clearly, this move to alternative investments by pension funds is creating new challenges for custodians. Hereʼs how some of Canadaʼs custodians are dealing with these challenges.
 David Linds
Senior Vice-president Business Development & Client Relationship Management CIBC Mellon Global Securities Services
“In our role as custodian, weʼre responsible to safekeep the assets our clients invest in. We also have an obligation to our clients to ensure that we keep pace with the dynamic changes in the marketplace. Here in Canada, what you have is a series of clients – be it pension funds, mutual funds, institutional investors, insurance companies – that are taking us places we frankly never thought we would go. By that I mean, they are investing in a whole range of overthe-counter investments, private placements, and alternative investments – including hedge funds – as well as direct investments in real estate, timber, and private equity,” says Linds.
Five years ago, he says, the use of derivatives to deal with the limitation on foreign investing was relatively straightforward. Itʼs when hedge funds and alternative investments started to show up that the marketplace, not just the custodians, was caught a little bit off guard. “For example, we had to go out and find a vendor to price these instruments.”
In many cases, custodians rely on third parties to provide those services. “All these derivatives have been engineered, so how do you account for them, literally, from a valuation perspective? How do you price them? Whatʼs the formula by which you determine the valuation?”
To do this, custodians have supplemented their teams to include staff who understand these trading strategies and understand the instruments that are being presented. Custodians have dealt with this through “a combination of the people theyʼve hired, the kind of brainpower theyʼve hired, and the continued investment in technology that enables them to account for these instruments on a global basis,” says Linds.
Is the industry 100 per cent there? Linds says “No, because there will always be a new item thatʼs engineered, so there will be a little bit of catch-up. Our challenge is to ensure that weʼre with our clients on the leading edge and participating in their strategy sessions to understand where theyʼre going. Itʼs important we align ourselves with our clients.
“Itʼs a real challenge. Twenty years ago, the challenge was how many markets can you get me into? We were in 40. Nobodyʼs talking about can you get me into that 86th market now. Itʼs a different kind of issue. Itʼs ʻcan you trade this instrument in that marketʼ?”
 José Placido
Chief Executive Officer RBC Dexia Investor Services
“We have definitely seen an increased appetite for alternative investments over the past several years – and this is driving a major shift in asset allocation strategies among clients – including Canadaʼs pension funds,” says Placido.
While much of the mainstream media coverage has tended to focus on the high-profile hedge fund sector, institutional investors are seeking opportunities across a much broader range of asset classes as they look to enhance profitability. Theyʼre looking at areas such as real estate, infrastructure, private equity, and more.
The shift to these new asset classes brings with it a unique set of challenges for both the investors and the custodian.
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