Stanhope Capital, the private investment office, examines how in the past wealthy families had several custody relationships for security and related reasons, but that this is changing.

Guy Paterson, of private investment office Stanhope Capital, examines the issue of custody and how, in a changing world, the issue of how to, or not, divide custody of assets of wealthy families remains a crucial issue. The views here are those of the author and not necessarily fully endorsed by the editors of this publication.

If you were to ask the members of a high net worth UK family to give you the name of their custodian bank, they would give you the name of the firm which is managing their money. Continental or South American families, however, have a different history. They have experienced political instability and worry constantly about the sequestering of their assets, so they focus their attention on where the assets are actually held and not who is managing them. This is the realm of custody.

Having several custodians
I have clients who arrive with up to three custodians. In economic terms, if they are using a global banking titan as a custodian, they need not worry about diversifying because if such a well-capitalised conglomerate were to go bankrupt then every other institution would have done so as well. Wealthy continental families, however, often pick four or five custodians to hold their assets because of their fear of a concentration of political risk and a number of families also do it because they do not want any one bank to know the totality of their assets.

There are many complications involved in having several custodians, because when the family wants to put an order in for a particular stock, or change something else in its portfolio, it has to find a custodian that holds that stock out of the several sets of telephone numbers and addresses that it has for its several custodians. In short, it has to manage several relationships. Somebody, somewhere, has to consolidate all the resultant information into a single report.

This obsession with privacy is probably unnecessary because if the trustee in question has done a good job of selecting the custodian, he/it must have gone to someone of undoubted balance-sheet strength, who is reasonably competent at the business of transacting in securities, and as long as he/it realises that there is a contractual difference between them holding a security on the family's behalf and holding cash on its behalf, the holdings should be relatively safe.

Planning for failure
We do not allow our portfolios to hold a lot of cash (in other words, currency rather than physical cash) on deposit or even on current account with the custodians, because if a custodian were to fail, the family would be an unsecured creditor with regard to that cash.

The age-old desire to ensure that no one bank knows the totality of one's assets is being overtaken by the fact that there is no secrecy any more. Every organisation with which a family deals is bound to have some obligation under some circumstances to report information to a tax authority. All the family can hope for is confidentiality.

As a result, the trends that I am seeing in major pools of assets owned by major trusts are an increasing recognition of custody as a key area of concern and the concentration of it in one major provider; but then also a splitting-up of the portfolio management. So if the trustee appoints a single, strong global custodian, he/it can have a number of managers managing parts of the money but the family gets a single, consolidated report. This enables them to ensure that if they are using four managers, those four managers are not all buying the same securities.

So when trust companies come to us at Stanhope Capital and ask us what the best way is of arranging custody, we say:

-- organise it separately, so that you get the best of the custodians and the best of the portfolio managers;

-- go for a single custodian which is of sufficient financial strength that the parent company will look after its offshore subsidiaries, because they will need to use an offshore subsidiary for tax reasons to hold the assets; and then

-- you can appoint a variety of portfolio managers to do different things and get consolidated reporting.

The bulk of the financial services world consists of very large banks selling their services, which are themselves bundled up together. Stanhope Capital was created from the desire of its founders to access unbundled services, so we can look very carefully at the other parts of the unbundled process.

You can point out where the inadequacies or weaknesses may be and, hopefully, avoid them. Our firm is using, believe it or not, about 45 different custodians for our clients. As a result, we can tell families or trustees who come on board with us who is good and who is not.