Asset owners are navigating an uncertain investment landscape, characterised by a low yield environment and evolving stakeholder expectations. New investment strategies, enhanced transparency and increased governance are leading asset owners to rethink their operating models across the value chain, to better optimise investment outcomes. Common considerations include the balance of in-house versus outsourced investment management, what technology platforms empower investment processes, reporting and risk solutions at a total portfolio level, and insourcing versus outsourcing middle office operations.
Deciding which part of the operational value chain to keep in-house or to outsource is key.
Custody banks play an important role for asset owners within the middle and front office. For the largest asset owners, the selection of a custody provider sometimes extends to deciding whether to adopt a single- or multi-custodial model. Some asset owners appoint multiple custodians to address specific objectives, including managing counterparty risk or accessing local expertise.
Asset owner clients are asking which model is best. A lack of data-informed analysis had prevented them from reaching a conclusion. Through a review of the top 50 global asset owners BNY Mellon engages with, it is clear that no one size fits all.
The organisations reviewed include central banks, pensions and sovereign funds, with a combined assets under management of $23tn.
The review uncovered five distinct custodial models and their corresponding adoption.
- Single custodial model: all assets are held with one custodian irrespective of investment approach, asset class or region.
- Geographic multi-custodial model: custodians are selected based on where assets are located (such as in either developed or emerging markets).
- Asset class-based multi-custodial model: custodians are selected based on the type of asset (equities, fixed income or alternatives).
- Manager-based multi-custodial model: custodians are selected based on internal versus outsourced investment management.
- Hybrid multi-custodial model: custodians are selected based on a combination of geographic, asset class and manager considerations.
Figure 1: Top 50 asset owners review by custodial model
Source: BNY Mellon
*Note: The remaining 6% refers to three central banks in the review that do not use a custodian.
Looking across the five models, there are specific nuances at regional and segment levels.
The single custodian model is by far the most common, used by 44% of the top 50 asset owners under review, followed by geographic (22%), hybrid (14%), asset class-based (8%) and manager-based (6%) multi-custodial models.
The single custodian model is primarily driven by US and European pension funds, which typically adopt this model, with a few notable exceptions. Half of Asia Pacific asset owners, mostly central banks and pension funds, use a variant of the multi-custodial geographic model. Two-thirds of sovereign funds use a multi-custodial hybrid model, selecting more than four custodians. Most European central banks do not use custodians but appoint local central securities depositories instead. Central banks are starting to diversify their holdings, moving into exchange traded funds and equity investments, which may lead them to diversify their custodians.
The choice of a custodian is underpinned by five common objectives, which can generally be achieved in both single and multi-custodial models. Some objectives may be emphasised over others depending on priorities or cultural preferences. First among these is operating efficiency, where asset owners require a data consolidation solution when appointing multiple custodians to maintain investment oversight, manage enterprise-wide investment risk and support external stakeholder reporting.
Second is counterparty risk. Rather than concentrating assets with a single custodian, asset owners appoint multiple custodians with high credit ratings for asset safety reasons, to spread and reduce counterparty risk. Third is market connectivity. Through global players with strong market connectivity, asset owners can benefit from enhanced expertise which is specifically important in the more complex emerging markets.
Fourth is benchmarking. By appointing multiple custodians, asset owners have the option to benchmark services between providers which drives optimisation and competitive pricing. Finally there are data privacy and confidentiality considerations. Asset owners appoint multiple custodians to prevent a single one having oversight at the total portfolio level and to protect (sovereign) confidentiality.
‘More than ever before, asset owners are facing a range of pressures impacting their outlook, priorities and decision making. They are increasingly looking at their service providers to help them orchestrate solutions and streamline information across investment and operational processes for richer insights and greater oversight to help meet their strategic priorities,’ said Rohan Singh, global head of asset owners, asset servicing and digital at BNY Mellon.
While most objectives can be achieved through any model, the choice of who to collaborate with and how to operate effectively is always a central component to determining success.
Xavier van den Brande is Head of Asset Owners, Europe, and Marvin Vervaart is Client Solutions Manager, Asset Owners, at BNY Mellon.