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Optimizing the Global Custody network
for sucess on the eve of Y2K
Global custodians operate in anywhere from 25 to 95 markets, relying upon a network of subcustodians. RBFG, for example, operates in 81 markets, and has 54 subcustodial relationships. (A regional subcustodian or an indirect custodian may act for us in more than one market.) Although we are providing services in an agency capacity to our clients, we have a duty to deliver these services as if they came directly from us.
To protect us against this reputation risk, we employ a process we call Worldwide Agent Network management (WAN). WAN is about selecting the best agent for your clients needs and for your organizations needs. It means ensuring that each of your agents is, in effect, your best agentbecause you can be sure that colleagues and clients will remember only your worst one! We want the subcustodian to fully understand what is required of him. We seek not only to fix faults but also to share successes. We want a genuine partnership.
WAN reports to the senior management of the organization; and while it is situated outside of operations, it works closely with them. Individuals from all the operational areas meet with the Network Management team on a monthly basis to deliver report cards as feedback, both positive and negative. For example, the income collection area would deliver feedback on the continuity and timeliness of dividend remittances. Tax collections would report on the agents progress in achieving tax refunds on dividends.
Our structure broadly reflects the different characteristics of securities services markets offered by our organization. We therefore have an emerging markets group and a developed markets group. Within those areas, however, we have incorporated a form of even more pro-active management via a controls group within the Network Team.
One of the senior network managers has the responsibility of ensuring that various control reports are delivered on time, that they cover the right aspects, that due diligence visits are made on time, that various forms of documentation are received and legal opinions are obtained. These may sound like very obvious things, but they tend to be the things that might otherwise be overlooked.
The principal objective for Worldwide Network Management is continuity of service delivery. We do not want spikes in our service delivery, because if you have a period when everything is going extraordinarily well, that may be simply a reaction to a period when everything has been going extraordinarily badly.
We ensure continuity of service delivery through a performance management process. Its results can be measured in two ways. The first is internal measurement, through our quality and assurance program, known as Quality and Excellence through Standards (QUEST).
The program itself requires depth and sustainability. RBFGs QUEST program has been ongoing for 11 years. It measures various targets set by the business areas themselves for client services delivery, number of transactions settling, performance and volumes, etc. The second way to measure results is through external commentary and ratings. These include the external monitoring done by Global Custodian Magazine, GSCS Benchmarks and Global Investor.
In selecting its subcustodians, RBFG utilizes a multi-stage process. The first step is to assess the reputations and credit-worthiness of potential providers in a specific market. Once we have compiled a short list for that market, members of the Network Management team perform an on-site due diligence review of the potential providers.
The next stage is the Request for Proposal, which provides an opportunity for a candidate to explain what he can do for us, and also to discuss how the local capital market dictates what he can and cannot do. It would cover all aspects, including the physical systems, technical systems and the regulatory environment.
Once RBFG has chosen a subcustodian, we follow a process of continuous relationship management. At a minimum, we visit each subcustodian annually for a due diligence review, examining the procedures they have for settlement, safekeeping and custody. We discuss with them any new developments in their market and their plans for improving their systems and processes.
For emerging markets, on-site visits may be as frequent as semi-annually or even quarterly. We meet not only with the subcustodian but also with officials of the securities regulatory body, the stock exchange, the central bank, and the finance ministry.
In fact, our performance management regime is even more intensive. When we first issue the RFP, we provide candidates with Service Level Standards (SLS). This is a framework indicating what all of our requirements would be in an absolutely ideal market. We ask each respondent to customize this document in accordance with his abilities and the capabilities of the market in which he operates.
The SLS sets out all of the standards to which they would work. It becomes the Magna Carta of the subcustodial relationship.
On a quarterly basis, all of our operational areas rate the subcustodian on whether he has met the target that he set for himself. We feed that back to each subcustodian in the form of a customized report of actual performance vs. the SLS. The SLS is reviewed and updated at least once a year as part of the annual due diligence visit to the subcustodian.
If a subcustodians service falls short of the SLS, we provide work plans where we set the milestones necessary to achieve the target levels. Where a service standard is being met, we highlight that as well. Without disclosing names to the subcustodian, we show him where he ranks relative to his competitors.
This year, one very crucial aspect of performance management has been the monitoring of the subcustodians Y2K remediation programs. This has become a fundamental element of our information gathering process vis-a-vis subcustodians. We telephone and conduct interviews on a bi-weekly basis with subcustodians regarding their Y2K progress.
Supplier readiness is a particularly difficult area for any companys Y2K program. It is a no-win scenario to some extent, because it involves something that cannot be controlled with a high degree of certainty. A firm can obtain certain levels of information from, say, its tier 1 or critical suppliers. However, this involves some sort of risk assessment which, by definition, requires it to classify some suppliers as less risky than others.
Furthermore, if a companys Y2K program should extend to tier 1 suppliers, then logically, the firm should ensure that the tier 1 suppliers are doing the same to their tier suppliers, and on and on.
In reality you can only do what is reasonable given your available resources. Certainly, for global custodians, the limits of supplier testing became clear when they considered the 50-plus markets in which they operate.
Even if they had the resources to co-ordinate 50-plus tests, they lacked the leverage to commit all their subcustodians. Factors such as reciprocity, lining up Y2K test environments, and the resources of the subcustodians militate against such participation. If, however, a global custodian can only test, say, 10 subcustodians, based on size of assets and availability of resources, what is its defence if the 11th biggest provider, or country, has a Y2K problem?
Fortunately, a solution has been developed based on the concept of proxy testing. This approach is feasible because many suppliers support the same clients. Many of those clients want to test the same aspect of the suppliers service. It is easier for all parties concerned if the supplier and one representative client perform the test work, document this and share it with all other interested clients. An example of proxy testing, on a global basis, is the Custody 2000 Working Group, which involves proxy testing 167 suppliers in 66 countries.
We should add that proxy testing of supplier readiness is only one of the opportunities for the financial community to act in partnership with respect to Y2K. Such teamwork is also highly desirable during the Y2K weekend itself for event management. If a situation exists where small problems become known and cause knee-jerk reactions amongst the financial community, then those small problems could quickly blow up into big ones and could lead to systemic risk.
Suppose, for example, that a mid-size bank finds itself in difficulty in a particular market on January 1, 2000. That bank will probably have credit lines with other organizations, external deposits, outstanding contracts with cross-border counterparties, etc. In a partnership philosophy, other financial institutions and, say, the central bank and regulators, would assist the stricken bank with an orderly analysis of its problem and provide some breathing room for it to be sorted out, e.g., the acceptance of broader quality collateral and/or a more relaxed interest rate corridor policy. Absent such partnership, the problem might be exacerbated rather than contained.
While it is right to emphasize a partnership approach, however, global custodians cannot afford to become preoccupied with Y2K efforts to the exclusion of day-to-day business. The reality is that, if you fail to keep your eye on the ball and manage your existing business, you wont have a Y2K problembecause you will have no business. Like a talented juggler, it is essential to keep all of the balls in the air at the same time!
This article is based on presentations made to the ICM Conference on Global Custody Relationships (June 28-29, 1999) by Paul Stillabower and Paul Hedges, senior executives of Royal Bank of Canada Financial Groups Global Securities Services.
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