Regulators require custodians and market infrastructures to look at the assets they are safekeeping and who they belong to, all the way down to the end-investor.
Two regulatory actions against Clearstream and Brown Brothers Harriman relating to sanctions and penny stock abuses in 2014 have forced custodians to look at the many layers of intermediation between themselves and the beneficial owner of the security. However, some custodians do not have the capabilities to gather all of this information and may face difficulties in identifying whether the end-investor is a criminal.
“We are concerned about the level of demand on having complete transparency. Even if it is a fund that is your client, are the underlying investors of that fund being scrutinised? If we leave that long-term, service providers will be left in riskier scenarios to track all of the underlying investors and we do not have the proper information to do all of that,” said Goran Fors, deputy head of investor services, SEB.
“We do not have the efficiency to provide that or the systems to do it. We are more concerned about what we have to do.”
The majority of custodians operate an omnibus account model as a means of netting and consolidating client accounts. Furthermore, the effort of maintaining and administering segregators is immense. However, the concern is the lack of transparency in the vetting process when commingling clients.
The problem custodians face is that while they may have a direct contractual relationship with a single fund manager, there is little oversight of the beneficial owner/end-client of the fund, especially when it comes to cross-border funds.
“For every single portion of a holding or transaction, you could be dealing with a range of jurisdictions. From a legal perspective, you have a single relationship based on your home law. We found out that none of us alone could change this,” added James Freis, chief compliance officer, Deutsche Boerse.
The International Securities Services Association (ISSA) recently published a white paper outlining certain principles custodians that operate a variety of account structures can adopt as controls on asset holdings. However, for the principles to be a success, all institutions need to adopt them.
“If one institution is fully applying the principles and another isn’t, there is a danger of arbitrage from that client,” explained Colin Brooks, vice-chairman, securities services, Standard Chartered.