Thomas Murray Institutional Newsletter

10 Questions to Ask Your Custodian in Turbulent Times

Suppliers and vendors are going into liquidation, employees are being let go, and the capital markets have been on a roller-coaster ride since Lehman Brothers filed for bankruptcy. In turbulent times such as these, an assessment of the appropriateness of the selection and continued appointment of your custodian bank is prudent.

When reviewing your fund's existing custody arrangement, some of the areas that you should examine include: custodian's credentials, delivery of core services such as corporate actions, internal functions such as network management, level of responsibility for loss of assets and cash, delivery and transparency of value-added services and fees. Here are ten questions that you should ask your custodian to get you started with your assessment.

What is your organisation's ownership structure and financial strength?
Today there is a strong focus on the financial stability of counterparties and service providers. Knowing the strength of your custodian's balance sheet and underlying insurance arrangements is important. Also knowing if it is publicly and widely owned, and if there are any major shareholders that have a direct influence over its strategic direction is also important in providing a full understanding.
Is the contracting party the main operating entity of the custodian?
It is important to have the protection of the most secure entity (well capitalised and a strong credit rating). If the contracting entity is not the main operating entity, then a parental guarantee would be appropriate.
Are cash balances held on your balance sheet?
Cash, unlike securities, is fungible and cannot be segregated from a custodian's assets and liabilities in the event of bankruptcy. Knowing if your custodian acts as principal and holds cash on its balance sheet or knowing if cash is held on the balance sheet of the sub-custodian will help you assess your exposure.
Have you, or your clients, had to take losses in your cash funds?
Many clients use various forms of short term investment funds (STIF's) provided by their custodian to invest short term cash surpluses or cash collateral arising from securities lending. You need to be sure that these funds are conservatively managed, appropriately rated and governed and that they have not incurred losses (or if it there have been losses, that the custodian has supported the fund and has taken appropriate action to minimise future losses)
Are the fund's assets "ring fenced" in all markets from the custodians and sub custodians?
In order to avoid co-mingling of the fund's, custodian's or sub custodians' assets in insolvency, the securities in each market need to be appropriately ringfenced. Has this been done in all markets? How does the custodian demonstrate that the maximum protection has been afforded?
What level of responsibility do you take for sub-custodians and agents?
The assessment of the risks resulting from the involvement of sub-custodians and agents that hold your assets, settle trades and arrange voting is important. What protection does the fund have if they are negligent? Is the fund covered for the direct loss?
What level of responsibility do you take for corporate actions?
It's not sufficient that the custodian has agreed to send you corporate action notices it receives from its agents and suppliers. If the information is publicly available in the market, then it should be the custodian's responsibility to provide you with that information on a timely basis.
How can you illustrate that the custody arrangement is fully transparent?
There should be a transparent fee structure across the full range of core custody and value-added services. Interest should be paid on all currencies and balances at a disclosed rate and linked to an established market formula. Likewise, foreign exchange rates should be similarly treated with an agreed spread by currency and deal size with all contracts time-stamped and monitored against a published benchmark.
Can you support my future investment strategy and asset mix?
Does your existing custodian have the knowledge, skills and technology that is required to support increasingly complex investment strategies that your fund might develop in the future? These include exchange and over-the-counter derivatives, units in hedge funds and fund of funds, infrastructure investments and property, both direct and indirect as well as active or passive currency hedging. Many of these investments do not require the custodian to actually safe keep the assets but it is required to accurately account for these investments in the financial statements it produces.
What is your long term commitment to the custody business?
To ensure future continuity, you need to know if your custodian will be a committed participant in 2009 and beyond. What is the custodian's overall strategy for growing and developing the business over the next three to five years and what is its investment technology expenditure?

For further information contact Nick Bradley.
Tel: +44 (0)20 7830 8300
Email: nbradley@thomasmurray.com

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