Published in Asia Asset Management September 2007
A key challenge facing Asian pension funds and institutional investors is how to get the best value out of their custodian relationships. As regulators and governments across Asia allow their large pension organisations more flexibility in invesing offshore, the funds have to contend with an attendant increase in the level of complexity.
“This is a different dynamic and a different model than what the organisations have been exposed to before,” observed Lounarda David, Sydney-based principal of Mercer Investment Consulting and head of Mercer Sentinel Asia Pacific. “What do you require as your core services?” she asked.
When investing overseas there is, for example, currency risk in addition to the risk of the actual investment. The ability to get the right information in a timely manner and an understanding of the local and offshore tax implications and accounting requirements on both the performance and compliance sides are key prerequisites for a custodian.
Global custodians have the framework to deal with this flexibility, said Ms David, although there is a limit to that flexibility. Local custodians, on the other hand, are under a lot of pressure to come up to speed with global market requirements and to protect their client base.
Many local custodians are starting to work in the global space for the first time and trying to understand how to do it, said Fiona Elliot, Mercer senior associate Asia based in Singapore. Some have tied up with other service providers, some have gone into partnership arrangements or third party outsourcing. “There are a lot of models evolving,” Ms Elliot pointed out.
As offshore investments grow in Asia, more multinational players are moving into the Asian market which puts mounting pressure on local providers who need to decide whether they want to stay local or go global.
A lot of global custodians think Asia is where the growth will be over the next five years, predicted Ms David, and many are considering bigger presences in Asian cities like Singapore, Hong Kong and Tokyo. Many, like Northern Trust and JP Morgan, already have hubs in Asia which effectively puts them in the same time zone as Asian clients.
While trying to have a presence in every country is not a cost-effective proposition, there is nothing like being close to the ground to provide ongoing support for deliverables that may be constantly changing.
According to Ms David, custodians in New Zealand, for example, are constantly revising their deliverables on tax. “If they not there, they can’t work through these issues quickly. If they want to be competitive with the local players, they need to be there,” she explained.
Global coverage from the transaction perspective is very important. Multi-currency reporting is another key requirement. If a client appoints a number of fund managers in a number of markets, the custodian appointed should be able to support all those markets.
With global custodians expanding their bases in Asia and local providers pushed to compete, the demand for people has become a major challenge for custody businesses. “Having good staff is challenging. Human resources are not at the level that they should be,” observed Ms David. “As more custodians move into Asia, the pressure on skills will impact the quality of service provided to the client,” she cautioned.
Custodians play a crucial role in the ability of the client to fulfill its fiduciary duty to its stakeholders, a responsibility which the fund cannot delegate. “A custodian appointment helps the client sleep well at night knowing that there is someone looking after their interest,” emphasised Ms David.
From the client’s perspective, an important point to note when appointing a custodian is the contract. Whether the contract is made with a custody business or a large bank is germane because the recourse that the client has is the custodian. “The contract is fundamental,” declared Ms David.
Clients should also look at a number of elements within the contract, such as service level standards, cost fee and insurance elements, according to Ms Elliot. They need to understand what the custodian can and cannot do and be aware of their ability to operate in and understand the markets in which the client is invested, as well as understand the legal parameters of a true custodian.
Custodian relationships are not an arrangement that clients would want to change every year, according to Ms David. Understanding the fee structure of the custodian can be very challenging for the client, she added, and if this is not done properly, clients could end up paying more than they need to.
When it comes to selecting a custodian, is big necessarily better? It is a function of what the client’s needs are, said Ms David. Custodians may need to properly value very exotic derivatives and alternative and hedge funds and bigger does not mean that they can do this well.
Big may translate to a bigger balance sheet which provides a lot of comfort, but this need not necessarily be better. At the end of the day, it is the quality of service that matters. It is better to make sure that the cultural fit is there and that the custodian can meet the client at all levels of its requirements.
Every custodian has its own strengths and weaknesses and it is important for the client to understand what they are, advised Ms David. “There is a right custodian for every client,” she said.