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Benefits and Pensions MonitorEvaluating, Selecting And Monitoring Global Custodians Fees and Commercial Arrangements This is generally where the real shock comes as institutions find that they have been disadvantaged by the fee and commercial arrangements in place. Normally, the ancillary cost items such as interest spreads, F/X margins, and securities lending splits (pre/post transaction costs) have been ignored in the past and when taken into consideration make a significant difference to the total cost of the custodian relationship. This is validated by the custodian providers many of whom will say that around 50 per cent of their revenues come from non-headline fees. Increasingly the findings from ʻhealth checksʼ are so disturbing that they trigger a full review of the custodial and related services arrangements. While the incumbent suppliers usually make strong competitive proposals to retain the business, the client relationship is sometimes damaged beyond reasonable repair. Further, competitor custodians try to add to the inducement to move by offering fee reductions, contributions, and fee rebates to facilitate the transition away from the incumbent. Commitments to provide support staff during the transition and beyond can make a persuasive argument against staying with the incumbent. While reviews can be time-consuming and costly, the pay back in terms of service improvements, access to new technology, reduced risk, and increased asset safety provisions as well as clear commercial benefits can make a compelling case for taking a mandate to market. Investors are also saying that it has a salutary effect on custodians as it shows that the business is not necessarily with the custodian forever. In order to deliver maximum benefit, the RFP review is best when highly structured and clear on what the key buying criteria for the investor might be. Our view is that the RFP review should be structured as follows (See Chart 1).
Custodian Benchmarking Following the appointment and transition of assets, it is obviously important to maintain an ongoing review of custodian performance against best market practices and, more particularly, the SLA. Many investors neglect this element of the relationship and allow the custodian to provide quarterly or bi-annual reports. Benchmarking service against the SLA is a clear-cut activity, but gathering universe data to ensure that service levels do not slip below standards generally accepted in the market is quite different. Further, regulatory interest in benchmarking, while not prescriptive, would suggest that structured ongoing comparison with the market is seen as best market practice. One approach is to gather data from custodians across a range of service quality indicators, put them into a comparative database, and analyze the results. Doing so clearly shows how a given custodianʼs service for a client compares with other custodians ʼ service for other similar types of clients. It is important to recognize that this benchmarking will often throw up deficiencies in the clientsʼ operations and for this reason custodians generally welcome being compared with other providers because it provides valuable benchmark tools for them to:
FX Benchmarking In addition to operational benchmarking, foreign exchange benchmarking can be particularly relevant for small to medium sized funds that may be using their custodian for a large percentage of their foreign exchange execution. Record Currency Management, who has been providing foreign exchange benchmarking since 1983, has found that a tiny minority of funds has currency trades being executed in an effective manner overall. The benchmarking component examines foreign exchange transactions executed by the custodian. These transactions are compared against a database. Foreign exchange benchmarking will identify the effectiveness or otherwise of the currency execution the fund is receiving from its custodian. Securities Lending Benchmarking Securities lending performance analysis is another area to examine. This will enable pension funds, asset managers, and other institutional investors who have mandated their respective custodians to carry out securities lending on their behalf, to monitor their performance, and to assess the risks associated with the activity. As portfolio values increase and custodian competition for mandates accelerates, investors are well advised to put in place sound evaluation, selection, and monitoring tools. The cost of implementing such tools and processes can be such that CFO approvals are required, but the costs of not doing so can be such that the CFOʼs job retention could be reasonably challenged by any reasonably informed CEO or auditor. ■
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Ross Whitehill is the chief operating officer of Thomas Murray, a firm specializing in the global securities industry.