Rice Warner’s Michael Berg and Steve Freeborn explain all the basics for choosing a custodian.

Custodians are often the unsung heroes of the superannuation industry, making a large and growing contribution to the delivery of investment strategies, member services, governance and risk management. It would be difficult to overstate the importance of having the right custodian, and engaging with them effectively.

What do custodians do?

Custody has moved far beyond its origins of holding paper securities, cash and gold in large vaults. Holding assets in electronic form lends itself to custodians holding rich data about clients’ investments and being able to link this to other data sources. Intelligent investment in technology is the key to delivering quick and accurate operational support, as well as leveraging off the data held to deliver a growing range of additional services.

Typical services are summarised in Figure 1 (click to enlarge). Key emerging areas include middle-office outsourcing, risk analytics and support in management of direct assets.

What does the market look like?

The custody market has continued to grow relentlessly, with total assets under custody approaching $2.8 billion at the end of the 2015 financial year. NAB Asset Servicing continues to be the largest provider, but faces intense competition from global providers which have committed to a substantial on-the ground presence in Australia. Six custodians now each hold over $200 billion of assets under custody for Australian investors (see Figure 2, click to enlarge). The range of providers who have been attracted to the market reflects the robust growth of Australia’s savings pool, with Australia now having (by assets) the fourth-largest funded superannuation system in the world.

From a custodian point of view, scale is vitally important to spreading IT investment costs over a larger client base. This has reinforced the competitiveness of the market, to the benefit of superannuation funds and their members.

Funds reviewing their custodial and investment administration arrangements are therefore able to do much more than “tick the box” with regard to the Australian Prudential Regulation Authority (APRA) requirement to review significant outsourced providers at least every three years. Funds can benefit simultaneously from reduced fee rates, more rapid turnaround times and improved services. This does not necessarily require changing providers or even carrying out a tender process, although clearly these are options which need to be considered.

 Figure 1. Click to enlarge.
Figure 1. Click to enlarge.

Deciding your strategy

It can be easy to start by thinking about what the alternatives are – but a better place to start is deciding what you want out of the review. This is critical to making the right decision on whether to go straight to a tender or first focus on dealings with the incumbent.

Some key questions to consider are:

  • What do you need from a custodian? Are there services that were unavailable or too expensive when you last reviewed your options which could now be attractive?
  • Is there a strong, mutually beneficial relationship with your custodian which you would like to continue? If yes, an independent review and bilateral discussions with your custodian may give you all the benefits of a tender process. This can be done at significantly lower cost (with reference both to fees and to management time) than a full tender.
  • In contrast, a situation where your custodian persistently falls short of requirements may mean that it is time to consider all the options.
  • Do you have multiple custodians (perhaps because of previous mergers)? This could point to a need to consolidate with one of them, or with a new provider, again pointing towards a full tender.
  • Who should handle negotiations and/or tender processes? These can be awkward for personnel responsible for day-to-day dealings with individuals at the custodian. Negotiations are one of the areas where independent consultants can help you to get an appropriate deal with the minimum of discomfort and complication in relationships with your provider.

 

Getting the right custodian – with the right terms

The process for selecting a custodian and agreeing terms will naturally depend on the overall strategy. Without attempting to discuss all the options in detail in this article, we would note a few key decisions.

 Figure 2. Click to enlarge.
Figure 2. Click to enlarge.

Bilateral negotiations:

  • What do you want with regard to services, relationship management and future proofing? While fees are important, it is not just about fees.
  • How has the custodian improved their services since the previous review? Has anything gone backwards? What new capabilities can be utilised?
  • How do you decide what fees can reasonably be agreed without going to a full tender?

 

Full tender:

  • What should the shortlist be? Which custodians have the capabilities that you need and have current capacity to take on more business?
  • What range of services should custodians be asked to tender for? It is important to get this right from the outset.
  • What questions should custodians be asked? These need to focus on the factors that will drive your decision, while being sure to cover the relevant APRA requirements.
  • If there is a transition, when would it happen, and how would you manage it to minimise disruption to your normal operations and other strategic initiatives?

 

Custody reviews are inherently challenging, but with the right strategy and the right help there is no need for them to be daunting. Our experience is that well-considered review processes are consistently successful in achieving further improvement in the value added by custodians.

 

Additional insights into custodians, from a range of industry experts, will be presented at the Investment Operations Conference at the Sheraton on the Park, Sydney, on February 24, 2016. To register click here.

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One comment on “How to choose a custodian”
    Troy Barnard

    Very Interested to read more post this article, though however I now have a better understanding of my requirements, Thankyou.

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