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Buyers of global custody services expect their global custodians to pass on the mutually beneficial effects of more efficient, automated technologies, by reducing fees as well as by improving service quality. The global trend towards lower safekeeping and settlement fees at the commodity end of the market has been given additional impetus by more aggressive competition between suppliers for highly valued customers; as evidenced by some high profile wins, during the past few years, based on very low or nil safekeeping and transaction fees.
In a few markets and sectors, buyers are obliged by law to select the cheapest supplier when they send out a custody RFP, as is the case for some State owned institutions. Pricing can also be a key factor for asset management and brokerage groups who have been given responsibility by their clients to select external supplier(s). These groups may opt for the cheapest supplier, on the basis that it improves their margins.
On the other hand, the level of custody fees paid for safekeeping, transaction and information services are not normally the most important selection criteria used by buyers on behalf of their institutional funds. For the vast majority of buyers, issues relating to the safety of assets and service capabilities are of significantly greater importance. Buyers often argue that “cheap buys trouble”, especially in emerging markets with manual systems, where they feel more exposed to the potential losses arising from poor settlements administration or erratic local customs and practices. Some buyers have also found that low ‘visible’ fees structures for safekeeping and settlements may hide larger ‘invisible’ earnings, in other areas, such as foreign exchange transactions. (Part 4 examines the full range of revenue generating areas and the importance of understanding ‘invisible’ fees).
Even in mature markets with automated systems, buyers will not necessarily opt for the cheapest supplier. Most buyers interviewed by Thomas Murray do not see fee levels becoming the critical factor in the buying decision until there are no clear differences in the financial strength, range and quality of services provided by competing suppliers. Having said this, of course, buyers will seek to reduce global custody fees during the latter stages of a selection process.
Reconciling custody fees, pricing structures and costs
An increasing number of buyers are considering the overall cost-benefits or "value for money" of using a supplier, rather than simply considering the level of fees paid. An appraisal of value for money involves reconciling the level of custody fees paid for the full range of securities services provided, with the pricing structures, i.e. the way visible and invisible fees are calculated and charged, and cost equations, i.e. the impact that using a particular supplier or mix of suppliers has on the economics of the buyer’s own operations.
Custody Pricing structures - bundled or unbundled
Pricing structures are a matter of considerable debate in the global custody industry. The majority of buyers prefer the simplicity of ‘bundled’ fees, where they pay a single charge for services used. Others prefer ‘unbundled’ fee structure, which itemise charges for individual activities. For this latter group, the benefits of tracking individual charges are perceived to outweigh the additional administrative efforts involved.
In most cases, basic custody fees are calculated according to the market value of each fund and the volume of transactions. In dematerialised/immobilised markets such as the US some suppliers prefer to be paid according to the number of lines of stock. Although the actual fee rates may be similar, the second method does not overtly penalise fund managers with above average performance. If the market falls, of course, buyers using this type of pricing method will be disadvantaged.
The cost equation
A better understanding of internal cost drivers helps buyers to assess the relative cost-benefits of their securities services arrangements. For instance, the resource requirements of using a single supplier with a single global interface, and standard operating procedures across all markets, will be quite different from the resources required to handle a mix of suppliers, with multiple systems interfaces and procedures.
At the same time, the escalating costs and risks of retaining services in-house is encouraging buyers to review the attractions of outsourcing, or entering into strategic partnerships, where development and servicing costs are shared. The perception that the costs and risks of outsourcing, switching or consolidating suppliers can outweigh the benefits is no longer so widely held.
Thomas Murray provides detailed custody fee analysis as part of the Custodian Monitoring service. |
