In an environment of rising market volatility and costs, network managers are under increasing pressure to shield clients from risk—and deliver efficiencies. Geoff Spindler, European Head of Network Management, discusses an option to help achieve these objectives.
Network consolidation becomes a talking point
It is not unusual for a global custodian to rely on different sub-custodian providers in the same geographical region. However, this arrangement has the potential to increase fragmentation and create inefficiencies—both for global custodians and their clients. In response, a handful of global custodians, including RBC Investor & Treasury Services, are consolidating the number of sub-custody relationships in certain regions and adopting what has become known as the “hub model."
The hub model leverages a single sub-custodian for one region
Under the hub approach, global custodians leverage a single sub-custodian to provide network coverage for an entire geographical region from a single market located within the region. For example, a global custodian with exposure to Africa might appoint a sub-custodian in Johannesburg or the location of the selected custodian’s operational service centre. In addition to providing coverage for South Africa, the sub-custodian may also support the global custodian throughout the African continent. This would enable the sub-custodian to connect with each of the markets either through their local representative offices or via direct links to the domestic FMIs (Financial Market Infrastructures) such as stock exchanges, central securities depositories and central counterparty clearing houses.
Clients benefit from seamless reporting and efficiencies
Asset managers and asset owners stand to realize various benefits from the hub framework. For instance, the model allows multiple markets to be supported through a single contact. As a result, it becomes easier to share market data with clients. The global custodian receives market data in a standardized format from a single sub-custodian, eliminating the need to reconcile multiple reports from different local counterparties. The custodian can then digest the information and forward it on to clients.
The appointment of fewer providers enables closer strategic relationships
The hub model also facilitates operational efficiencies during trade settlements that involve multiple markets within the same region. In these situations, the settlement process can be standardized, enabling straight-through processing for global custodians and their clients. And the allocation of greater wallet share to fewer providers allows for closer strategic relationships, providing global custodians and sub-custodians with the ability to collaborate on co-creation programs and digitalization initiatives. The client ultimately reaps rewards if these projects yield positive results.
Risk management is an important consideration
The hub approach can insulate global custodians and their clients from risk, especially in frontier markets where volatility tends to be more prevalent. Since the global custodian maintains a cash account with the hub provider in a large regional market, they are not exposed to potentially disruptive currency movements in the frontier economies.
There are ways to mitigate counterparty risk
Reliance on a regional hub provider does expose global custodians and their clients to greater concentration risk, especially if the sub-custodian were to exit the region altogether or become insolvent. That said, custodians can mitigate this counterparty risk by maintaining strong relationships with alternate providers, who can support the markets inside their network. If the primary sub-custodian were to exit a market or fail, client assets could be promptly transferred to the identified provider.
Managers need to stay in touch with local markets
Although the hub model allows network managers to streamline their workflows and simplify the due diligence process, this model may tempt global custodians to reduce on-site due diligence visits to those markets outside the home location of their regional provider. This could lead to client concerns that global custodians will miss certain risks, especially in frontier markets where on-site visits to domestic FMIs often yield invaluable information and insights.
Some global custodians are engaging third-party due diligence providers
Under the hub approach, local FMIs still need to be visited on the ground as part of the due diligence process, and some global custodians are engaging third-party due diligence providers, such as Thomas Murray, to carry out these reviews. In addition, investor concerns about lack of participation in local market advocacy efforts can be alleviated through the network manager’s engagement with local market practitioners via the regional sub-custodians or industry bodies such as the Association of Global Custodians.
The hub model is a worthy option
The hub model has the potential to offer a number of advantages to global custodians and their clients, including enhanced risk management, improved operational efficiencies and greater partnership opportunities for developing strategic solutions that benefit all participants throughout the custody chain. This approach is likely to become increasingly popular as more providers recognize these benefits.