Understanding Global Custody Accounts and Fees
One of the things that separate inexperienced investors from those who have amassed substantial capital and utilize private portfolio managers is an understanding of global custody and global custody accounts. How does global custody work? How much does it cost? Who are the major providers of global custody services? These are important issues to understand if you become an affluent investor.
What Global Custody Is and Why Investors Should Care
When you purchase a stock, bond, or other security, the broker of your choice executes the trade. It handles the paperwork, records the details of the price that was agreed upon between the parties, and arranges to exchange cash for the stock certificate on the corporation's books via the transfer agent showing that you now own the asset.
Typically, trades settle in three business days in the United States. That means by the deadline, you have to show up with your part of the deal—in this case, liquid cash to complete the purchase—and the counterparty has to show up with their part of the deal—the asset to be transferred to your name. Failure to deliver or settle can result in penalties, fees, and problems with regulatory bodies.
Small investors don't give this process much thought because of retail stock brokerage firms without exception couple custody with execution services. If you put $10,000 into an account at an online discount broker, you deposit cash into your brokerage account, enter the trade, see the money taken from you instantly and the shares deposited onto your account ledger.
That's not actually what is happening. Your online broker is simply taking your money and holding onto it until the settlement date, then taking possession of your shares for you. In almost all cases, they won't even register the stock in your name directly, instead entering it in their name while recording you as the beneficial owner. In such a situation, it is said your stock is held "in a street name" since the company you own doesn't know who you are. They just see your brokerage firm on the roster of owners as they are holding it on your behalf.
This has all sorts of benefits. It makes life considerably easier for the investor. You can buy and sell frequently in a heartbeat. You can often instantly pledge margin debt against your stocks and bonds, using the securities as collateral in case you want to come up with money quickly without realizing your capital gains and losing the advantage of deferred taxes.
Even better, most of the downsides are taken care of for small investors because if your brokerage firm goes bankrupt, and it is a member of SIPC, there isn't much reason to worry in most cases because account balances of up to $500,000 are insured against firm failure (the cash component is lower so be careful).
This system was set up back in the 1970s following a spate of brokerage house failures that spooked investors and sent shockwaves through the financial community. It was so bad at the time that the father of value investing and mentor to Warren Buffett, Benjamin Graham, wrote in his classic 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, may be the way to go. Advantages to such an arrangement include the comfort of knowing all their assets are held in the same place, on a single statement—and the freedom to hire a registered investment advisor, invest in limited partnerships, hold U.S. Treasury bonds and other valuable property—while not worrying about the $500,000 insurance limit.
You can even pay to have every single position registered directly in your name through the DRS, or Direct Registration System. You assign a cash, money market, or other liquidity accounts to fund all of your purchases or receive all of your income distributions, and you instruct your global custodian to accept any incoming buy or sell orders from pre-approved brokers with whom you work.
The broker executes whatever buy or sell orders you tell it to execute (provided it believes you are good for the trade—remember, it no longer holds the securities so it has to check with the custodian to make sure you're going to keep up your end of the bargain) and the custodian sends the money or receives the asset. At that point, the custodian handles its other major responsibilities, known as "asset servicing." These responsibilities frequently include, but are not necessarily limited to:
- Providing daily or monthly asset price history so you can see your holdings' value over time on your account statements
- Making sure your dividends and interest are received according to the corporate announcements that have been made
- Informing you of corporate actions and handling any necessary paperwork (e.g. stock splits, tender offers, merger proposals)
- Tracking expenses charged to your various accounts
- Providing snapshots of liquidity so you know how much free, unrestricted cash is available at any given time
- Establishing an audit trail to prevent fraud or having your securities stolen
- Facilitating securities lending if you want to make some extra money by letting short sellers borrow your shares
- Measuring compound annual growth rate figures over time so you can see how well your holdings are doing
The "global" part of global custody adds 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
- Collecting income in other currencies such as interest on foreign bonds
- 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.
- Handling tax treaty issues on the receipt of international dividends. The global custodian figures out your foreign tax credit reporting to give to your accountant when it comes time to file your returns with the IRS so you can claim possible overpayment or deals with foreign tax authorities so correct tax rates are withheld.
Custody Accounts and Global Custody Services: Providers
The Bank of New York, State Street, Fidelity, Charles Schwab, T.D. Ameritrade, Scottrade, UMB Bank, U.S. Bancorp, Northern Trust, JPMorgan Chase, Citigroup, and Mellon Financial are just a few of the major global custody providers in the United States. In Switzerland, Credit Suisse and UBS are among the biggest institutions offering the service. Elsewhere in Europe, HSBC is a major global custodian.
Cost of Global Custody Accounts
Like investment management services, global custody services are often contracted on a negotiated basis depending upon the level of assets you have and the complexity of your needs.
Municipal pension funds, for example, can often get custody services that charge as little as 1/2 of a single basis point—that is 1/1,000th of 1 percent—per U.S. stock position per year, plus a very small fee at the time of trade execution. Other, smaller, individual global custody accounts might involve 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 million dollars, a global custody account may well be worth the peace of mind and convenience of having everything in one place, knowing you are less exposed to institutional failure. No matter how many wealth managers, advisors, or brokers you utilize, your capital is parked safely in the custody account, a central treasure hoard from which all activity flows.