Global Custody Accounts

Understanding Global Custody Accounts and Fees

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An understanding of what a global custody account is, and how to use one, can help you decide if you should look into opening one. The major providers of custody services can make life much more convenient for wealthier investors and reduce anxiety over the possibility of lost assets in situations outside of their control.

Global custody accounts are designed for investors that have over $500,000 in assets. Their primary function is to serve as safe storage, while allowing funds to be transferred in and out as needed for trades or purchases.

It helps to understand a few details about how securities are traded so that you know what can go wrong. When you know the risks you face, you'll understand the advantage of a global custody account if you have enough assets to warrant the extra expense.

How Security Trades Are Executed

When you purchase a stock, bond, or other security, your broker executes the trade for you. They handle the paperwork, record the agreed-upon price, and arrange to exchange cash for the security.

Trades typically settle in three business days in the United States, so by the agreed-upon deadline, your and your counterpart complete your portion of the deal—in this case exchanging cash and an asset.

Failure to deliver or settle can result in penalties, fees, and problems with regulatory agencies. This is generally why brokers are the ones making transactions—you have an account with one, and they conduct the trade for you so that transactions take place with minimal problems.

When you look at your account upon executing a trade, you'll see that the money is taken instantly and the shares are deposited onto your account ledger. However, this isn't actually what is happening.

Brokers and banks typically work the same when transferring capital and assets—you'll see the transactions occur in your brokerage account, but they are not usually executed until the settlement date.

Your online broker is taking possession of your recently purchased shares for you, and transferring your payment to the other party. Your name is not transferred to the stock—in this situation, your stock is said to be held "in a street name", which is the name of your brokerage.

Most of the downsides of investing are taken care of for small investors using brokerage firms—if yours goes bankrupt, and is a member of the Securities Accounts Protection Corporation (SIPC), you little reason to worry because account balances of up to $500,000 ($250,000 for cash) are insured against firm failure.

However, if you have more than $500,000 in your accounts, you have reason to be concerned—because amounts greater are not protected. This is where a global custody account can benefit you.

Global Custody System

The global custody system was set up back in the 1970s following a spate of brokerage firm failures that spooked investors and sent shockwaves through the financial community. It was so bad at the time that Benjamin Graham (mentor to Warren Buffett) wrote in his book, The Intelligent Investor, that every investor should consider using a custody account at a local bank as protection.

For investors with considerably more than $500,000, a global custody arrangement (preferably with a bank trust department) is much safer than traditional accounts or storing your assets with your broker.

The advantages to this arrangement are that all of your assets are held in the same place, you can hire a registered investment advisor, have an ability to invest in limited partnerships, and the ability to hold U.S. Treasury bonds and other valuable property—all without worrying about the $500,000 insurance limit.

Global custody accounts exist to reduce the risk of institutional failures that can cause investors to take significant losses.

You can even pay to have every single position registered directly in your name through the Direct Registration System (DRS). You assign a money market, cash, or another liquidity account to fund all your purchases or receive all of your income distributions. Then, you instruct your global custodian to accept any incoming buy or sell orders from pre-approved brokers.

The broker executes whatever buy or sell orders you tell them to, provided they believe you will hold up your end of the transaction. Since they no longer hold the securities, they have to check with the custodian to make sure you're going to keep your end of the deal. The custodian then sends the money or receives the assets.

Asset Servicing

After sending the money or receiving the asset, the custodian continues its other responsibilities, known as "asset servicing." These frequently include providing asset price history so you can see the value of your holdings over time, making sure your dividend and interest payments are received according to corporate announcements.

You'll also be informed of corporate actions—like stock splits, tender offers, or merger proposals—and will have any necessary paperwork handled. You'll also be assured that expenses charged to your various accounts will be tracked.

Depending on the custodian, they may also be responsible for providing snapshots of liquidity, establishing an audit trail to prevent fraud and theft, facilitating securities lending, and measuring compound annual growth rate figures over time.

Global custody accounts add a few more benefits for investors who hold assets outside of the United States. Cash balances can be tracked, and settlements handled, in multiple global currencies on multiple global stock exchanges.

The establishment of a base reporting currency allows you to translate the equivalent value of your foreign holdings and currency at any given time, so you know the purchasing power in your home country. The global custodian also handles tax treaty issues and determines foreign tax credits you'll need when it's time to file your tax returns with the IRS.

Providers of Custody Accounts and Services

The Bank of New York, State Street, Fidelity, and Charles Schwab are a few of the major global custody providers in the United States. In Switzerland, Credit Suisse and Union Bank of Switzerland (UBS) are among the biggest institutions offering the service—in Europe, Hong Kong and Shanghai Banking Corporation (HSBC) is a major global custodian.

Costs of Global Custody Accounts

Like investment management services, global custody services are often contracted on a negotiated basis depending on the level of assets you have and the complexity of your needs. For reference, stocks and bonds are level one assets, interest rate or currency swaps are level two assets, and level three assets are mortgage-backed securities or complex derivatives.

Municipal pension funds, for example, can often get custody services that charge as little as half of a basis point (0.001%) annually per U.S. stock position, plus a very small fee at the time of trade execution. Smaller, individual global custody accounts might charge an annual fee of a few hundred to a few thousand dollars, a set charge per position, plus a few basis points.

For a family that has amassed several millions of dollars, the expenses of a global custody account may be worth the convenience of having everything in one place—and you'll know you are less exposed to institutional failure.

No matter how many wealth managers, advisors, or brokers you utilize, your capital is parked safely in your custody account—your central treasure hoard from which all activity flows.