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Custodians have long been in the perfect position to assist pension funds in their pursuit of good governance, but the financial crisis has emphasised their worth as neutral monitors. Stephen Isgar explains

the evolution

of custody

22 November/December 2010 cisi.org


continuing professional development

against a backdrop of ageing populations and volatile markets, there is more focus than ever on pension scheme governance – how and where assets are invested and how risk is monitored and managed. Schemes are being forced to devise more innovative investment solutions to match their rising liabilities. To support this approach custodians are making intelligent use of the data they hold and the latest technology to help pension scheme clients track their funding levels and liabilities, and manage these in a more proactive way. The evolution of the modern custodian Custody is the safekeeping and servicing of clients’ assets to provide additional revenue and protection from economic exposure. It is provided by a custodian bank, which is either part of a larger bank or a specialist custodian. In the days when investors generally held securities in the form of physical certificates, there was a clear need for somewhere safe for these to be stored. Custodians, with their impregnable vaults, were a natural choice and could be- relied upon to hold these certificates over the long term. This was an essential function, but a passive one; custodians arguably melted into the background – always there, always With developments in reliable. technology, access to a client’s securities in safekeeping allowed the custodian to provide additional asset-related services, such as settlement (delivery versus payment), tax reclaim and proxy voting, and led to the emergence of global custody. Custodians are now single-access points to markets across the globe, and offer investors with geographically diversified portfolios a host of information processing and reporting services. The challenges facing pensions trustees At the same time, pension funds are becoming more sophisticated and devising investment strategies to match their liabilities. Trustees, who hold the ultimate responsibility for their funds’ performance, have recognised that they must understand the key issues affecting their schemes and put in place robust governance frameworks. They must also implement checks, balances and policies to underpin that framework if they are to govern their schemes successfully in line with their investment policy and funding flight path. Unfortunately, given the time constraints on trustees, it is perhaps unreasonable to expect them to monitor continuously and manage the overall scheme investments and risks within their This is governance remit. where the custodian should step in. Today, custodians spend billions on technology to service assets globally, and the high levels of automation have, to a large extent, led to the

commoditisation of their core services. But the best are making intelligent use of the data they hold and leveraging their technology to become independent and trusted monitors for their pension fund clients. In doing so, they have been able to provide invaluable assistance to funds pursuing good governance. The recent upheaval in the markets has forced a renewed focus on asset safety, and once again brought custodians into the limelight. The role of the custodian in effective scheme governance Custodians can assist pension trustees in a number of ways. They have access to comprehensive information concerning the scheme’s assets and are, therefore, uniquely placed to provide independent and neutral analysis of the scheme’s funding level. Sound investment accounting, compliance monitoring and performance measurement on the asset side (and using this information prudently to match liabilities) are the core building blocks of scheme governance, supporting two crucial aspects of any scheme’s strategy: investment strategy and Custodians risk management.

Trustees must understand the issues affecting their schemes and create robust governance frameworks can play a vital role in helping trustees and investment consultants to maintain and monitor a robust investment strategy for their schemes, since they can provide independent compliance checks on the activities of their asset managers and ensure that the investment guidelines set for the scheme are followed. As well as providing regular valuation reports on the scheme’s funds, they measure the performance of both portfolios and managers. Secondly, custodians can offer a range of solutions in support of effective risk management. As well as providing indepth analysis relating to the performance and compliance of the funds and the fund managers, custodians can help the trustees identify the risks associated with investing scheme assets, enabling the trustee and consultant to build a risk management framework based on assessing the risks to the total portfolio and asset classes, stress testing and risk budgeting (is the scheme staying within its pre-defined risk To take budgeting levels?). this further, if fund accounting is the basis for reporting the value of the scheme’s investments, why not use it to the benefit

of the trustee by demonstrating the overall cost and performance of the asset allocation? If compliance monitoring is the basis of keeping track of the assets invested and the asset managers investing those assets, then why not develop this further by providing a breakdown of the limits and breaches of the individual portfolios and the benchmarks set? This will offer the trustee a much deeper insight into how the scheme’s investment strategy is being governed compared with the Statement of Investment Principles. Of course, trustees are accustomed to receiving detailed analysis of the scheme liabilities in the form of actuarial valuations, and regular hard-copy reports of the fund’s investment performance from their custodians. But the best custodians combine these two separate sets of information within a single online portal, bridging the gap between the two and enabling more efficient analysis. Graphs and tables augment the data-heavy reports of old, to allow both trustees and sponsors to assess, at a glance, where their schemes stand, and make informed changes to their strategic asset allocation policies in response. Such portals can also provide compliance monitoring and risk management capabilities, and allow drilling down to underlying data. So independent custodians are taking the core building blocks – fund accounting, performance measurement, compliance and risk monitoring – and integrating them with trustees and other key stakeholders in mind, to underpin an effective governance structure for the scheme. Access to concise, yet comprehensive, information from a single source empowers trustees and consultants to maintain control of funding levels, and will potentially deliver efficiencies in both Ultimately, it is time and cost. the trustee’s responsibility to make use of this analysis, in particular to monitor their advisers. As Marian Elliott, Director and Head of Actuarial at Atkin and Co, puts it: “Crucially, trustees can use the results of any monitoring platform to question advisers and analyse the reasons for any underperformance, ensuring that the strategy remains appropriate and taking The action where needed.” custodian’s ability to provide in-depth analysis on the asset side and to combine this with liability valuation assumptions will ultimately deliver the framework for an all-round, effective investment governance structure. Stephen Isgar is Business Development Manager, Institutional Investors at KAS BANK

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