2.Enhanced investment risk reporting requirements By operating as an agent, investment managers have been primarily motivated on achieving investment returns at a product level. As long as they complied with the rules of the investment mandate, they have traditionally had relatively unsophisticated market risk reporting requirements. In many cases risk reporting has been deployed as a front office decision support tool, with limited involvement from the middle or back office. Super funds, conversely, operate as an investment principal and as such carry a direct ‘balance sheet’ exposure to market risk. Whilst achieving investment returns is also a key business driver, the ability to manage investment risks is a fundamental requirement and requires the fund to actively monitor and manage its market risk exposures. Risk testing procedures such as value-at-risk (VAR) and simulation testing, while being considered at the cutting edge of investment management processes, represent commonplace activities for super funds. To save funds from going down the path of deploying expensive and complex risk management systems, it is our view that market risk reporting should be a core component of any custodian offer to this market.
3. Reliance on custodian expertise A number of custodians have built their administration service offering to the market off the back of large scale outsourcing of functions from investment managers to their organisations. Accordingly, custodians have been able to leverage the knowledge resident within investment managers, with the key focus being on the transfer of knowledge from the investment manager to service provider. Where services have not been transitioned, there has not been the need for custodians to develop knowledge over these processes, so there is still limited knowledge by custodians over some front and middle office activities that have remained insourced. Where super funds are developing internal investment management capability, there may be limited knowledge resident within the organisation with respect to operational processes required to support investment management functions. To bridge this gap, super funds may look to their custodians to supply this expertise, noting this may extend to operational processes outside the scope of outsourced functions. Whilst this likely requires custodians to ‘tool up’ their current knowledge base, it also allows them the opportunity to define processes that align to their standard operating model.
4. Leveraging custodian technology to supp ort investment processes Most investment managers have existing technology to support investment processes such as portfolio management and dealing. Custodians are expected to provide the required data to support the ongoing operation of these systems. Where super funds have made the decision to insource investment management they will often not have front office systems in place, and will need to select and implement these platforms. Depending on the system selected, this often represents a challenge to custodians insofar that many systems require data to be provided that cannot be easily supplied by custodians without a significant change to their model. Further, the super fund may not have the expertise required to select and implement this system, resulting in a protracted transition period. In these circumstances, it is our view that the super fund and custodian should consider whether there is the opportunity for such systems to be supplied by the custodian even where this represents a departure from a traditional outsourcing model. For example, the provision of dealing systems is not something that custodians would typically offer to the market but is something that could be sought by super funds, particularly those entering the investment manufacturing space.