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April 15, 2011

Get Your Facts Straight

By Spear's

It sounds simple, but the more efficient a family office is at managing its clients’ information, the better for everyone, says Rupert Phelps 
SINCE THE DEMISE of Lehman in September 2008, there are two big questions that business heads in the family office sector have most asked themselves. First: ‘Are assets genuinely segregated off-balance sheet?’ Then: ‘How secure as a corporate entity is my custodian?’

Master global custody (MGC) involves having a single custodian for all assets, even though a custodian will in turn use the services of sub-custodians in various countries where laws and regulations may not make sense for them to operate directly. The essential significance to consider is that of balance-sheet risk. Client assets and securities should always be segregated from the assets of an MGC and from those of the custodian’s other clients. This ensures that creditors of a custodian don’t have any rights to the securities in such client accounts.

There was an example in my firm, on a Friday in early 2009, when the chairman of a large commercial MFO asked for full legal title to answer the first question: ‘A year ago my COO would have told me once a year that this was in order and in practice probably had someone two reporting layers below him actually doing the due diligence every few years. That’s not good enough — now I need to know for myself.’ He read 87 pages from our legal department over that weekend.
Security here should be understood in several senses: safety of assets (ie off balance sheet), confidentiality and privacy of platform and strong processes for monitoring corporate actions and receiving dividend and interest payments which are due to the client family. Robust state-of-the-art systems are crucial given the content of private client details that are being held and processed.


These lie in interconnected and integrated systems and repositories of data and information. There will be daily interfaces to all major advisers and while not all of them will wish such regularity, a sophisticated, consolidated reporting platform represents the favourable utilisation of technology for a family office.

Reduced administrative functions

One central benefit is to categorise assets in a standard format for reporting and accounting. MGCs usually offer a multi-currency platform that fully integrates core systems of custody, full double entry accounting and performance and risk analytics. Of particular significance will be the provision of year-end tax information in a suitable format for the actual tax adviser to use. Such systems also naturally lend themselves, through the ability to store detailed information, to becoming the FO’s ‘book of record’ and repository of historic data.

Spreadsheets are arguably no longer acceptable as the primary tool for consolidated reporting for an FO. At the SFO, it sometimes took us two weeks after quarter-end of working with spreadsheets to have a fair view on assets and positions.

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Economies of scale

In addition to consolidated reporting, an MGC should deliver other services such as performance and risk analytics, cash management including overnight sweeping and forecasting and aggregating commissions paid to individual brokers to allow clients to negotiate more favourable charges.
THE FINANCIAL CRISIS has resulted in FO leaders returning to the basics: the fundamentals of how assets should be held and reported on. If such matters are established well, then these back and mid-office functions can be largely behind the scenes, while focus is put on the front office and alpha-generation side — but these important investment decisions must not be based on faulty information.

Intellectual capital and scale can be linked strongly. For example, BNY Mellon, the world’s largest custodian, has $24.4 trillion in assets under custody. Given this astonishing concentration of assets, such a firm and other scale players have a ‘ringside seat’ to the financial world, actually being part of the markets.

So what happens when arrangements go wrong? Potentially all the clever efforts of the front office may be futile. Luqman Arnold, a former president of UBS and well-known activist investor, founded Olivant Advisers Limited. Olivant’s entire shareholding in UBS was held in accounts managed by Lehman — in other words, not segregated off balance sheet. When Lehman failed in September 2008, Olivant tried to recover its 2.78 per cent stake in UBS (worth about SFr1.4bn), but it was unable to locate the shares.

Because of the uncertainty over its shareholding, Olivant, which had been pushing for significant management and strategy change at UBS, was not able to exercise its votes at UBS’s EGM in October 2008, the ultimate horror for an activist investor, and a salutary lesson for all.

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