Financial Markets Operations Management (36 page)

The single custodian is known as a
global custodian
and the individual local custodians are known as
sub-custodians
(or
agent banks
). Collectively, we refer to this as
global custody
.

A global custodian was defined by the International Securities Services Association (ISSA)
¹
in 1990, as follows:

It should be noted that the client and its global custodian do not have to be in the same country.

The global custodians are typically banks that offer a range of services including securities services. For example, Northern Trust's Asset Servicing includes the following headline services:
²

• Collateral and liquidity management;
  
• Cross-border pooling;
  
• Execution services;
  
• Fund services;
  
• Global custody;
  
• Investment operations outsourcing;
  
• Securities lending;
  
• Transition management;
  
• Treasury services.
  

Gauging the size of the business is difficult, but it is estimated that the key figure, assets under custody (AUC), exceeds USD 140 trillion, with the top ten global custodians holding around 80% of this. The top five global custodians are shown in
Table 10.8
.

As you will observe in
Figure 10.4
, the client has one relationship to manage; this is with the global custodian. For the global custodian, in addition to its clients, it has to manage its network of sub-custodians, each of which represents the entry point into the relevant market (e.g. clearing systems and CSDs).

The network consists of banks that operate in a particular market and whose clients are the global custodians. Please note that the same banks can act as local custodians, as explained above.

An example of a sub-custodian network is that of HSBC Securities Services
³
in
Table 10.9
.

In addition to HSBC Securities Services, other banks that act as sub-custodians in multiple locations include:

• Citi
  
• BNP Paribas
  
• Deutsche Bank
  
• Standard Chartered Bank.
  

The main types of institutional investor that purchase global custody services tend to be:

• Investment managers (including sovereign wealth funds and hedge funds), who use external custodians to handle their client business across the globe.
  
• Institutional investors (e.g. pension funds, insurance companies and charities):
  
  • Pension funds can be self-invested but are more likely to use investment managers. Using a global custodian can ensure that information is consolidated by the custodian on behalf of the pension fund.
    
  • Insurance companies use external custodians to handle their client business across the globe.
    
• Institutional funds (e.g. mutual funds, sicavs, hedge funds, private equity funds, etc.), which use external custodians to handle their business across the globe.
  
• Custodian banks looking to appoint sub-custodian agents in those markets where the global custodian does not have suitable branches. It is therefore likely that some global custodians will choose to use competitor banks as sub-custodians.
  

It is possible to consider the relationships between institutional clients, investment managers and the global custodian banks from two points of view. In both cases, information (e.g. transaction instructions submitted to the custodian and reports submitted by the custodian) is exchanged between the investment manager and the custodian. The question remains as to who is the actual client of the custodian: is it the investment manager or is it the institutional client?

Institutional Client appoints Custodian

The institutional client appoints one or more investment managers (at “A”) and the custodian (at “C”); it can arrange for its investment manager(s) to communicate with the single custodian (at “B”), as shown in
Figure 10.5
. This has the advantage that the custodian is totally involved with all the investment managers and can report on a consolidated basis back to the institutional client.

In terms of a day-to-day operational relationship, the investment managers are quasi-clients of the custodian, although the latter's fees are charged back to the institutional client.

For any investment manager involved in this type of arrangement, there is one disadvantage and that is the likelihood that the investment manager will be dealing with several global custodians, each one having been appointed by the investment manager's client. That can make it challenging for the investment manager to manage so many relationships.

Investment Manager appoints Custodian

The investment client appoints the investment manager, as above (at “A”). However, as an alternative to the above arrangement, it is possible for the investment manager to appoint its own choice of global custodian (at “B”) and thus the institutional client just has a single relationship to manage, i.e. with its investment manager. The choice of global custodian remains solely with the investment manager, as shown in
Figure 10.6
.

The advantage for the investment manager is perhaps clear to see; it is able to deal with the global custodian of its choice and not have to be concerned with managing a network of global custodial relationships. The disadvantage for the institutional clients is that they cannot benefit from some of the compliance-related services offered by the global custodian.

If we can regard the services offered by the clearing systems and CSDs (and to a lesser extent by the sub-custodians) as being wholesale-based, we can think of the services offered by the global custodians as being more retail-based. Let us take settlements as an example; for a CSD, a transaction will settle when both the asset and cash are available. This can be regarded as wholesale. The global custodian will attempt to make the settlement look better than it really is; it will attempt to add value to the client. We will see how this can be achieved below.

The global custodian is therefore acting as an intermediary between the owner and the market infrastructure and, at the same time, adding a degree of value for the benefit of the owner.

The types of service offered by the global custodians can be divided into two groups:

1. Basic services.
   
2. Value-added services.
   

Not every client will want or need all of the services on offer, but it is generally the case that most clients will require the basic services. Clients may not need or may not be permitted to take some of the value-added and related services; it depends entirely on each client's situation.
Nevertheless, global custodians are innovators and will constantly seek to develop services and products that clients might be interested in taking.

1. Basic services (see
   Table 10.10
   ).
   
2. Value-added services (see
   Table 10.11
   ).