By Barb Shegog
There are a lot of things that treasurers would rather do than work with their custodian banks. But with MMF reform, custodian banks are here to stay.
Is the best custodian the one that you aren’t using? The custodian provides significant support services to the investment program, yet many investment managers and certainly most NeuGroup peer group members would only rate their custodian as average. NeuGroup members would also admit to some sort of work-around or staying the course, because switching custodians can be very cumbersome.
Now with money market fund reform effectively negating that destination’s benefits, more investors are looking toward selecting a custodian. Unhappy with MMF reform’s fees, gates, and market-value adjustments, investors are looking toward separate accounts (which require a custodian) to replicate the qualities of prime money funds. This can be seen in a recent increase of almost 7% in custodian bank assets over the past year (see chart below).
But not all custodians are created equal. In fact, the only way they are similar is in how much investors don’t like dealing with them. The questions that often come up in NeuGroup peer group discussions on custodians are how difficult the switch might be to a new custodian, how peer group members have worked with their current custodians to provide a service that better meets their needs, and what the process is for selecting a new custodian.
Opinion on custodians is not pretty
The overwhelming majority of the NeuGroup’s Treasury Investment Managers’ Peer Group (TIMPG) members rate their custodians as good, certainly not great. This was a surprise as the custodians are such an essential component of a successful investment programs.
At the most recent TIMPG2 meeting only one member present rated their custodian as excellent, and they had recently hired them. Despite the negative opinion in the room, only one member in the group has conducted a replacement search for a new custodian in the last few years. Many felt their current custodian was just good enough not to warrant the trouble and disruption of a search and change; further, members are not convinced that there is anything better than what they have.
And changing custodians is not fun. Many members dread a switch so much they stick with the status quo even if it isn’t really working. Have investors given up on excellence? When members are polled, many say their custodian is “average”; members are very loyal to good customer service with the chief complaint across many custodians being the lack of security knowledge and mistakes.
Time for change?
Have no fear, members assured one another that it is possible to make a pain-free switch and find something better. A TIMPG member walked fellow members through their custodian search. This member had used the same custodian since 1999; the service was declining while fees were not.
The company also had seen very little improvements in tools and reporting over the years, so it was time to look and see what else might be out there. One factor in considering a custodian is the credit facility. Often a member of the credit facility is awarded the custodian services.
Where to start?
This company’s first decision was to award the accounting to an outside provider independent of the custodian. By removing the accounting portion, the RFP could focus on the custodial services.
Many members rely on the custodian for their book of records. If this is the case, performing due diligence on outsourced pricing models is important. Check for their track record on failed trades. This seems to be a pain point for members, so experience and track record around this is important. Current investment managers can be an excellent source for input on custodians.
Also, consider how responsive the custodian is to questions. After switching custodians and receiving more timely information, one member realized how long it took their prior custodian to produce simple information. Sometimes members are willing to give up technology for responsiveness.
Fees can be misleading, too. Some custodians include accounting in the fee, some offer a flat fee and some offer a scaling fee. Trying to make an apples-to-apples fee comparison can be difficult. Then there is credit for money fund portal use and other various credits, so the challenge becomes bigger.
what to look for
All the information below was summarized on reporting grids for side-by-side comparison.
Key Requirements for the RFP Response
- Separate price quotes for Custody and Accounting.
- Detailed descriptions of customer service structure, trade processing.
- Security pricing, controls, accounting, reporting.
- Additional services offered: e.g., analytics, compliance.
Framework for Evaluation
Members have found with better communication of issues the relationship can be improved. Everyone agreed this is the best first step when thinking about replacing your current custodian. One member shared their evaluation template to use when reviewing and communicating with your current custodian.
Report Card for Custodians
Many members put together a scorecard for the investment managers; however, not all prepare the same feedback for their custodian. Peter Shen presented a framework to conduct a more formal discussion.
- Custody: Any issues with service or process?
- Accounting: Are they meeting reporting requirement or any issues with accuracy?
- Compliance: Any issues with compliance monitoring?
- Performance Reporting: How is this working (if applicable)?
- Service: Client relationship team and service.
- Reinvestment: Any system developments or improvements?
Custody Banks trying to improve
For their part, custody banks are trying to improve. To that end, they are trying to organize and analyze the reams of data they collect, to improve their responsiveness and optimize customer understanding of their portfolios.
According to Joseph L. “Jay” Hooley, chairman and CEO of State Street Corp. in Boston, the global custody business is starting to move from transactional business to a data and analytics business. This has “redefined the audience we’re talking to: it used to be back office to back office, and now it’s back office to front office, as the information inherent to what we do becomes more interesting to portfolio managers and risk managers,” he told Pensions & Investments in March. And success, he added, will go to “those that can extract insights on a real-time basis” from the trillions of dollars of assets they oversee globally, “to help inform client judgments about investment management, risk management and compliance.”
Whether this leads to better data aggregation and analytics and more automation remains to be seen. For now, selecting a new custodian remains an overwhelming task but it need not be. Regular communication and a more formal evaluation process with your current custodian can help improve the relationship. Always remember, the best custodian could very well be the one you are not using.