|
In the wake of the global financial crisis, Tier 1 and 2 banks and brokers have, or are reviewing, their procedures for monitoring risk across their global sub-custodian network, being sub-custodians and central securities depositories (CSDs). In the past, some global network management groups have relied heavily in their sub-custodian risk monitoring on input from industry surveys, passive web conferencing or sub-custodian relationship and sales visits to complete their operational reviews which has its obvious weaknesses. The banks and brokers now want to verify this themselves.
Indeed, under FSA regulations in the UK, broker-dealers and global custodians running their own network have previously faced no explicit requirement to conduct regular on-site monitoring for their sub-custodians. Network managers would ask their sub-custodians to complete risk questionnaires, in many cases supplementing this with additional information acquired by conference calls, and commonly this would satisfy their internal compliance requirement. Little, outside the largest groups, was done at all to look at the local market infrastructure organizations, including CSDs. It is evident that some network groups were not conducting regular on-site operational reviews, particularly for the smaller, low-volume markets within their networks. Some broker-dealers had little in place for monitoring the performance of their sub-custodian and for identifying points of risk. As a consequence it was questionable whether this level of passive monitoring provided the robustness and resiliency to adequately protect client assets.
European regulatory initiatives are forcing change. Both the AIFM and the pending UCITS V Directives currently require the global custodian to take responsibility for their sub-custodians. This is a very sensitive issue in the industry. Some global custodians have responded by expanding their own self clearing arrangements, reducing dependency on a network and keeping the risk on their own balance sheet. We have also noted pressure in this direction from asset owners, which are demanding greater transparency from their global custodians regarding potential risks to their assets at market level. This level of risk disclosure is something that the US Securities and Exchange Commission, under its Rule 17f-7 to the Investment Company Act, have required for mutual funds for nearly a decade.
In responding to these pressures, the large banks and brokerage companies are setting in place continuous and active sub-custodian monitoring, including increased regular on-site operational reviews. Moreover, some are taking steps to share this information more effectively with their clients – providing beneficial owners with a view through to the local market in order to provide a more transparent, real-time picture of how sub-custodian risk, infrastructure risk or other risk sources may impact their assets.
It seems likely that the larger Tier 1 banks may continue to do much of this risk assessment internally and other network teams will continue to review the larger markets themselves. For brokers and smaller banks it may make business sense to outsource a major share of their data collection and network monitoring to an external specialist allowing in house network managers to concentrate on higher value elements of the agent bank relationship and operational issues.
We feel that we are at a tipping point for the industry, whereby banks and brokers will await clarification around the future operational review obligations that will be required by financial regulators before they take firm decisions regarding their business and operational strategies. Many groups are not waiting and are being forced by their Boards to beef up their network management activities and the quality of information available to their clients. Some global intermediaries wish to be at the leading edge of industry standards, ensuring that they support their risk evaluation with quality data input and a robust methodology. Others may wait until they better feel the direction and push from their financial regulator before seeking assistance from an external specialist. Whatever the outcome of future regulations, custodians and brokers need to adequately demonstrate to the asset owners that they are taking pro-active steps to ensure the safety of their clients’ assets through a rigorous programme of monitoring.
Derek Duggan, Director, Data Services
dduggan@thomasmurray.com |
