How custodian banks optimise investment administration services for retirement funds

Central Securities Depository Participants, or custodian banks as they commonly known in South Africa, have led the way by creating an independent accounting treatment for medium to large pension funds (typically funds with assets of +/- R2 billion or greater) to monitor asset managers’ compliance to investment mandates in addition to improving the accuracy of financial reporting.

A custodian-driven model for investment administration is differentiated from other types of service providers. The major difference is that custodians construct investment accounting records that are independent of the asset manager’s reporting.  Custodians create investment accounting records from the ground up. 

For listed assets, the only external inputs required by custodians to produce an investment accounting book of record are the details of the purchase and sales of investments made by the fund’s asset managers, which is already resident in the custodian’s systems.  For unlisted assets, the custodian imports trading and valuation information sourced from asset managers into the investment accounting platform.

Custodians take this purchase and sales information and enrich it with additional data to calculate average book costs and then create trade dated, full accrual and multicurrency-compliant accounting book of records, where asset valuations, corporate actions, income and expense accruals and gains and losses are calculated independent of the asset manager’s records. 

The custodian’s investment accounting platform performs double entry bookkeeping where debits and credits are posted to a comprehensive chart of accounts, feeding into a working trial balance report. The monthly movements across the trial balance can be integrated into a client’s general ledger system to provide the pension fund with a high degree of automation and accuracy when constructing its financial reporting.

Additionally, the custodian will reconcile the investment accounting records to the cash and securities held in custody and the asset manager’s records to produce daily, weekly, or monthly reporting on the differences that exist between the three sets of records to identify and resolve differences. This three-way reconciliation provides  excellent oversight control and peace of mind for Principal Officers and Trustees of pension funds in terms of the reliability of financial reporting.

By contrast, when financial reporting is constructed outside the custody-driven investment accounting model, there is seldom a three-way reconciliation between the custody, accounting, and asset manager records, which can result in unsolved differences between the three sets of records.

In the non -custody driven model, there is also a strong element of consolidating the asset manager’s records to produce the fund’s financial reporting, resulting in potentially inconsistent accounting frameworks across the fund’s investment mandates. This is because accounting systems, accounting frameworks and valuation policies will differ from one asset manager to the next, making it near impossible to have a standard accounting framework applied to all the investment mandates. 

This challenge relating to standardisation becomes more complex as pension funds increase their number of investment mandates. For example, some of the medium to large South African pension funds have over 60 investment portfolios so it’s not hard to imagine the inconsistencies in accounting frameworks that can exist at the overall pension fund level.

Once the independent accounting records have been created and fully reconciled by the custodian to ensure accuracy, they can then be leveraged for other purposes.  These typically include mandate compliance monitoring, bond duration and effective exposure reporting, Regulation 28 reporting and performance, attribution and risk reporting. 

Again, when delivering these services, the custodian uses its own accounting records, asset valuations and cash flow data to monitor mandate breaches and calculate portfolio returns. If you think about it, it makes a lot of sense for a pension fund to have a view on the asset manager’s compliance to investment mandates and performance returns that are calculated using independent data, especially where asset manager remuneration is increasingly based on performance returns.

Independence and consistent accounting frameworks are the hallmarks of a custody driven investment administration model. With their significant scale and large balance sheets, custodians are exceptionally well-placed to invest in the people and technology required to produce timely and accurate investment reporting.

“The custodian banks are ahead of the curve in supporting the larger end of retirement fund industry with efficient turnkey investment administration solutions,” said Adam Bateman, Head of Business Development and Strategic Partnership at Standard Bank’s Investor Services business unit.

Internationally, the global custodian banks have provided investment administration services for the past 50 years, with roots dating back to the establishment of the Employment and Retirement Income Security Act (ERISA) of 1974 in the United States. In fact, for decades now, it’s been commonly considered best practice in places like the US, the UK and Europe for custodians to hold the accounting book of record for retirement funds.

In South Africa, custody driven models for investment administration were introduced in the early 2000’s. This resulted in local custodians implementing capabilities that provide comprehensive investment monitoring and reporting across a pension fund’s entire domestic and global investment universe.

With over R13.4 trillion (USD735 bn) of assets under custody, administration and trusteeship, Standard Bank is the largest custodian in Africa and as of 30 June 2024 supports over R3.7 trillion (USD 200 bn) on its investment administration platform.