Institutional Investor Services - ioandc.com · particular Australia’s institutional superannuation funds and investment managers. Prepared by the Australian Custodial Services

Institutional Investor Services

How custodians support Australia’s wholesale

superannuation and investment sectors

© Australian Custodial Services Association 2020 2

Table of Contents Introduction ............................................................................................................................................ 3

Purpose ................................................................................................................................................... 3

What is custody? ..................................................................................................................................... 3

Scope and limitations .............................................................................................................................. 4

Overview ................................................................................................................................................. 4

Typical services and benefits .................................................................................................................. 5

Size and trends ........................................................................................................................................ 7

Evolution ................................................................................................................................................. 8

Scale, specialisation and support for change .......................................................................................... 8

Adding value ....................................................................................................................................... 8

Change management .......................................................................................................................... 9

Institutional flows ................................................................................................................................. 10

Books of record ..................................................................................................................................... 11

Providers ............................................................................................................................................... 12

Types of custodian ................................................................................................................................ 13

Sub and domestic .............................................................................................................................. 13

Master and global ............................................................................................................................. 13

Investment administration ............................................................................................................... 14

Custody market overview ..................................................................................................................... 15

The legal basis of custody ..................................................................................................................... 16

Frequently asked questions .................................................................................................................. 20

Annexure A – The Australian Custodial Services Association ............................................................... 23

DISCLAIMER: While care has been taken in preparing this material, The Australian Custodial Services Association Limited

does not warrant or represent that the information, recommendations, opinions or conclusions contained in this document

(“Information”) are accurate, reliable, complete or current.

The Information has been prepared for dissemination to informed participants in institutional administration, regulatory,

custodial and fiduciary roles in Australia. The Information is not investment or legal advice, nor advice on selection of

administration or custodial services, or advice or endorsement of any other service. The Information should not be

regarded as the views of any particular member of ACSA.

In all cases, anyone proposing to rely on or use the Information should independently verify and check the accuracy,

completeness, reliability and suitability of the Information and should obtain independent and specific advice from

appropriate professionals or experts.

To the extent permissible by law, ACSA shall not be liable for any errors, omissions, defects or misrepresentations in the

Information or for any loss or damage suffered by persons who use or rely on such Information (including by reasons of

negligence, negligent misstatement or otherwise).


Introduction This document explains the role of the custodian as a service partner to wholesale investors, in

particular Australia’s institutional superannuation funds and investment managers.

Prepared by the Australian Custodial Services Association Limited (ACSA), the document is intended

to provide greater insight into the roles and responsibilities within institutional investor servicing.

It also provides a basis for ongoing dialogue with stakeholders, with the common goal of improving

systemic efficiency and maintaining the safety of Australian investors.

Purpose This document is a general guide to the role of the custodian, institutional investor services and

overview of the Australian market landscape. An understanding of the role of the custodian,

including the boundaries, provides insight into how institutional investment works.

It is primarily aimed at stakeholders who need to know more, but who are not industry practitioners.

What is custody? In general terms, custody is the provision of asset safekeeping and trade settlement. Investment administration provides accounting and valuation to allow reliable reporting of the fund’s holdings and value, and in turn the client’s asset book of record. Custody and investment administration emerged as outsourced services in the 1980s in Australia and remain key services to clients. The role of the custodian continues to evolve based on the growing sophistication of client investment strategies, expanding data needs and provision of scale solutions. Custodians are licensed, regulated and typically bank-owned entities. All major providers of wholesale custodial services operating in Australia are members of the Australian Custodial Services Association (ACSA). As a specialised outsourced back office service, it is not surprising that the role of the custodian can be misunderstood outside of the institutional marketplace. Although a critical service, custody is provided behind the scenes and on a sub-contracted basis to brand-name clients. It is important not to over or under interpret the benefits provided by the custodian:

The custody function protects the fund’s assets firstly by providing clear separation from the investment management function (whether in-house or outsourced), and also by ensuring that payments of money and delivery of securities only take place as the result of a proper instruction (and in accordance with the rules and conventions of the relevant market’s clearing and settlement functions).

Additionally, the custodian provides a consolidated view of holdings and transactions. This role, as the single trusted record-keeper (across all of the client’s assets and portfolios), provides the cornerstone for consistent reporting and data services. See Typical services and benefits on page 5 and Books of record discussion on page 11).

The custodian does not (and cannot) second guess or have a view on the investment decisions or override proper instructions.


Scope and limitations This paper focuses on custody and investment administration services as the primary solutions

offered by ACSA members. These services are provided to institutions (fund managers,

superannuation funds, sovereigns and other wholesale participants). Retail financial services are out

of scope. Although the focus is on Australia, many of the functions, benefits and constructs are

global in nature.

This paper should be used as a general introduction to custody but is no substitute for direct

engagement with ACSA or your ACSA member on specific issues.

Overview As at June 2019, the industry held $3.73 trillion in assets under custody for Australian

institutions, up from $285 billion in 1996 (the first year statistics were collected by ACSA1).

Custodians provide custody and related services to the financial services sector, including institutional superannuation funds and investment managers. These institutions are in turn the guardians of a significant portion of the wealth of millions of ordinary Australians.

Of total assets in 1996, $43.6 billion (15 percent) was invested offshore. As at June 2019 this figure was $1.04 trillion (28 percent of total assets).

Custodians also facilitate access for overseas investors into Australia’s capital markets. As at June 2019, $1.66 trillion in Australian assets under custody was held for foreign clients by ACSA’s sub-custodian members.

In Australia, institutional buyer behavior has typically been to take custody, investment administration and other related securities services from a single prime contractor referred to as the custodian. In most other developed markets, the term “custodian” has a narrower connotation referring solely to providers of core custody.

The ongoing investment by custodians in market infrastructure and maintaining expertise in asset servicing, investment administration and data provisioning is significant. The current ASX CHESS Replacement Project is an example of how custodians are engaged in consultation, advocacy for positive change, technology build and workflow redesign in the interests of overall market efficiency and robust change management.

Importantly, custodians do not underwrite or take the investment risks of clients (whether institutions or underlying retail investors). Clarity on roles and responsibilities within the superannuation and investment sector is fundamental to effective risk management.

Custodians and key client segments operate in a highly regulated environment, and one that is subject to ongoing change. Staying responsive to regulatory reporting and promoting the efficient implementation of compliance needs represents a significant contribution by custodians to the broader industry.

ACSA continues to work with policy makers, regulators and other associations to improve the efficiency of regulatory implementation in the interests of lower systemic cost, better outcomes for consumers and improved competitiveness of Australia relative to peer markets.

1 The Australian Custodial Services Association collects aggregate statistics from members to provide an overview of the size and key characteristics of the market in Australia.


Typical services and benefits Custody is the safekeeping of assets (such as cash, shares and bonds). The safekeeping function reduces risk for clients (asset owners) and provides the definitive book of record for institutional holdings and transactions. The Australian market has traditionally favoured a “bundling” of services with a prime contractor (sometimes referred to as master custodian, or simply “custodian” for short). Accordingly, in many cases the custodian provides investment administration and master custody services including portfolio valuation, tax records, regulatory reporting and unit pricing as outlined in the following table. These core functions require custodians to be participants with clearing houses and depositories to support traded markets (equities, bonds and derivatives) and to also efficiently access domestic and international payment systems. To provide a fully consolidated asset view, clients may also request that direct and non-market traded assets be serviced by their custodian (such assets can include syndicated property holdings, private equity, commercial loans, managed funds and over-the-counter assets). This service range allows clients to take advantage of standard operating models, market best practice and economies of scale that their custodian service partner provides. This allows the client to focus on their core business, investor/member experience and investment strategy, not the back office.

SERVICE BENEFITS Custody

Asset safekeeping, custodial book of record

Trade settlement

Corporate actions, income collection, proxy voting services, class action support

Safety and security of title for assets held in custody

Segregation of duties and control processes over fund assets

Market access (local and international)

Efficient asset servicing

Accounting & Valuation, Tax Reporting

Portfolio accounting

Tax accounting

Unit pricing / crediting rates

The accounting “book of record” (ABOR)

The basis for consistent reporting and accounts

Provides the basis for equitable member benefit calculation

Key input to a funds’ overall tax position (TBOR)

Regulatory Reporting

Preparation and submission of regulatory reports

Consolidated reporting at whole of fund level, investment option or asset class

Consistency across fund activity and underlying investment managers

Efficiency


Custodians may also offer optional additional services to institutional clients to add value through

income enhancement, lower implementation leakage or outsourcing of specialist functions.

Examples of optional services include:

unit registry

securities lending (equities and increasingly bonds)

transition management

trade matching

trade execution services

foreign exchange

hedging

alternative asset type services (private equity, commercial loans, property syndicates, commodities, gold bullion, etc.)

hedge fund services

collateral monitoring and management

cash monitoring and management

data enrichment and repository services

data access and API support

broker settlement account operator solutions

component outsourcing

SERVICE BENEFITS

Performance, analytics and monitoring

Performance calculation

Attribution and risk metrics

Mandate compliance monitoring

Consistent valuation and calculation methods

Benchmark and peer comparison

Portfolio, sector and whole of fund

Data management

Data provisioning and enrichment

Storage and access

Enhanced information access (for investment decision making and/or member reporting)

Data control

Hosted infrastructure

Middle office

Trade support

Open positions

Cash forecasting

The investment “book of record” (IBOR)

Allows client to take advantage of scalable solutions provided as middle office and retain focus on investment strategy and front office enhancements

Added value through integrated service provision and technology alignment

Access to custodian’s middle office know-how


Size and trends Custodians service the assets of Australia’s institutional superannuation, managed funds and other key financial services entities (see Custody market overview on page 15). These institutions are the guardians of a significant portion of assets underpinning the wealth of millions of ordinary Australians Custodians hold over $3.7 trillion2 on behalf of Australian institutions. In addition, they support $1.6 trillion3 on behalf of overseas wholesale clients investing into Australian financial assets. Accordingly, custodians play a key role in the security and efficiency of the industry and support vital links to both domestic and global capital markets. The following chart shows the growth in assets under custody for ACSA members in each reporting

period (six monthly) for the past decade.

A dominant driver of Australia’s investment pool is our superannuation system. Large in total value (ranked fourth in the world) and increasingly dominated by large funds with sophisticated investment strategies, this pool now represents some 150% of Australia’s GDP as of December 2018 and continues to grow. Australia also boasts large and innovative funds management and wealth sectors that offer investors professionally managed investment strategies implemented across hundreds of markets and hundreds of thousands of securities. The services that a custodian provides continue to evolve driven by client expectations, technology,

market infrastructure changes and disruption to the institutional investment supply chain.

Accordingly, it is important to keep up to date with the range of services offered in the market.

Driven by this scale and sophistication, Australian institutional investors are global and diverse in their investment outlook. This in turn drives the need for access to global markets, the full range of asset classes, and a requirement to keep pace with technology.

2 ACSA Statistics (Table 1) June 2019 3 ACSA Statistics (Table 4) June 2019


An additional driver is the need to be responsive to investors/members in terms of supporting choice, greater transparency and responsible investing – including the well-established trend for environmental, social and governance (ESG) themes to be incorporated in portfolio construction, along with the rise of individualised accounts. Custody ensures the safekeeping of assets owned by funds and investment administration provides the book of record for down-stream data and services – including regulatory reporting, fiduciary decision-making and the basis for calculating end investor account balances.

Evolution Over the ten years to June 2019, domestic assets under custody for Australian investors grew by 104

percent, international assets grew by 185 percent in the same period.

As described in more detail below, demand for custodial services continues to grow based on institutional investor demands for support in implementing sophisticated investment strategies, timely and complete information, greater efficiency and risk mitigation as well as a backdrop of continual regulatory change. Data provisioning has also emerged as a key service in support of client’s needs for insight and efficiency. Driven by increased scale and sophistication, Australian institutional investors are global and diverse in their investment outlook. This in turn drives the need for:

access to global markets and a full range of asset classes

a requirement to keep pace with technology, and leverage scale

ever-increasing demands for data

support for internalised investment management functions by superannuation funds

trends for environmental, social and governance (ESG) themes to be incorporated in portfolio construction and investor choice

support for hedging and protection techniques

support for expanding use of over-the-counter and non market-traded investments (including private equity, commercial loans, direct infrastructure and real estate, precious metals, water rights and other non-traditional asset types)

support for continual change in the regulation of superannuation, funds and markets, including new reporting requirements

Scale, specialisation and support for change

Adding value Custodians add value by providing access to core market infrastructure and subject matter expertise in the areas of asset servicing and investment administration. Investment by custodians include mandatory drivers:

Keeping up with market infrastructure, locally and globally, entails significant investment by the custody community. The ASX CHESS Replacement is an example of this investment. This multiyear program, ultilising blockchain-like technology (distributed ledger), involves an entire re-platforming of our market’s core equities clearing and settlement system, interfaces and functionality.


Domestic and global regulatory change is affecting custodians directly and their key client segments at an accelerating pace. Strong capability in assisting clients with local rules for investing and holding securities is an integral part of the custodian’s value proposition – along with multi-currency accounting and tax capability to service an increasingly diverse and international asset mix.

Additionally, custodians are making decisions on their own business profile and service offerings, including:

Ongoing investment in client online experience (data and digital), enhancing the ability for clients to access their data directly and in real time.

Customised services, including those driven by the need to support more scalable and robust investment management functions. Supporting the front and middle office and providing consolidation across internal and outsourced investment functions is a current significant trend.

The section above on Typical services and benefits outlines services that may form part of a client’s

service roster. As clients differ, so too will the individual mix of services. For example, highly tailored

services may be provided to support specific needs of an asset owner to service private equity,

commercial loans, direct infrastructure syndication, direct property, tailored ESG mandates or

complex asset/liability matching.

Custodians support their clients in implementing diversified investment practices – particularly in

handling the complexity of settlement and servicing of assets in both domestic and overseas

markets, and across the range of listed and unlisted asset classes. A large institution will typically

have needs across hundreds of markets, dozens of currencies and thousands of individual securities.

In addition to market access, demand is also driven by growing institutional size and investor

sophistication, data requirements and the search for operating efficiency via outsourcing.

Custodians themselves may specialise. For example, a sub-custodian may only offer services to

other custodians. The management of a network of sub-custodians is in itself a specialisation and

provides the basis for global market coverage to underlying clients.

Change management ACSA encourages early-stage engagement with stakeholders in all areas of change and/or

opportunity. This applies to industry change and regulatory consultation, as well a general guidance

to ACSA members and clients on the benefit of including an assessment of custody, asset serving,

risk and data impacts flowing from the implementation of new investment opportunities or

operating models.

Engagement early in the change cycle benefits all parties by delivering outcomes that are better

aligned to policy, have lower implementation impact, address operational risk and lessened

potential for unintended consequences.


Institutional flows Funds, as collective investments, aggregate money from many retail customers to form institutional pools. The fiduciary of the fund (in the case of superannuation, the trustee) contracts with a number of investment managers (these may be third parties or related entities). Each investment manager is engaged with a documented investment mandate that sets out the rules on how the investment manager can invest their allocation of the fund’s assets. Investment managers access traded markets through brokers or crossing networks, orders are filled and once confirmed are instructed to the custodian for settlement. It is the responsibility of the investment manager and/or trustee to ensure trades are funded with cash (if a buy) or the fund holds sufficient stock (if a sell). On instruction, the custodian updates the client’s portfolio accounts on the basis of the fund’s agreed rules and accounting standards (generally trade date, full accrual basis). Post settlement, the custodian updates the client records (actual cash and securities positions) and corporate actions. The investment manager is also provided daily reports on open trades and available cash. The following schematic shows functional components for a typical institutional superannuation investor.


Books of record An additional view of the role of the custodian is from the perspective of “books of record” – the data needed by fund fiduciaries to manage their business from the investment perspective. These building blocks of data form the basis for the fund’s investment management information needs along with the basis of internal and external reporting. Accounting and tax records form the basis for the calculation of individual member/investor account balances in the fund through unit pricing or crediting rate calculations utilised by the unit registry or member administrator. Data enrichment, classification and provisioning to clients and third parties forms a major component of contemporary custodial services.


Providers Custodians are licensed, regulated and typically bank-owned entities. All major providers of

wholesale (institutional) custodial services operating in Australia are members of the Australian

Custodial Services Association. The Annexure provides a list of current members.

All custodians offering services to superannuation and managed funds in Australia must have an

Australian Financial Services License, hold minimum capital levels, and comply with the regulatory

regimes of the markets in which they operate.

The next section of this paper contains a description of domestic, sub, global and master custody

service. The size of custody sector in Australia is also outlined.

At law, the provision of core custody is generally considered to be as a “bare trustee” in that the

custodian holds assets for beneficiaries and will only act on the proper instructions. The terms on

which the custodian will act are established under a custody agreement between it and the client.

For over three decades in Australia, and much longer in other countries, superannuation (pension)

funds and other institutions have recognised the benefits of using a custodian to hold their assets.

In many jurisdictions, the use of a custodian is also a requirement under the law.

The use of a custodian achieves a separation of duties between the role of the investment manager,

brokers and other market players from the legal ownership of client assets and settlement functions.

Settlement - being the moment in time when legal entitlement to a security is exchanged for cash -

is performed by the custodian under proper instruction.

The legal basis of custody section on page 16 provides a more detailed description of the entities

involved, regulatory environment and typical contractual interaction.


Types of custodian

Sub and domestic Sub and domestic custodians represent the in-country service providers for their respective

domestic markets, and are direct clearing, settlement and payment system participants.

The distinction between a sub versus domestic custodian relates to the nature of their clients, and as

a consequence also their level of systems integration. The term “sub custodian” generally relates to

those appointed by other custodians (global or master), and are typically integrated as part of a

global custody network. The term “domestic custodian” generally relates to custodians providing

services directly to domestic clients only. Many custodians perform both roles.

An inventory of possible sub/domestic custody services that may be offered in Australia:

Safekeeping (through nominee registration)

Settlement of trades for listed equities, fixed income, and unlisted securities

Trade confirmations and cash reporting

New issue application

Corporate event reporting and administration

Registration of physical securities

Dividend and income collection

Proxy voting services

Regulatory reporting

Payment of income and sales proceeds

Consolidated trade and income reporting

Settlement and/or clearing agency arrangements. Delivery of these services would also typically include client service desk access, market information

updates, and possibly optional customised data interfaces or reports. The custody agreement

and/or agreed operating procedures would also include specified cut-off times for trade instruction,

the form of proper instructions, and appropriate links to the custodian’s online information portal.

Some sub/domestic custodians may also provide (either directly or through related parties) foreign

exchange and cash management services, securities borrowing and lending, contractual income and

possibly contractual settlement on certain security types, payment and banking solutions, and

portfolio transition management services.

Note that not all services are offered by all custodians, and the list is not exhaustive.

Table 4 of the ACSA Statistics tracks the total sub custody assets. A total of $1.6 trillion was held for

foreign clients as at 30 June 2019.

Master and global Master and global custodians provide services to institutions that invest across borders, supporting

multiple portfolios for their clients (generally run by separate professional investment managers).

In practical terms, there is no distinction between the terms global and master custodian, although

the label “global” is sometimes used for organisations that support the bulk of underlying in-country

custody network through their own branches (rather than through a sub custody network of third

party providers).


An inventory of possible master/global custody services that may be offered to Australian clients:

All of the sub/domestic custody services as outlined above (also specific to each traded market - that is, core custody services will vary depending on the nature of the security type and maturity of the market)

Portfolio valuation (daily, monthly)

Tax reporting

Foreign withholding tax reclaim (if the client invests offshore)

Investment mandate monitoring (post trade)

Investment performance measurement and benchmark comparison

Performance analytics, including attribution

Regulatory reporting including APRA, ASIC and other Australian and foreign regulators (where applicable)

Unit pricing

Unit registry

Trade execution reporting

Transaction cost management (so called “master manager” services)

Note that these services generally do not extend to individual superannuation fund member

administration - which is a separate specialised sector in Australia. Some custodians may have

related parties who provide this type of service, but these are typically distinct business lines.

Note that not all services are offered by all custodians, and the list is not exhaustive. Services also

continue to evolve over time, with custodians adapting solutions to better service clients’ changing

needs.

Investment administration Investment administration generally refers to valuation, accounting and related services and “book

of record” support.

Investment administration can also refer to the so-called “middle office” of investment managers

and life insurance companies. The service elements are similar to those provided to superannuation

master custody clients, but typically more aligned to daily managed fund processing, integrated to

the needs of a single fund manager (the client), and possibly offered in combination with specialised

accounting, retail registry and payment system solutions.


Custody market overview The clients of ACSA members generally comprise:

The trustee (RSE) of large superannuation funds

The trustees or responsible entities of managed investment schemes

Operators of investor directed portfolio services (IDPS) or managed accounts (SMA, MDA);

Life and general insurance companies

The trustees of endowments and charitable funds

Australian governments (Commonwealth and State) and agencies

Overseas governments and sovereign funds

Global custodians, banks and brokers with a need for sub-custody arrangements in Australia (supporting in-bound institutional investment)

Listed trusts and other closed ended investments

Some of the larger Australian charitable foundations

Overseas pension funds

Other overseas institutions (investment banks, broker/dealers, endowment funds, charitable foundations)

Technically (and contractually), the “client” is the company that acts as the fiduciary of the fund

(for example, trustee of a regulated superannuation fund, or the Responsible Entity of the

regulated managed fund).

The following table provides a view of the Australian market from the Australian Bureau of

Statistics (ABS). Note that the ABS also measures retail unit trusts on a consolidated basis which

shows a total of approximately $957 billion in this sector, the difference largely due to unlisted

trusts accessed directly, not via superannuation funds.

Source: ABS 5655.0 - Managed Funds, Australia, Dec 2018 - Unconsolidated assets total managed

funds institutions.


The legal basis of custody Important note

Regulation of superannuation and investment changes frequently. While care has been taken in

preparing this material, The Australian Custodial Services Association Limited does not warrant or

represent that it is complete or current.

Overview

In Australia institutional investors such as a trustee of a regulated superannuation entity or the

operator of a registered managed investment scheme may appoint a custodian to hold fund assets.

The client may choose to use a custodian or may be required to do so to meet a regulatory

requirement. For example, a responsible entity of a registered managed investment scheme may

need to appoint a third party custodian to hold scheme assets where it does not have sufficient net

tangible assets or does not meet the operational requirements to hold scheme assets itself.

The trustee and responsible entity have full and ultimate responsibility to the investors in their fund

or scheme in respect of management of the fund/scheme and its assets, but may delegate the

performance of some of their functions to third party service providers, such as custodians and

investment managers, via outsourcing arrangements.

Registrable superannuation entity

The trustees of registrable superannuation entities are primarily subject to the Superannuation

Industry (Supervision) Act 1993 (and regulations) and the prudential standards made by APRA under

that legislation.

When outsourcing custody functions, the trustee must have regard to specific provisions of that

legislation. Part 15, Division 2 of the SIS Act contains standards relating to the appointment of

investment managers and custodians. These include that an investment manager of a

superannuation entity must not appoint or engage a custodian of the entity without the written

consent of the trustee, or the trustees, of the entity (Superannuation Industry (Supervision) Act 1993

(Cth) s 122(1)), and that custodians have adequate financial resources (Superannuation Industry

(Supervision) Act 1993 (Cth) s 123).

In addition, the trustee is bound by APRA Prudential Standard SPS 231 Outsourcing which requires

that an outsourcing agreement must, at a minimum, address designated matters, including liability

and indemnity, sub-contracting and insurance.

Registered and unregistered schemes

Operators of registered managed investment schemes are subject to the custody standards which

are contained in ASIC Class Order [CO 13/1409], which varies Chapter 5C of the Corporations Act

2001 by the inclusion of new provisions which set out the obligations which the responsible entity

must meet in relation to the holding of scheme property (whether it holds scheme property itself or

arranges for another person to hold scheme property).

Similar obligations apply to custodians directly when providing custodial or depository services (for

example, to operators of unregistered managed investment schemes) under ASIC Class Order [CO

13/1410], which modifies Part 7.6 of the Corporations Act 2001.

ASIC has issued guidance on its approach to these obligations in the form of ASIC Regulatory Guide

133 Funds management and custodial services: Holding assets.


Generally, under these provisions, a custodian is required to have (amongst other things):

An organisational structure that supports the segregation of client assets from its own assets, segregation of staff in a way that minimises any potential conflict of interest and is structured so that custodial staff are able to report directly to the compliance committee of its client.

Staffing capabilities whereby staff must have the experience, qualifications, knowledge and skills necessary to perform the functions of a custodian properly and access to specialist areas so that custody staff can adequately carry out their duties.

Administrative resources associated with the holding of clients’ assets which is likely to include computer systems, procedures for recording of client assets, movements of those assets, recording corporate events, pricing those assets and regularly reporting those assets to clients.

The custodian is required to hold client assets in a way which ensures that those assets are clearly

identified as belonging to each client. Trustees and responsible entities also have a responsibility to

ensure that custodial arrangements are suitable for the particular assets being held.

A custodian must also generally meet certain minimum financial requirements which are applicable

to it because either:

a) the responsible entity must ensure those requirements are met under ASIC Class Order 13/760; or

b) the custodian is subject to minimum financial requirements as a licensed provider of custodial or depositary services under ASIC Class Order 13/761.

Other types of client

Depending on the nature of the client, there may be similar or other requirements which need to be

met by the client in relation to the outsourcing of custody functions. For example, the operator of

an investor directed portfolio service or managed discretionary account service has similar

obligations in relation to custody as a responsible entity of a registered managed investment

scheme.

Nature of custody

While a custodian is generally considered to hold assets as a trustee, it is often referred to as a bare

trustee because the custodian will only act on the proper instructions of the custodian's client in

dealing with the assets.

The terms on which the custodian will act (and hence the manner in which proper instructions may

be provided by the client and accepted by the custodian) are established under a custody agreement

between it and the client.

Custody agreements are commercially sensitive and bespoke between the custodian and

institutional client.

Nevertheless, custody agreements do have a number of common elements due in part to

compliance with the specific laws and regulations in Australia that deal with the appointment of a

custodian by certain regulated institutional investors.


Some common elements of custody agreements include that they:

specify which asset types and markets for which the custodian offers services;

contain a list of specific services, fees and service levels relevant to the specific client profile (for example, trade instruction cut-offs for domestic and overseas markets, income collection expectations, corporate event reporting methods, proxy voting protocols, etc);

refer to the custodian's right to appoint sub-custodians (if any);

specify the form of proper instruction, and the approach to be taken regarding unclear or incomplete instructions;

state the standard of care that will apply to custodial services;

contain an indemnity from the client for loss or liability of the custodian incurred in providing its services;

provide undertakings by the custodian regarding business continuity and disaster recovery (planning and testing), professional indemnity insurance, independent audit and reporting against custodial standards;

limit liability for force majeure events;

reference other services (if any) provided to the client (including investment administration, value added services and electronic information delivery systems) – although these may be covered under a separate agreement.

This list is not exhaustive, nor necessarily representative of the elements that may be included in any

specific custody agreement. It is anticipated that clients would seek appropriate professional advice

on the terms of any agreement.

What custodians do not do

Custodians do not apply discretion to investment decisions and exclude responsibility for making or

checking investment management decisions by the client or third parties. The institutional investor

must have confidence that their investment decisions (typically outsourced to a professional

investment manager) are being carried out as instructed - not second-guessed by the custodian.

Nominee companies

Nominee companies are special purpose vehicles established by custodians to hold client assets.

In Australia, and most other (English common law) countries, custodians have regulatory

requirements to keep assets of clients separate from their own assets. The use of nominee

companies enables a custodian to comply with these requirements.

These nominee companies may not hold an Australian financial services licence, as many of them

will have the benefit of an exemption from the requirement to hold an Australian financial services

licence under paragraph 7.6.01(1)(k) of the Corporations Regulations or will be exempt under

paragraph 911A(2)(b) of the Corporations Act because they are acting as an authorised

representative of the licensed custodian.

Omnibus accounts

Traded market securities held by custodians and their nominees are typically registered or held in

what are known as 'omnibus accounts'.

An omnibus account is a single account in which the assets of a number of clients may be pooled. For

example, shares listed on the Australian Securities Exchange may be held in a single CHESS account,

with a single holder identification number (HIN), with the custodian’s systems tracking individual

client (portfolio) ownership.


The use of omnibus accounts brings considerable efficiency to institutional investor servicing, as a

number of functions can be undertaken once by security, rather than many times by individual

client. Examples include dividend processing, corporate event notification and reconciliation

functions.

Securities held in an omnibus account are fungible. The client's interest in the securities is recorded

in the books of the custodian. The client is entitled to recover equivalent securities to those which

may have been acquired originally on the client's instructions; in other words, to an identical number

of the same securities.

Note that not all assets are fungible, and not all markets fully support the concept of omnibus

holdings. In these cases, assets may be registered individually rather than in omnibus accounts.

Additionally, some custodians may offer the choice to major clients on whether or not to use

omnibus securities for that client’s holdings. If offered, custody fees may differ for non-omnibus

holdings due to the additional work associated with individual processing.

Not-in-custody assets

An important practical consideration in the provision of custody service is to differentiate between

reporting on assets versus actual custody of assets. To gain the full benefit of some investments, or

for legal reasons, it may not be appropriate (or even possible) to register some assets through

nominee arrangements.

In such cases, the client may hold these assets directly. In other cases, specialist custodial nominee

arrangements may be offered by some providers or third parties. An example is direct real estate

where (in most jurisdictions) evidence of asset ownership requires physical deeds of title, along with

the physical notation and stamping of encumbrances, lease agreements and the like. In some

markets, specialist custody providers may offer services for this type of physical asset. The

institutional investor may contract directly with such a specialist provider if the master custodian

does not provide this service.

Regardless of whether the client owns the asset directly, or through a specialist nominee, they may

request that their master custodian incorporate trade, income and holding information into

consolidated reporting for the fund as a whole.

In this scenario, the master custodian is not responsible for custodial functions (they are, by

definition, not holding the assets) and are reliant on a third party for data integrity (so called “hear

say” reporting).


Frequently asked questions As a specialised outsourced back office service, it is not surprising that the role of the custodian is

not well understood outside of the institutional marketplace. The following misconceptions are

common:

Custodians appear as major shareholder in most of Australia’s top listed companies – does this mean they control these businesses?

No. These shareholdings are as nominee only. The custodian has no beneficial rights to the shares it holds. The custodian cannot vote, sell or seek to influence the company’s business or participate in any corporate event without the instruction of the client (who has control of their actions as owner of the shares). Examples from Australia’s top three listed companies (by market capitalisation, as at January 2020) BHP, CSL and CBA: BHP Group Limited (Annual Report 2019)

CSL Limited (Annual Report 2019)


Commonwealth Bank of Australia (Annual Report 2019)

If a fund uses a custodian, does that mean that investors can never lose money?

No. Custodians stand behind their contracted services but cannot and should not take responsibility for investment outcomes. The custodian does not influence, nor is accountable for, the individual consumer’s choice of fund, the fund’s choice of investment manager, the investment manager’s investment strategies, nor the fund’s decisions to hold a particular asset, participate in a particular market or make a particular trade. In other words, responsibility for investment outcomes is the responsibility of the fund fiduciary, not the custodian.

Do custodians have all the data?

In part. If the custodian is contracted to provide the portfolio accounting book of record, it will have a comprehensive set of data describing the asset side of a fund’s balance sheet (that is, the investments). But data is context specific, and accounting data may not be appropriate for other reporting or analysis purposes – a further description of “books of record” and how data can be classified and enriched is provided on page 12.

What are the core benefits of using a custodian?

Custodians provide services to institutional investors, reduce uncertainty faced by asset owners and managers, and support critical elements of investment infrastructure. These services reduce the frictional costs of investing, lower risk and improve efficiency through scale, expertise and automation. A key benefit is the separation of duties provided by the core safekeeping function of custody. This allows institutional investors to appoint a range of third-party investment managers and other agents while keeping the fund’s cash and assets separate from the balance sheets of these agents.


Custodians act as the definitive record keeper and “source of truth” for transactions, holdings and investment information (also refer to Books of Record discussion on page 12). Valuation and accounting for transactions and holdings is performed consistently and independently by the custodian as investment administrator across all assets and portfolios. Importantly, the accounting book of record provides the base for all down-stream fund operations, including the calculation of individual member/investor account balances.


Annexure A – The Australian Custodial Services Association Membership and focus as at January 2020. Additional information is available at www.acsa.com.au

In addition to systemic operational issues and market practice, ACSA believes that there are

opportunities to improve the efficiency of regulation, especially in areas of data reporting - this is a

current major focus of the ACSA Executive and our industry Working Groups.

For more information on ACSA including recent submissions, industry updates and statistics please

see our website at www.acsa.com.au

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Institutional Investor Services - ioandc.com · particular Australia’s institutional superannuation funds and investment managers. Prepared by the Australian Custodial Services