Seeing Clearly

Getting to Know You
Custodians also have other challenges to deal with. After weathering a difficult period, plan sponsors are concerned about managing risk and are demanding more transparency into custodians’ operations. This means, custodians are seeing a renewed interest from plan sponsors in their operations—that is, they want to know just who their custodians are. “People are using this crisis to really look at who their providers are and [ask,] Will they sustain this crisis better than others?” says Arti Sharma, senior vice-president, Americas, with Thomas Murray (a custodian overseer). “We’ve seen movement in the business with clients where they’ve taken [knowing their custodian] as a reason to move in the last little while,” she says, adding that though this activity has waned, it won’t completely disappear in 2010. Ron Robertson, senior vice-president and managing director of State Street’s investment servicing business in Canada, says custodians must be more agile, more responsive and more flexible to help their clients.

Getting to know your custodian makes sense—particularly with the looming threat of litigation against another organization’s imprudence. Although there have not yet been any lawsuits against custodians in Canada, sponsors have only to look to the U.S. for examples. Last October, the California attorney general’s office charged State Street Corp. with fraud, claiming that the custodian had illegally overcharged the CalPERS and CalSTERS pension funds for a number of foreign exchange trades since 2001. State Street says it “categorically denies any allegations of wrongdoing” and will defend itself against litigation. But regardless of the outcome, the incident stresses the importance of transparency. “It validates the point of clients really taking a look at their service providers, the services that they are providing to them, the nature of those services, the value of those services and how they’re created,” says John Lockbaum, managing director, Canada, with RBC Dexia.

Transparency, Sharma explains, is a theme that plan sponsors will be consumed with for a few years. “We think, post-Lehman and post-Madoff, that area becomes even more critical—what services you’re providing, what risk you’re assuming and what you’re charging for it,” she says. Case in point: in January 2010, the Federal Reserve Bank of New York and Stanford University released a report stating that over-the-counter (OTC) derivatives need more central clearing requirements and more transparency.

“You’re going to see our industry move toward finding more fortress-like solutions [for derivatives],” says Lockbaum. For example, he says, since certain aspects of the derivatives instrument markets are more manual in nature, there will be a move to improve technology and enhance straight-through processing rates.

Another example is pricing. Usually, traditional pricing has dual pricing sources, but that’s difficult to do with derivatives. “The move in the industry is to make sure that, from a transparency perspective, we understand how the price was derived—where it came from and that there’s an enhanced validation process,” says Lockbaum. Northern Trust’s latest product, Numerix, does just that. “It allows for pricing of these complex-structured derivatives, which is a challenge in the industry,” says Robert Baillie, president and CEO of The Northern Trust Company, Canada.

Certainly, derivatives will continue to be an area of investment for plan sponsors and a focus for custodians going forward. For example, OTC derivatives transactions at Northern Trust have grown by 30% each year from 2000 through to the end of 2008, says Baillie. He adds that Northern Trust will continue to look at making further enhancements to its OTC derivatives platform, including valuation and risk management.

Custodians are also accelerating their communication efforts. Robertson says there’s not only more communication but also the sharing of best practices. “Clients are coming to us now and asking what we are doing internally to optimize our own operating model.”

Tech Check
Technology is key for many custodians in delivering access to information. “People want information that much quicker,” says Scott Scobie, general manager of Canadian Western Trust (CWT), adding that monthly or quarterly reports just aren’t acceptable anymore. Scobie says a combination of elements is prompting this trend: the media frenzy over the last 18 months, greater client awareness and the fact that the aging baby boomers managing the pension plans have an increased personal vested interest. Baillie adds that clients want to know which managers are sending automated transactions and which ones aren’t. “Automation can minimize operational risk.”

Web applications provide another way for custodians to reach their clients. State Street’s Web portal, for instance, provides clients with reporting that allows them to view and monitor the activity in their portfolios. But information alone is not enough: Robertson adds that education is key. “A large component of our approach is educating our clients on how to optimize and realize the full benefits of this portal for their specific needs.”

For its part, Northern Trust is currently focusing on mobile technology; specifically, the smart phone. Its smart phone apps provide basic data—common sense information applications such as an exposure report or daily market values—that clients would find most vital. “It’s not designed to completely replicate our online product,” says Baillie, “but it’s meant to give critical information to clients when they’re not in the office.”

Lockbaum says RBC Dexia has a few clients that use mobile technology for end-of-day critical timeliness and accuracy reports. But while he believes there could eventually be a groundswell around this technology, it hasn’t happened yet.

Sense of Securities
With greater pressure on custodians to be upfront about their operations, the practice of securities lending is still under scrutiny. According to the 2009 Agent Bank Review for the Major Markets, program revenues over the last year have declined. Bank of New York Mellon, for example, had only US$43 million in lending revenues as of September 2009, compared with US$155 million in September 2008. And State Street Bank had US$105 million in September 2009, compared with US$246 million in September 2008.

In Canada, although custodians did see a drop-off in their securities lending programs, many of their clients have come back. “Although margins are low in these economic conditions, people think that the rewards (the revenues) are worth the risk involved when a program is well managed,” says François Gagnon, executive vice-president, custody services, with Desjardins Trust.