Custodians Essay

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The global custody business is the safekeeping of clients’ assets. It includes processing cross-border  securities trades, keeping financial assets safe, and servicing the associated portfolios. Institutional investors, money managers, and broker/dealers are among those who rely on custodians and other market participants for the efficient handling of their worldwide securities portfolios. The kinds of assets involved include 1) equities, 2) government  bonds, 3) corporate  bonds, 4) debt instruments, 5) mutual  fund investments,  6) warrants, and 7) derivatives.

Custodians effect settlement  of trades (that is, completion of a transaction,  wherein the seller transfers securities or financial instruments to the buyer and the buyer transfers money to the seller) and provide safekeeping of the assets on behalf of clients. The services also include (1) collection of income arising from the portfolios (dividends and interest  payable), (2) application  of entitlements to  reduced  rates  of withholding  tax at source  and  reclaiming  withheld taxes after-the-fact,  and (3) notification  and dealing with corporate  actions (such as bonus issues, rights issues, and takeovers).

In terms of service offering, custodians have moved far beyond the core services on which the business was founded—safekeeping and settlement, income collection, proxy voting—as companies have sought to add value for an increasingly sophisticated globalizing client base. Securities lending, benchmarking  services such as performance  measurement and risk analysis, compliance  monitoring,  fund accounting,  and retail transfer  agency are today variously or all part of the deal, as custodians seek to recast themselves as information enhancers and global market facilitators.

Many custodians  outsource  safekeeping of assets in foreign markets  to sub-custodians.  Sub-custodians use their knowledge and expertise for that particular  market  and  charge  a fee for their  services. This helps custodians  extend  their  network  over a wider region and provides better service irrespective of region of operation.

While  much  of  the  work  is administrative   and repetitive, the role of the custodian has widened to a range of other services. Custodians  typically specialize in a particular  area. Custodians  also have client focused and technical  personnel.  Relationship managers, for example, work with clients to reassure them that their assets are safely maintained.

The global custody product  was conceived out of changes to U.S. pension laws. In 1974 the Employee Retirement  Income  Security  Act  (ERISA) became law, requiring  U.S. pension  plan  sponsors  to  segregate investment  management and custody of the underlying assets. Prior to this, banks had provided settlement  and safekeeping services on an international basis. However, these activities were typically provided free of charge—and the functions therefore starved of resources—as part of investment management or other activities. The term global custody was coined in 1974. Global custody services include the following:

  • Safekeeping activities: Ensure that assets are protected.
  • Clearing: Operate in a highly automated  environment  to ensure accurate records are kept of mutual  positions  in the  exchange  of cash and securities  between  counterparties or among  a group of participants and to effect orderly settlement of their obligations on a net basis.
  • Settlement activities:  Ensure  timely,  accurate, and  secure  transmission  of trade  instructions and  timely completion  of settlement  Straight through  processing  (STP); an  automated  passage of a securities trade from execution to settlement is used for faster turnaround time.
  • Derivatives: Ensure timely  and  accurate accounting  for derivatives and associated margin payments.
  • Network of markets: Ensure strength  and reliability in supporting  all required markets.
  • Other services such  as reporting  and  recordkeeping, cash management, securities servicing, and income collection.

Today  technology  is also enabling  an  unprecedented  democratization of business. It is now feasible for mid-size and even smaller companies to go global. In the future,  global custody is going to be more concentrated, more comprehensive,  and more competitive.  Relationship management will be crucial: Custody will become commoditized.  There will be  more  products   and  more  consolidation.   Only those who extend  their  product  through  joint ventures,  acquisitions,  alliances, and  consortiums  will survive. Stratification  and  specialization  will continue, and processes will be more transparent. There will be more players, but technology will allow custodians  to  become  more  specialized. Their clients will choose the best products  from a large group of specialists. Technology is a major driving force. Clients will want the ease of access that already exists on the retail side. Key players are the Bank of New York, Citibank, HSBC, EFG Eurobank, and Mellon group, to name a few.

Bibliography:   

  1. Pierre Agnes, “Embeddedness in Custodial Banking,” Tijdschrift Voor Economische en Sociale Geografie (v.93/3, 2002);
  2. Gregg Miller “Maintenance and Custodial Services: Getting the Most for the Money,” School Business Affairs (v.59/7, 1993).

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