May 2009

FRANCE: The rising cost of Custody

French custody banks charge the lowest fees in Europe, they say. But investors should expect these to increase, finds Angèle Spiteri Paris The Madoff hedge fund scandal made investors acutely aware of the role that custody banks play as safekeepers of assets. A political spat broke out between Paris and Luxembourg when Madoff was found to be the sub-custodian for French investments. Yet clients had assumed the Luxembourg branch of UBS, the Swiss bank, had held their assets nice and securely.

Custody banking is big business in France, but it would be difficult for the country’s custodians to make capital out of the situation at the expense of their European rivals or at the expense of Luxembourg. Like UBS, they also have significant business interests in the Grand Duchy.

UBS was the custodian for the Luxalpha fund and HSBC acted for the Herald fund. Both funds were exposed to the Madoff fraud and have been liquidated.

Alain Closier, global head of Société Générale Securities Services (SGSS), says: “The Madoff affair was very interesting because HSBC or UBS was the trustee and the sub-custodian was in fact Madoff Securities.

“The final client is not aware of the connections between the distributor, asset manager, the depot bank and the sub-depot bank. An investor can believe his investment is comfortably being held by HSBC or UBS when, in fact, it is being held by a firm like Madoff Securities.”

He adds: “It was not clear where the responsibility lay. I believe one of the consequences of this will be that the final client will request clearer information regarding those involved in their investment.”

Jacques-Philippe Marson, the CEO of BNP Paribas Securities Services, adds: “In the case of UBS and Madoff it was multiple functions in the chain that were implicated. So it was not specifically the custodian or the depositary. All these services were embedded and because they cover the full spectrum they will have a tough time to escape.”

Closier expects there to be “an evolution in the responsibility of the depot bank”, and he believes that sub-custodian selection
by global custody banks will become more sensitive.

“Things are changing,” he says. “The need for global custodians to reconsider their network of sub-custodians will have an important impact on the industry.”

Custodians are always keen to talk about their size and scale, and are  keen to be seen as direct players in a number of markets.

Marson says: “In terms of sub-custody, we’re well positioned. Ninety percent of our sub-custody is with ourselves. This is unique in the European framework, because no one else has the span we have.

“You cannot use a domestic bank with a rating that is not good in a country where you have risk. You simply cannot continue to work like that.”

Fees versus risk
One way or another, a greater risk is creeping into custody and custodians are recognising this. The broader financial crisis is forcing change in the general banking sector but custodians have largely avoided being confused with their investment banking cousins. Yet the roles and responsibilities of these asset service firms are bound to change too, and beyond calls for them to take a greater liability for assets, the crisis means custody banks have other more everyday risks to contend with that hit the bottom line.

Low interest rates and falling stock market value all have undesired effects on their business.

Closier, of SGSS, says the new risks that custodians have to manage are completely specific and different from those faced by an investment bank or an investment manager. He says asset servicers tend to have more exposure to operational risks rather than market risks due to the industrial nature of the business.

Fee structure
A big issue on everyone’s mind is what the changing roles and responsibilities of custodians – along with the market impact – will have on fees. Historically, asset service companies such as the custodian banks have not commanded a large portion of an investor’s total expense ratio. But with income from their back-office clearing and settlement functions typically linked
to the net asset value of trade flows, income has inevitably shrunk in line with market values.

François Marion, chairman of Caceis Group, says: “Currently most of the margin is taken by the distributor. Then the asset manager levies its fees. Then finally you have the custodian/administrator, who takes a very small part of the margin.”

Marson, of BNP Paribas, says: “The post-trade business has always been squeezed. It is on average 5% of the total cost to the investor. So now it is being squeezed to the maximum and we have to be very careful to not take on more liabilities without additional fee.

“If you have to cover for additional liabilities you move into a different business, you become an insurer.”

Approaching adjustment
In France this is of particular importance since post-trade prices are almost three times lower than those commanded in a jurisdiction like Luxembourg.

Marion says: “The question of fees does not only concern the administrator; it also relates to the depository and trustee function. It is obvious that if the risk taken by the depository banks increases, prices will have to go up.

“France is the European market where prices for custody/depositary and fund services are the lowest.

Therefore, if it appears that the French market charges the lowest price but bears the higher risk, then an adjustment will
be necessary.

“I think we will go towards a model, where basically what is priced is risk, which is not the case today.”

©2009 funds europe

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