Selecting a global custodian bank is an important decision and should not be taken lightly. The primary role of a custodian bank is to hold securities for safekeeping, undertake due diligence, and manage record-keeping and reporting.
Whether choosing a custodian bank for the first time through a request for proposal process or reviewing your current provider, it is worth taking the time to find a custodian that can be a valued partner in your operations and best suits the needs of the business.
Scott Lee, investment management director at KPMG, says: “Insurers and reinsurers should be looking for robust credentials in a custodian bank, and look for case studies and evidence that the organisation can do the basics. They have to have good service levels, good data management, and also good security – including cybersecurity.”
(Re)insurers should look at their own business to work out what their needs are and consider if and how their business could be run more efficiently.
“What would good or better look like, and what would it look like in five years' time?” asks Mark Austin, head of UK, institutional investor group at Northern Trust.
“Quite often when someone comes to review a custody arrangement, they don't look at what they want the service to encompass and what it should look like. They should take a step back and look at what it is that they want their business to look like, and then let the custodian understand what that looks like.”
The banks provide largely the same core service and they have to provide it in exactly the same way, according to Jessica Hynes, head of custody and securities services at Taurus Management Consulting.
Custodians are responsible for monitoring corporate actions for the securities they hold on for their clients, including rights issues, stock dividends, stock splits and tender offers.
While there is not a huge difference between corporate actions services among custodian banks, there can be a difference in the timeframes up until the actual point that clients need to instruct, says Austin.
According to Hynes: “All custodian banks can settle trades on time, do corporate actions and tax reclaims - so that isn't a differentiator. What differentiates custodian banks is what new things are going on. What new technologies have they got? How are they responding to the new asset requirements? How is their new technology improving the client experience?”
Determining which custodian bank is the best depends on the (re)insurer’s needs and asset mix because different banks have different specialisms.
Alternative assets
Insurers and reinsurers typically used to have a simple asset allocation of just stocks and bonds but since the financial crash of 2008/9, their investment profiles have become much more sophisticated as they invest more in alternative assets in the search for higher returns.
Hynes says: “If insurers hold alternatives, they need a custodian that specialises in this asset type or has acquired a firm that specialises in it. Whereas, if an insurer is mostly sitting on government bonds, they can just go with the lowest bidder.”
This echoes what Austin is seeing from the sector: “When insurance companies come to market, they are focusing less on the pure custody, and actually focusing more on their problems which quite often are the alternative assets.”
Management of cash and capital is also an important consideration when selecting a custodian, he adds, as insurers often have lots of subsidiaries and move capital between insurance centres in order to be more capital efficient.
“Quite often, they end up with smaller portfolios to manage and have a lot of working capital that could be better utilised,” says Austin. “We have seen some insurers look at fund structures in a set domicile as a way of centralising the fund management and fund administration while still allowing the capital to be decentralised.”
Tech and data
Custodians have historically been viewed as providing unexciting commoditised services with little innovation, but many have now invested millions in improving automation, and making technology advances. For example, query handling has become more automated.
KPMG’s Lee says custodians have been repositioning themselves to offer clients both a commoditised service and value-added service. He believes custodians will become data consolidators as opposed to just receivers of transactional data.
“The custodian banks that are reinventing themselves are those organisations that have a lot of data and information - most of which they never really used for purposes other than the transactional commoditised services,” he says. “[Those] custodian banks probably have the largest set of data because they receive it from multiple sources.”
Custodians can also provide clients with financial data for regulatory and shareholder purposes.
“Going forward, the insurer should be able to look upon the custodian bank as being completely regulated for them and therefore able to provide exactly what they need, when they need it and how they need it. And that has started happening,” says Lee.
For example, custodian banks can help with fund accounting and regulatory Solvency II reporting, which have become much more onerous.
Austin says insurers should ask themselves: “What data do you need to get back into the system to enable you as a CIO of an insurance company to make the best use of your ideas, make the best use of your time and invest profitably for the company?”
ESG capability
Another value-add service that custodians can help with is environmental, social and governance (ESG) scoring, an increasing burden on the insurance sector.
Lee says custodians are working on mechanisms for how they can provide ESG data assessment information for their clients but there are “huge differences” between the banks' approaches.
“The partners that the banks are engaging with have different ESG methodologies, and so you could have a completely different ESG score between one bank and another depending on who they are using,” he explains.
“If insurers are interested in ESG investments, then they need to dig into how it's being done and who it's being done with. Can the custodian give you the data and granularity that you require?”
Custodians can provide a myriad of services beyond their core products – if their clients are prepared to pay for it, of course. It all comes back to insurers and reinsurers looking inwards to really work out what their needs are before selecting a provider.
