Global Custody Accounts

Understanding Global Custody Accounts and Fees

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An understanding of how global custody and global custody accounts work is one thing that generally separates experienced investors from those just beginning. Knowing how global custody functions, how much it costs, and the major providers of services can make life much more convenient for investors.

How Security Trades Are Executed

When you purchase a stock, bond, or other security, your broker executes the trade. 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 deadline, you have to show up with your part of the deal—in this case, cash to complete the purchase—and the counterparty has to show up with the asset that is being transferred to your name. Failure to deliver or settle can result in penalties, fees, and problems with regulatory agencies. Small investors don't give this process much thought because brokerage firms and other financial institutions act as middlemen and handle the logistics.

If you put $10,000 into an online brokerage account and execute a trade, you see the money taken from you instantly and the shares deposited onto your account ledger. That's not what is actually 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; they'll put it in their name while recording you as the beneficial owner. In this situation, your stock is said to be 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.

Most of the downsides are taken care of for small investors because if your brokerage firm goes bankrupt, and is a member of SIPC, there isn't much reason to worry in most cases because account balances of up to $500,000 ($250,000 for cash) are insured against firm failure.

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 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 this arrangement include the comfort of knowing all your assets are held in the same place, the freedom to hire a registered investment advisor, the 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. You can even pay to have every single position registered directly in your name through the Direct Registration System (DRS). You assign a cash, money market, or another liquidity account to fund all your purchases or receive all of your income distributions, and 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 it to execute, provided it believes 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 up your end of the bargain. The custodian then sends the money or receives the asset.

Asset Servicing

After sending the money or receiving the asset, the custodian handles its other major responsibilities, known as "asset servicing." These frequently include providing asset price history so you can see your holdings' value over time, making sure your dividend and interest payments are received according to corporate announcements, informing you of corporate actions—like stock splits, tender offers, merger proposals—and handling any necessary paperwork, along with tracking expenses charged to your various accounts. Depending on the custodian, they may also be responsible for providing snapshots of liquidity, establishing an audit trail to prevent fraud or having your securities stolen, facilitating securities lending, and measuring compound annual growth rate figures over time.

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. 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 figures out your foreign tax credit you'll need when it's time to file your tax returns with the IRS.

Providers of Custody Accounts and Global Custody Services

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 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 on 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 0.5 of a single 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, a global custody account may be worth the 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.