Global Custody RFP

Institutional buyers of global securities services who decide to switch to a new custodian bank have two options. They can either (1) approach a bank who has been recommended to them and enter into direct negotiations without formally assessing other banks, or (2) carry out a formal tendering process, typically called the Request for Proposal ( "Custody RFP"), and assess the pros and cons of a range of competing global custodian banks.

The uncontested bid

The decision to appoint a new supplier without formally assessing the merits of the competition is not uncommon in the market. As a straight-forward and apparently low cost approach it has some appeal, especially where the chosen supplier comes highly recommended by other clients.

However, the pitfalls of uncontested bids are considerable, and the ultimate costs and risks of appointing the wrong supplier can far out-weigh any initial cost savings.

• The quality of basic services, personnel and support (e.g. initial transfer of assets, on-going problem resolution and training) can vary enormously across different suppliers.
• The level of risks assumed, as well as the nature of guarantees and indemnities also vary enormously by supplier.
• Fees quoted by the supplier may be more than competitors who provide a higher quality service and better deals on areas such as interest paid on cash balances, lending rates and charges for incidentals.
• Furthermore, the fees charged may be ramped up once the buyer has committed to a single institution.
• The supplier may not be able to offer the full range of added value services, and this can limit the buyer’s ability to develop the services needed by its clients going forward.
• Overall, the buyer will miss out on the opportunity to compare the quality, range and cost of services provided in the market.

The RFP approach

The alternative to an uncontested bid is to carry out a formal selection procedure, involving an appraisal of a number of competing suppliers. The suppliers submit their credentials and proposals through a formal custody RFP. This process is designed specifically to avoid the pitfalls identified in an uncontested bid.

The RFP process has on occasions received a bad press in specialist industry journals, with issues raised for both buyers and suppliers:

• Buyers of global securities services can find the process to be overly time consuming, and extremely complicated when it comes to analysing responses, and selecting a preferred supplier. What starts out as a rational-analytical approach can all too soon become a confusing, subjective exercise. The appointment of external advisers can add an extra dimension to this complexity. The production of massive RFP documents covering an ever increasing multitude of clever questions (not all necessarily relevant, and some rather misleading), can make the process of analysing or verifying the results extremely difficult.
• Suppliers suffer the consequences. The leading suppliers, in particular, receive a flood of RFPs every year: up to 300 a year for some of the major global suppliers. In one crucial sense, this is a bonus, because it means the suppliers are “still on the radar screen” - to quote a major US player. However, RFPs come in all shapes and sizes, with questions ranging from the vague and open ended to the immensely detailed and intrusive. Given the time it takes to respond to an average RFP, even with word processing efficiencies and standard, off-the-shelf answers, a particular concern remains: is the institution serious or is this simply a data collection exercise, designed to gather ammunition to use against incumbent suppliers?

A highly structured Custody RFP approach is essential

Thomas Murray have worked extensively with both buyers and suppliers of global securities services in an attempt to simplify and improve the RFP process - for the benefit of all those involved. The aim has been to focus on what is the right approach for a particular buyer, not how to come up with more and more clever and difficult generic questions.

It is strongly recommended that any institution who is considering a change in supplier follows through the formal and highly structured RFP process outlined in this chapter. The steps involved have been well tried and tested with leading institutional buyers. One part of the Thomas Murray toolkit* contains a more detailed set of model questions, formats and analytical tools, designed to help buyers build upon the approaches described in this Chapter and through-out the book. It has been prepared in a modular form so that the questions can be easily modified to suit the specific requirements of individual institutions.

The RFP process

• Phase 1 involves the input of specific service requirements and agreed strategic options (covering the issues described in Chapter 5).
• Phase 2 involves the RFP process itself, where a series of formal evaluation methods and hurdles are used to filter down the long list of potential candidates to the final, preferred supplier.
• Phase 3 involves the transfer of assets to the new supplier (if a new supplier is selected) and post selection evaluations.

Selecting the long-list of RFP candidates

An institutional buyer with investments in 30 countries, is potentially faced with the need to review sixty to one hundred suppliers during the RFP process if it decides to go direct to local agents.

For example, if a strategic decision is made to use a securities services supplier direct in each country, it would be prudent to assess at least two alternatives in each country, and it would be possible to include a lot more. The outcome, as Figure 7.7 shows, could be that the buyer actually appoints more than one supplier in some countries.

The numbers of potential candidates available depends largely upon the buyer’s country of origin. Not all countries have as many as 15 securities services suppliers able to provide global support. In some countries, the choice of candidates may be much more limited - say to 5 players. The buyer may choose to include only 3 of these in the RFP*.

The initial issue for institutional buyers is how to get from I to II in Figure 7.7, and filter down the significant number of potential candidates into a final list for inclusion in the RFP. The starting point for this exercise is a consideration of the generic set of buyer requirements discussed in Chapter 4.

The first task is to convert basic requirements into a list of specific selection criteria or ‘key hurdles’, against which all potential candidates for inclusion in the RFP can be judged.

Key hurdles for selecting candidates

A list of key hurdles (Figure 7.8) agreed at the start of the selection process, can be an extremely effective and fast method of filtering out suppliers who should not be included in the final list of RFP candidates for full scale analysis. Furthermore, the initial hurdles can be used through-out the exercise, cascading down into a more detailed set of selection criteria.

Institutions who have adopted this approach have usually re-prioritised the main elements of the requirements listed in Chapter 4 to suit their own aims and objectives. An appraisal of the financial strength and credit worthiness of a potential candidate is usually carried out right at the start of the process, because it is such a critical go/no go factor. On the other hand, the level of pricing tends not to be a key issue at the outset of a selection process, and so this is commonly left out of the initial hurdles.

The result is the specify a logical sequence of hurdles to be applied to the universe of potential candidates. The detailed questions relevant to each hurdle will then by included in the full RFP sent to the qualifying candidates.

The use of closed questions in the model RFP

Traditionally, RFPs have asked a large number of open ended questions. Open ended questions are appropriate for some areas - such as ‘Please describe your procedures for problem resolution in the trade settlements area.’ However, in many areas, open ended questions are unnecessary and may be misleading. They may only serve to give respondents the freedom to procrastinate or avoid directly answering a question requiring a specific answer.

One of the innovations that Thomas Murray has successfully introduced into the RFP process for a number of clients, has been the development of a model RFP with a high percentage of closed questions. Using closed questions has many advantages for both buyers and suppliers, as long as the questions are properly worded, and generate a complete transparency of response. Most significantly, closed questions make the analysis of responses from different suppliers much easier carry out, with answers that are more consistent and comparable.

The next page shows a sample page from a model custody RFP, containing questions in the securities lending area. Suppliers have to tick one of three boxes for each question, and have a limited/fixed amount of space to justify their answer in the main document:

1. ‘Yes without qualification’ means that the supplier is able to meet the service levels required as stated in the question;
2. ‘Yes with qualification’ means that the supplier is able to meet to provide the service, but not in precise way required. For example, in question 2, a supplier may respond that the buyer can impose restrictions on the borrowers that the buyer is prepared to lend to with the exception of two particular, named borrowers.
3. ‘No’ means that the supplier is unable or unwilling to meet the service level required.

SAMPLE PAGE FROM MODEL RFP

2.1.6 Partial settlement:

Where market practice permits, are you able to handle partial settlement for both equities and bonds?

Yes, without qualifications Yes, with qualifications No

Comments:

Step 3: Short-listing candidates for final analysis

A comparative analysis of RFP responses can be an extremely complicated and time consuming exercise, even when the majority of questions are closed. An RFP covering the full range of basic, added value and related services may have as many as 300 or more detailed questions. Suppliers’ responses can run into many volumes, especially if the supplier includes examples of their reports and market intelligence data on individual countries.

Buyers should consider dividing the RFP analysis stage into two parts starting with a first cut analysis of key criteria, before progressing on to a full scale analysis of the RFP responses.

First cut analysis of key criteria

The first cut analysis concentrates on a limited number of specific requirements (say 15-20) that are absolutely critical to the institution. Typically, these requirements will include two or three detailed questions taken from each of the key hurdles listed in Figure 7.8.

Each candidate’s answer to a specific question can be scored out of 10, using a common basis for scoring across all questions and candidates. Not all requirements will be equally important, and so a weighting factor can be applied to the critical requirements, to boost their impact on the final score. The initial scoring and weightings should be carried out by a senior executive with specialist inputs from operational staff or other parts of the organisation as necessary, or by an independent adviser with proven credentials.

Out of this process, a ranking of candidates will emerge which indicates their respective abilities to meet key requirements. It is helpful to use dedicated RFP management software to create the weighted scores and rankings, and test the sensitivities of alternative weightings - for example, placing greater emphasis on attitude to risk management versus commitment to the business, or vice versa.

The focus at this stage should be on the candidates with the lowest scores. Experience suggests that buyers may be able to relatively quickly identify candidates who lag behind other candidates in critical service areas. Where a particular supplier is clearly behind the rest, the buyer may decide to exclude it from the detailed, final analysis of suppliers.

Step 4: The decision to appoint

The final choice of preferred supplier(s) will be based on the detailed assessment and review of the full RFP responses, combined with follow-up meetings and discussions to clarify specific issues or uncertainties.

Full analysis of RFP responses

The full analysis of RFP responses should be carried out using the same weighted scoring approach as applied to the key criteria. (Figure 7.9). Each section should be scored by managers responsible for the activities or functions covered in the RFP. For example, the manager responsible for corporate actions should score the RFP questions on corporate actions. Non-functional areas, such as each suppliers’ commitment to the business, should be scored by a senior executive, with specialist external consultancy inputs as necessary. A legal perspective of the contractual guarantees and indemnities sought by buyers can also be of significant value at this stage of the review.

Follow-up clarification meetings

The candidates’ responses will inevitably give rise to a number of additional issues during and after the scoring process. These issues may range from something as basic as an apparent miscalculation in fees in the RFP response (it does happen), to a more complex debate over the rights and wrongs of handling specific service requirements in a particular way. Follow-up meetings and discussions should take place at senior management level, and should not involve more junior operational managers or staff.

A considered assessment of the final weighted RFP scores and follow-up meetings should enable the buyer to identify one or more preferred candidates. At this stage, buyers may choose to carry out diligence on only their preferred candidates, or they may still want to keep their options open, until the results of the due diligence exercise have been obtained.

Due diligence

The due diligence exercise should ideally involve both executives and senior operational staff in a site visit to each supplier. It should also include consolidation and formal legal review of the contractual guarantees, indemnities and service level agreements made by the supplier in their RFP response and any follow-up correspondence.

The exercise serves two main purposes. Firstly, it provides buyers with an essential check on whether or not the preferred supplier(s) can actually deliver the services they say they can, and to a level that meets or exceeds specific standards of service. Further assurances can be gained by taking up references with existing customers of each supplier.

Secondly, the due diligence exercise provides the buyer’s senior operational staff with an opportunity to meet the people they will be working with from the supplier’s team. The human relations aspects are vital, especially during the early stages of a new buyer-supplier relationship. However, this meeting also gives the buyer the opportunity to assess the strength in depth of the supplier’s staff in general, and experience and suitability of nominated account staff in particular.

The transfer of assets and post selection evaluations

Once the due diligence exercise has been successfully completed, and the board of directors/trustees (or senior executives) have approved the final selection, the buyer and supplier will enter into final negotiations and legal agreements. This will typically cover:

• agreement on the main Custody Contract between the buyer and supplier;
• the preparation of specific Service Level Agreements;
• detailed plans for transferring business, and the personnel to be involved; and
• agreed fees, including the costs incurred in the transfer.
• Fees can become a key issue at this point, with final negotiations over both the level of fees to be charged over a specified period, as well as who pays what for any costs incurred during the transfer of assets.

Phase 3: The transfer of assets and post selection appraisals

Following these final negotiations and agreements, the buyer will arrange for the transfer of assets to the new supplier, and agree a formal mechanism for monitoring progress over the coming months (post selection appraisals).

Conclusions

The process of formally reviewing existing arrangements and/or changing global securities services suppliers can be an expensive and time consuming exercise for all concerned. It is not an exercise to be entered into lightly. However, it is a process made easier if the buyer chooses to follow the step by step procedures recommended in the book, and described in more detail in the supporting Thomas Murray toolkit and supporting databases of best market practices and suppliers.

Is it worth the effort?

The answer to this question, from feedback volunteered by institutions who have recently switched suppliers, is a unequivocal YES. The benefits of carrying out a formal RFP process do outweigh the costs, as outlined in Figure 7.10.

BENEFITS OF A FORMAL REVIEW COSTS OF A FORMAL REVIEW

• Opportunity to compare the services provided by competing suppliers
• Better understanding of market best practices
• Better understanding of internal requirements and opportunities for enhancing internal services
• Potential to negotiate a more favourable deal on fee rates, based on a range of competing quotes
• Resource requirements - in terms of management time and effort
• Potential delays in appointing a new supplier, caused by going through the various formal steps

Buyers must be committed to the RFP process, and in particular, must be willing to include the full range of potentially suitable candidates in the long-list for selection. The influence of long-standing relationships and additional factors (described in Chapter 4) may point to a shorter list of preferred suppliers. However, even if a buyer does not opt for the ‘best’ supplier on global securities services merits alone, at the very least they can learn from different suppliers’ approaches, and seek to develop best practices within their own arrangements.

Secondly, buyers must be prepared to change their existing arrangements, if they find that genuine and sustainable improvements are available from another supplier or suppliers. If the exercise is designed simply to persuade existing suppliers to deal with particular service deficiencies or (say) reduce prices, then there are other, less time consuming evaluation approaches - described in the last Chapter.

Reference

Article describing a custodian bank